(Published Oct. 18 by Bob Ciura)
ExxonMobil Corp. (XOM, Financial) has a long and illustrious history that goes all the way back to its predecessor company, Standard Oil.
Standard Oil is quite simply one of the most legendary success stories of American business and could be viewed as the founding father of the U.S. oil industry. In 1904 (near its market share peak), Standard Oil controlled 91% of oil production and 85% of final sales in the U.S.
Standard Oil was founded back in 1870 by John D. Rockefeller. It started out as a two-man partnership between Rockefeller and his brother William.
Standard Oil grew at such a rapid pace that in 1911 it was dissolved by the U.S. Supreme Court on antitrust grounds. Standard Oil was separated into 34 smaller companies, including many large companies today, such as ExxonMobil and its close competitor Chevron Corp. (CVX, Financial).
Today, ExxonMobil is the largest oil corporation in the world based on its market cap of $359 billion. For comparison, the second largest is Royal Dutch Shell (RDS.A, Financial) with a $208 billion market cap.
ExxonMobil and Chevron hold a special distinction that shows their durability. They are the only two Dividend Aristocrats in the energy sector.
Being a Dividend Aristocrat is not some arbitrary distinction, either. The Dividend Aristocrats Index has performed exceptionally well over the last decade, as the image below shows:
Source: S&P Fact Sheet
To be a Dividend Aristocrat, a stock must have 25-plus years of consecutive dividend increases. Dividend Aristocrats are often the strongest and most dominant stocks in their industries, as is the case with ExxonMobil. You can see all 50 Dividend Aristocrats here.
Business overview
The reason why the Rockefellers were so successful was their laserlike focus on keeping costs low and innovative drilling techniques to separate themselves from the competition.
This strategy allowed them to steadily gain market share. The current ExxonMobil keeps the same tactics today. This is why ExxonMobil routinely generates industry-leading returns on capital and has the best balance sheet in the industry.
For example, even though the huge decline in commodity prices over the past two years has caused many oil and gas companies to incur steep operating losses, ExxonMobil remained profitable last year.
It still earned $16.2 billion in net profit for 2015, thanks to its cost-cutting efforts. ExxonMobil cut capital spending last year by $7.5 billion. These efforts helped the company generate an 8% return on capital employed last year, solidly above its peer group.
Unfortunately, conditions have not improved much over the course of the year.
ExxonMobil’s earnings per share declined 62% over the first six months, compared with the same period in 2015. The biggest area of weakness for ExxonMobil is its upstream operating segment, which is composed of its exploration and production activities.
Upstream is the side of the business that is most highly exposed to commodity prices, which is why ExxonMobil’s upstream profits collapsed by 86% last quarter, year over year.
Source: ExxonMobil Second Quarter 2016 Earnings Presentation, slide 9
Still, ExxonMobil earned $3.5 billion in profit over the first half of the year, again due mostly to cost cuts. ExxonMobil slashed its capital spending by 36% in that time and also suspended its stock buybacks.
The good news is that ExxonMobil has a large portfolio of high-quality assets and several major projects set to ramp up over the next year, which will help improve its returns on capital and allow the company to capitalize on any recovery in commodity prices.
Growth prospects
Like Standard Oil, ExxonMobil has kept a focus on pursuing the most valuable opportunities. That is why it has planted its flag in the premiere oil- and gas-producing fields in the U.S., including the Permian Basin and Bakken fields.
ExxonMobil is the largest operator and driller in these two fields. The company has significantly reduced its operational costs to help maximize profitability while commodity prices remain low.
Source: ExxonMobil Second Quarter 2016 Earnings Presentation, Slide 19
Going forward, investors can expect ExxonMobil’s earnings to continue growing at a steady pace. Not only will the company benefit from a recovery in commodity prices, but it also will help ExxonMobil’s cash flow position simply by no longer requiring such high levels of spending.
For example, ExxonMobil has huge projects in Papua New Guinea and the Kearl oil field in the Canadian Oil Sands. The Papua New Guinea liquefied natural gas, or LNG, field is expected to produce approximately 6.9 million tons of LNG per year. The Kearl oil field is expected to produce nearly 500,000 barrels per day of diluted bitumen at full capacity. ExxonMobil estimates the field will last more than 40 years.
Once these projects are up and running, they will go from being a use of cash to being a source of cash. This will help ExxonMobil’s bottom line, even if commodity prices remain weak.
This is in contrast to the company’s 10-year growth numbers – which look bleaker than investors should expect going forward. From 2005 through 2015, ExxonMobil’s earnings per share actually declined by 3.2% a year. Dividend payments per share grew by 9.7% a year over the same period.
The reason earnings per share declined is due to the significant decline in oil prices. The volatility of ExxonMobil’s earnings per share makes dividend growth a far better judge of the company’s long-term growth ability than its 10-year historical earnings-per-share growth.
Put another way, oil prices declined from around $140 a barrel in 2005 to under $50 a barrel in 2015. That type of decline is not going to happen again over the next decade – in fact, the reverse is more likely to occur.
Competitive advantage and recession performance
ExxonMobil’s key competitive advantages are:
- Its massive scale.
- Operational efficiencies.
This provides the company with the financial strength to aggressively pursue growth opportunities that smaller drillers cannot.
In addition, ExxonMobil is an integrated company, meaning it has large upstream, downstream and chemicals businesses. These businesses complement each other well and provide valuable diversification.
When commodity prices decline, it is bad for upstream. But ExxonMobil’s downstream and chemicals businesses still produce earnings and help the company stay profitable. Nonintegrated energy businesses do not have the same level of stability.
These qualities helped ExxonMobil navigate the 2008-2009 recession, which was a period similar to the current environment, in which commodity prices fell significantly. Still, ExxonMobil remained profitable throughout the Great Recession.
- 2007 earnings per share of $7.26.
- 2008 earnings per share of $8.66.
- 2009 earnings per share of $3.98.
- 2010 earnings per share of $6.22.
Oil prices fell by around 50% from 2008 through 2009, but ExxonMobil remained profitable. ExxonMobil is the largest and most powerful oil company in the U.S. It is the "black gold standard" in the industry.
Valuation and expected total return
Analysts expect ExxonMobil’s earnings to grow 68% next year. Its large upstream projects will likely be a major contributor of this growth. Oil prices will not fall forever. When they rise, ExxonMobil’s earnings will surge.
ExxonMobil increased its dividend by 2.7% in 2016, which was its 34th consecutive year of dividend increases. ExxonMobil is a Dividend Aristocrat and has paid a dividend for more than 100 years. ExxonMobil stock has an above-average 3.4% dividend yield.
It’s difficult to value ExxonMobil based on its earnings alone – because they are so volatile. The company’s book value is much more stable. Over the last decade, ExxonMobil has traded for an average price-book (P/B) ratio of around 2.7. The company is currently trading for a P/B ratio of 2.1.
Even the more stable book value isn’t a perfect gauge of ExxonMobil’s valuation multiple. It is likely that the company’s value will rise significantly when oil prices rise, thanks to both increases in earnings and valuation multiples.
I expect the company to generate earnings per share growth of 4% to 6% a year over the long run. This growth combined with the company’s current dividend yield of 3.4% gives investors expected total returns of 7.4% to 9.4% per year before changes in the valuation multiple. As discussed above, it’s more likely than not that the company’s valuation multiple increases from current levels when oil prices rise.
Final thoughts
ExxonMobil operates in a highly cyclical industry, but it has generated strong returns over a long period of time. The company does an excellent job of cutting costs to keep returns on capital high.
It has a proven ability to navigate the ups and downs of the oil market exceptionally well. While its performance can be volatile depending on commodity prices, ExxonMobil is an excellent stock to hold over the long run for investors looking for high dividends and (relative) stability in the energy sector.
The company is one of the six oil and gas "super majors" – and is likely the safest investment among the six.
Disclosure: I am long ExxonMobil.
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