On Sept. 14, Saudi Arabia’s oil facilities suffered an attack that caused the world’s largest producer of oil to cut its production in half. This caused the price of oil to spike as much as 15% the day following the attack. Oil prices have come down since, but this proves how a single incident can impact commodity prices.
As a result, investors can identify companies with key projects and properties that will help drive growth in the future.
Many energy companies offer attractive yields and potential for high total returns, particularly if oil prices continue to rally. One of the top oil stocks that we believe will perform well over the next five years is Exxon Mobil (XOM, Financial).
Company background and recent financial results
With a market capitalization of $305 billion, Exxon Mobil is one of the largest companies in the world. The oil giant has taken steps to diversify itself in recent years. Prior to the collapse of oil in 2014, nearly 90% of earnings came from the company’s upstream segment. Last year, upstream operations contributed 60% of earnings while downstream accounted for 26% and chemicals was responsible for the remainder. Exxon Mobil generated $290 billion in sales in 2018.
The company reported second-quarter earnings results on Aug. 2. The company earned 61 cents per share, which was 10 cents lower than consensus estimates and a 34% decrease from the previous year. Revenue declined 6% to $69 billion, though this was $1.26 billion more than analysts had expected. Declines in downstream operations and chemicals were the primary reasons for the drop in revenue and earnings.
Upstream earnings were 7.2% higher as production increases and lower taxes more than offset lower energy prices. Production grew 7% from the previous year. Much of this growth was due to increased production in the Permian Basin. Output in this area grew 20% from the first quarter of the year and 89% from the second quarter of 2018. It should be noted that last year’s second-quarter production was unusually low. On a sequential basis, production was 2% lower.
Downstream earnings swung from a loss in the first quarter of 2019 to positive in the most recent quarter. Downstream earnings, however, declined 38% from the same quarter in 2018. Much of this decline was due to weaker results in the U.S. Non-U.S. downstream operations were actually quite strong. Margins improved, but sit near five-year lows.
Chemical earnings declined 79% from a year ago due to margin declines and an increase in downtime. Chemical earnings were down 64% from the first quarter of the year, again due to downtime in operations. Exxon Mobil anticipates less downtime in the third quarter.
As a result of the second-quarter results, we believe our previous estimate for earnings of $4.20 per share for the year is unrealistic. We now expect Exxon Mobil will earn $3.50 per share in 2019, which would be a 28% drop from last year.
Due to ongoing investments in the Permian Basion and the fact the company is investing in its operations in order to increase productions form 4 million to 5 million barrels of oil per day by 2025 and our conservative estimate of $60 per barrel oil, we anticipate Exxon Mobil can grow earnings per share at an annual rate of 17.4% through 2024. Applying this growth rate to our earnings estimate of $3.50 for 2019, the company could earn $7.80 per share by 2024.
Dividend analysis and total returns
Despite a poor showing in the second quarter, there are some positives for Exxon Mobil. The company has increased its dividend for 37 consecutive years. This makes it a Dividend Aristocrat. Dividend Aristocrats are those companies with at least 25 consecutive years of dividend growth. You can see all 57 Dividend Aristocrats here.
Exxon Mobil has increased its dividend:
- By a compounded annual growth rate of 2.7% over the last three years.
- By a CAGR of 3.6% over the last five years.
- By a CAGR of 6.9% over the last 10 years.
Slowing dividend growth over the past few years shouldn’t be a complete surprise as Exxon Mobil, and the rest of the energy sector, dealt with the aftermath of the collapse in oil price between 2014 and 2016.
More recently, Exxon Mobil increased its dividend by 6.1% for the June 10 payment. This increase is more in line with the company’s long-term average.
One negative for the company is its high payout ratios. The company’s annualized dividend of $3.48 represents a payout ratio of 98% of our projected earnings per share for 2019.
The story is the same when using free cash flow. Exxon Mobil produced $34 billion in cash from operations over the last four quarters. During this same period, the company had capital expenditures of $22.7 billion, resulting in free cash flow of $11.3 billion. Exxon Mobil has paid out $14.2 billion in dividends over the last four quarters, meaning it has a free cash flow payout ratio of 126%. The company averaged a free cash flow payout ratio of 126% from 2015 through 2018 as well.
Exxon Mobil has managed to increase its dividend for nearly four decades. This means the company has seen several boom and bust cycles for energy prices and has managed to raise its payments to shareholders. Dividend growth is likely to continue going forward, but investors should be aware that payout ratios are elevated.
Shares of the company yield 4.8%, which is much higher than the 10-year average yield of 3.1% and more than double the average yield of the S&P 500.
Exxon Mobil’s stock closed the Sept. 23 trading session at $72.12. Using our earnings per share estimate of $3.50 for 2019, shares have a price-earnings ratio of 20.6. We have a 2024 target price-earnings ratio of 13, which is closer to the average multiple prior to the oil price decline seen in the middle of this decade. Reverting to our target price-earnings ratio by 2024 would reduce annual returns by 8.8% over this period of time.
Total returns for shares of Exxon Mobil would consist of the following:
- 17.4% earnings per share growth.
- 4.8% dividend yield.
- 8.8% multiple reversion.
Therefore, Exxon Mobil is expected to offer a total annual return of 13.4% through 2024.
Final thoughts
Exxon Mobil’s most recent quarter showed a decline on both the company’s top and bottom lines. Production increased against a soft comparison base, but had a slight decline from the first quarter of 2019.
The company has an impressive history of dividend growth, especially since its business is so closely tied to the price of a commodity that has undergone several severe downturns. Exxon Mobil has spent heavily to increase its production, but this has caused earnings per share and free cash flow payout ratios to become extremely high. Still, the stock offers a very attractive dividend yield.
While shares are expensive against our target valuation, investors are likely to see double-digit annual returns from shares of Exxon Mobil through 2024. Because of this, the company is awarded a buy recommendation from Sure Dividend.
Disclosure: No positions in any stocks mentioned.
Read more here:
- Diageo: A Top Beer Stock to Hold During Recessions
- Wheaton Precious Metals: A Gold Stock to Avoid for Now
- Why Glencore Is Our Top Silver Stock Today
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
