- If the ECB re-iterates its recent stance not to expand its easing measures, the dollar could sell off significantly.
- Exxon Mobil is doing everything right in the current environment, like increasing production and its volume mix which are helping margins on the upstream side.
- Exxon has the strongest balance sheet in this sector, and it could start acquiring companies once some of its upstream competitors' earnings break down.
With crude oil now trading down to $36 a barrel, many investors are vacating energy stocks in droves - especially dividend investors who feel that many companies in this sector at the moment are at risk of having their dividend cut. Upstream companies are finding it increasingly difficult in this environment, especially in the U.S., upstream companies as shale operations are nowhere near being profitable at present levels. The result of the carnage in this sector has seen companies like Marathon Oil (NYSE:MRO) cut their dividend in order to keep operations going. Exxon Mobil (NYSE:XOM) on the other hand, despite the current downturn, continues to increase its dividend which currently is at $0.73 per share (increased back in May) which equates to a yield of 3.76%. Exxon Mobil's sheer size and integrated business model has resulted in its stock dropping just under 25% since the 20th of June in 2014 (see chart). Instead of running from this sector, I believe this company offers an excellent risk/reward set-up especially for income investors.
Why? Well back in the summer of last year, Exxon stock's yield dropped back to 2.47% when its stock traded north of $104 a share (see chart) and that's where most dividend investors would have invested. However 3 advantages stick out in my mind as regards to why now is a better time to invest. Firstly, a $50k investment will net an investor 649 shares compared to 480 last summer. Secondly the annual dividend income if one invested now (ignoring future increases) would be $1,895 whereas last summer it would have been $1,401. That's an income gain of 35% in 18 months. Thirdly and this is key. It's obvious that there was far more risk to the downside in this sector when oil was trading north of $80 a barrel. Now with oil trading at sub $40 levels, the risk/reward trade has to be to the upside. If more carnage is to come, Exxon stock will undoubtedly be the last company to succumb due to its strong balance sheet and constant positive earnings ($4 billion in net income last quarter). However, I don't think it will come to that. Here are three reasons why I see Exxon stock rising from here going forward
Firstly dollar strength has put huge pressure on the whole commodity sector over the last 18 months. However the short term behavior of the dollar illustrates to me that we may very well have a top in the dollar index. As you can see from the chart below, the index topped out at the start of this month when the European Central Bank stated that it would not be expanding its QE programs. Furthermore dollar bulls predicted a rebound in the dollar index the day after the ECB's announcement and when the Fed raised interest rates, but both rebounds have been weak. The index is now trading very close to its 50 day moving average which is at 97.98 but the real line in the sand is its 200 day moving average is 96.86. The ECB has its next meeting on the 21st of January and if it comes out with more hawkish commentary, it could be game over for the dollar. Continued dollar weakness should spike oil which would be bullish for Exxon, which has a huge upstream division.
Secondly Exxon's growing gross margin metric will ensure the company will outlast the current downturn. Exxon's gross margin is expected to reach 39.4%, which will be its best figure since 2009. Compare this with struggling upstream companies like ConocoPhillips (NYSE:COP) and Marathon Oil, of which both will see gross margins slip by 20% and 7% respectively this year. This illustrates the advantage of Exxon's integrated model where its downstream division brought in $2.03 in earnings last quarter, which was a gain of $1.44 billion. In fact downstream margins are expected to improve in the near term due to efficiency improvements across its refinery operations. Furthermore Exxon is slowly moving its production more into liquids, due to the higher price realizations. Currently liquids almost make up 60% of the company's hydrocarbon production which means that this company is set up much better (margin-wise) than previous years when it had too much production concentrated in natural gas when oil prices were elevated. On the company's upstream side, all the company can do is concentrate on production growth and margins. Margins as discussed are improving and production is expected to grow to 4.3 MMBOED by 2017 which will mean fatter profits once oil prices rise once more.
Thirdly if the price of oil continues to fall in the near term, investors need to remain conscious of the rising dividend yield this company will be paying out. This is why I would advise investors to double down on their initial investment because I see Exxon gaining market share going forward. New production about to come on steam from Iran and sustained production from both OPEC and non-OPEC countries indicate to me that supply will be elevated at least until mid 2016. However this will have consequences. Investments in the oil patch will continue to drop off especially in areas where drilling oil continues to be loss making like in US shale plays, which is why the longer oil prices remain low, the better it will be for Exxon as it has the balance sheet to make acquisitions. Company names ripe for acquisition that have already been mentioned are EOG Resources (NYSE:EOG) and Occidental Petroleum (NYSE:OXY) and when you look at their income statements, it is obvious why they are prime candidates. Both are expected to announce negative EPS results this year of at least -$7 which means they are both living on borrowed time. One thing is certain, Exxon when and if it acquires will take a long term view and base its decision on the where the assets are based (and what the volume mix is like) and how they can be tied into Exxon's existing infrastructure. This is where margins can really be boosted going forward as the oil major can leverage its existing positions it has in its shale plays in the US.
To sum up, I believe the longer the carnage continues in this sector, the more favorable it will be for Exxon Mobil. Its treasury stock alone (worth more than $300 billion) illustrates more than sufficient liquidity to acquire companies when the opportunity arises. The oil major has already bought 38 million shares of common stock through the first 9 months (just under 1% of the float) and continued buybacks will ensure the price remains elevated compared to its peers which simply don't have the earnings to keep buying back its own stock. Watch the dollar, as weakness here should spike energy stocks with sound fundamentals.