- Oil prices are not done rallying. Exxon will continue to bring in more profits as crude oil prices move past $50 a barrel.
- Free cash flow levels are set to increase which should mean higher dividend and stronger buyback programs.
- Investors love this stock and with good reason. It's low volatility and commitment to shareholders ensure strong returns will continue.
With crude oil now back up hovering at just over $49 a barrel, it seems that the Brexit vote isn't going to produce a top in oil markets just yet. In fact, the sentiment is still at benign levels and we are still nowhere near being overbought as is illustrated by the 5 day RSI indicator. Exxon Mobil (NYSE:XOM) has had a significant 5 days as we have seen the stock rally from just over $88 a share up to close to $94 a share. The bigger than expected oil discovery off the coast of Guyana has definitely aided the stock price recently plus rumors that the integrated oil major is about to move in on natural gas plays off the coast of Mozambique also aided in rallying the stock.
This has resulted in the company's price to sales ratio spiking to 1.6 and the price to book ratio going to 2.3 which definitely means the stock is not cheap at just under $94 a share currently. However, this stock should always find its way into a diversified portfolio where income is the main priority irrespective of its current valuation. Crude oil is still trading $25+ off its 200 weekly moving average which means that we are still very much trading on the low side from a historic basis. Therefore if one holds for the long term and for income, Exxon Mobil will undoubtedly continue to return capital in spades to its shareholders.
Free Cash Flow Set To Rise
Firstly, I see free cash flow rising in the next few years as the company continues to wind down spending on some big capital intensive projects as production levels increase. Therefore I wouldn't worry too much about the earnings drop last quarter (down to $1.8 billion from $4.9 billion) as oil prices were still very mute in the first quarter despite the strong rally we have had since February. Furthermore because of the company's shift into liquids (where realizations are better), Exxon's cash flow break even is expected to fall to around $40 a barrel next year which means if crude stays around $50 a barrel, the company should have no problem in increasing its dividend and continuing its share buybacks.
Strongest Balance Sheet In Energy
Exxon Mobil spent $3.05 billion on dividends and $721 million in share buybacks last quarter which is a feat in itself considering the carnage this industry has undergone in the past two years. The pay-out ratio has spiked to 93.9% and although this will probably remain very high throughout 2016, it will come down in 2017 due to increased production at higher prices and lower capex spending. Moreover even if oil prices don't do what I expect over the next few years, Exxon Mobil has the best balance sheet in energy at present. The company has almost $180 billion in equity on its balance sheet which means it could borrow at will for capex or shareholder commitments. No other company can come near its economies of scale which is why it was still able to bring in over $16 billion of net income in 2015 whereas many other energy companies were going bankrupt.
This is where income investors should be focusing on. Free Cash levels topped well over $20 billion in 2011 and 2012 and the company really impressed with returning capital to shareholders through buybacks and dividends in those years. I believe we are about to start a similar cycle where free cash flow levels will soar once again. Is this priced into the shares already? Maybe. but I reiterate that Exxon Mobil is a long term option for primarily income investors who want to hold a diversified group of companies.
Low Volatility And Strong Yield Makes Exxon Mobil An Attractive Income Play
The last 8 or so years demonstrate the attractiveness of using Exxon Mobil as a vehicle for income purposes in a diversified portfolio. If one had invested $50k at the start of 2008, when the share price was trading at similar levels ($95 a share) one's income would have been $815 for the cumulative year of 2008. Fast forward to today. Your initial $50k has now reached $58k (assuming all dividend were re-invested) and although this doesn't seem much from a capital gain's point of view, remember that we are looking at this from an income point of view.
Exxon Mobil's current dividend yield is 3.2% meaning that our present $58k would give us an annual income of $1,856. This means our annual income has grown by 127% in just over 8 years and the share price has actually gone down! Furthermore, the benefit in investing now for income is that one can accumulate more shares quickly because of the current high dividend yield (see chart).
To sum up, I view Exxon Mobil as a pure income play in a diversified portfolio going forward. I have shown above how income can increase meaningfully over a period of time in an environment of share price stagflation. The company has the best balance sheet in energy which means if more carnage were to come, Exxon would be the last company left standing. Concentrate on income, re-invest dividends and one can't lose over the long term here.