- I don't see this newest climate change investigation gaining much traction. Investors should use recent weakness in the share price to go long.
- Some OPEC countries are currently under serious pressure to balance their budgets. This over time will definitely affect the supply side of oil.
- Exxon is currently running a deficit due to elevated capex spend and shareholder commitments. I expect the deficit to end by the end of 2016.
- Exxon sells at a premium to its counterparts as its a proven dividend aristocrat with a very strong balance sheet.
- It would be foolish to just chase yields in this sector at the moment as one may caught holding a stock with a big paper loss and paying no dividend.
Exxon Mobil (NYSE:XOM) has lost almost $3 a share (currently just over $84 a share) in the last 3 trading sessions due to the company being investigated for possible climate change lies it reported in the past. This is an ongoing saga that has been going on for years, but time after time, the topic seems to raise its ugly head. What's the worst case scenario? The worst case scenario is if the company loses in court (like many tobacco companies in 2015), it could open up years of settlements and litigations for the oil major which undoubtedly would affect the company's balance sheet negatively. But I don't see this happening. Why? Well the company has already been warning investors about the risks of climate change, in that governments might become much more stringent about limiting emissions. If you think this will be the outcome too, the recent correction could be an opportunity.
Therefore since Exxon has been slowly moving its production from gas to oil (which has a much higher carbon footprint), new taxes or more government involvement would undoubtedly make Exxon's products more expensive to bring to market. If Exxon are "in the know" that new taxes and restrictions are coming down the track, then of course the company could be in trouble. We saw a similar case this year with American Express (NYSE:AXP) when investors sued the company because they felt it knew well it advance that the Costco partnership was expiring. However concerning Exxon and climate change, I don't see this investigation gaining much traction. The world badly needs energy and the alternatives such as wind and solar are still nowhere near being viable for mass production. Therefore I would use the recent downturn In Exxon's stock to go long. Let's discuss why.
Why I'd Go Long On Exxon Stock
Firstly the energy sector is one of the most beaten up sectors at the moment and Exxon-Mobil definitely has the strongest balance sheet in this sector. Nevertheless bears will point to the fact that the company's free cash flow thus far in 2015 has not been large enough to cover share repurchases and the dividend. In the third quarter of this year, the company's free cash flow number was $1.6 billion short of covering the dividend and share repurchases. However investors need to be mindful that the company has elected to take this route. It has decided to run at a deficit temporarily as it has not cut in-house operations or cap-ex budgets meaningfully like some of its counterparts. Morning Star believes that $60/barrel Brent can achieve cash-flow neutrality for the oil major, so if that oil price benchmark is not achieved in the near term, expect Exxon's debt to increase marginally or to see more asset sales (less likely) over time.
When dividend yields spike in dividend aristocrats, astute investors take notice. Furthermore I just believe this stock is protected on the downside when you consider its integrated model (which will always have it producing free cash flow in the event of an oil price drop) and the current state of affairs of many OPEC countries. Many OPEC countries need rising oil prices in order to balance their budgets. Saudia Arabia's economy for example is basically run off its oil revenues. As revenues have plummeted since June of last year, the country has had to sell bonds in July of this year in order to plug the hole presently in its finances (for the first time since 2007) and more bond sales look likely going forward. Venezuela is in far worse shape and has had to start selling its gold reserves in order to plug its own financial hole. Therefore its obvious that oil producing nations will not be able to borrow indefinitely or sell their assets until the price of oil rebounds as production would have to suffer. Furthermore when you combine the woes of many OPEC countries with many private upstream companies which are cutting their capex budgets by 30%+ in some cases, it is evident that supply should be restricted going forward. When this restriction comes is another question but an investment in a company such as Exxon should enable you to get paid through increasing dividends every year.
This stock ticks all the boxes if you are an income investor. You definitely should have a diversified portfolio and a position in energy is a must considering how oversold the sector is on a historical basis. Obviously there are other energy companies that have higher dividend yields and more upside potential but I would stay away from these because of the risk involved. Income investors need to be extremely mindful of existing cash flow levels as well as future cash flow projections. Investors who don't do this fundamental homework and just chase higher yields usually get caught holding the stock (deeply underwater) when the respective company announces a dividend cut. Look at Royal Dutch Shell -A (NYSE:RDS.A) for example. Its down 20%+ to date despite paying out a 7.22% dividend and now rumors are surfacing that it will have to cut its dividend before long if low oil prices presist from here.
On the contrary, Exxon's cash flow should be boosted going forward as many of its long life production assets come on stream. In fact from 2018 on, long life production assets should account for 50% of production which will mean cap-ex spending will be reduced. Furthermore, the company is continuing its shift to more liquid production, which will increase cash flows even more going forward (higher price realizations from oil compared to gas). All these excellent developments going on at Exxon mean that its going to sell at a premium compared to the rest of the market. For a sector that has been beaten down so much, the company currently has a price to book ratio of about 2 and a forward price to earnings ratio of close to 20, which is not cheap. Nevertheless you are going to get paid and this stock will hold its value far better than competitors in this field.
To sum up, Exxon Mobil in my opinion is a good choice for dividend income. It is currently running a deficit but positive free cash flows should be on the horizon from higher oil price realizations and lower cap-ex spends. Furthermore its integrated model means your income is ultra safe if low oil prices persist going forward. Use recent weakness in the Exxon stock price (from climate control investigation) to start scaling into this stock for income.