Exxon’s New Mega Discovery Indicates Its Belief In The Recovery Of Oil Prices

  • Exxon has made mega-discovery in offshore Guyana.
  • Oil prices have already shown a significant rebound and should have brought profit to Exxon's upstream segment in the second quarter.
  • The average target price of the top analysts is at $100.50, an upside of 8% from its July 6 close price, however, shares could go higher.

Last week on June 30, Exxon Mobil (NYSE:XOM) announced world-class discovery with a recoverable resource of between 800 million and 1.4 billion oil-equivalent barrels, in offshore Guyana. The new major South American offshore discovery is good news for the company, and it could bring more discoveries in the region. What's more, the fact that the exploration took part in deep water (the well was drilled to 5,475 meters in 1,692 meters of water) demonstrates Exxon's belief in the recovery of oil prices, since exploration and production in deep water are more costly than onshore drilling.

In the announcement, Steve Greenlee, president of Exxon Mobil Exploration Company, said:

"We are excited by the results of a production test of the Liza-2 well, which confirms the presence of high-quality oil from the same high-porosity sandstone reservoirs that we saw in the Liza-1 well completed in 2015. We, along with our co-venturers, look forward to continuing a strong partnership with the government of Guyana to further evaluate the commercial potential for this exciting prospect.”

There are continuing signs of improving oil fundamentals which will benefit Exxon along with other super major oil & gas companies. According to OilPrice.com, market fundamentals continue to suggest that the combination of robust demand and weak supply growth will move global oil markets closer into balance by the end of the year.

Oil prices have already shown a significant rebound in the last five months. As such, we can expect much better results for Exxon's upstream operations in the forward quarters. The last price of Brent crude oil $48.09 per barrel is already up 77.4% from its 12-year low on January 20, of $27.11, while WTI crude oil last price of $46.70 per barrel is up 79.3% from its February 11 low of $26.05.

In the table below, I have calculated the average price of Brent crude oil, WTI crude oil and natural gas, in the first and the second quarters of 2016. I have also shown the change in the average price in the second quarter from the first quarter. The average crude oil price increased about 22% in the second quarter compared to the first quarter, and the natural gas price increased 6.5%.

1-1 2016-07-06 10_48_35-XOM 5-7-16 Pitch - Microsoft Word

Increasing oil prices will benefit Exxon's upstream (exploration and production) operations. Exxon's upstream earnings have fallen sharply in the last few quarters due to the crash in oil prices, as shown in the chart below. However, the increase in oil and natural gas prices should have brought profit to Exxon's upstream segment in the second quarter.

1-2 2016-07-06 10_49_03-XOM 5-7-16 Pitch - Microsoft Word

Source: company's reports

Before the crash in oil prices, upstream operations accounted for about 75% of Exxon's earnings, as shown in the table below.

1-3 2016-07-06 10_49_26-XOM 5-7-16 Pitch - Microsoft Word

Source: company's reports

Valuation

Since the beginning of the year, Exxon's stock is already up 19.3% while the S&P 500 Index has increased 2.2%, and the Nasdaq Composite Index has lost 3.7%. However, since the beginning of 2012, Exxon's stock has gained only 9.7%. In this period, the S&P 500 Index has increased 66.1%, and the Nasdaq Composite Index has risen 85.1%. According to TipRanks, the average target price of the top analysts is at $100.50, an upside of 8% from its July 6 close price. However, in my opinion, shares could go higher.

XOM Daily Chart

 1-4 2016-07-06 10_49_47-XOM 5-7-16 Pitch - Microsoft Word

Chart: TradeStation Group, Inc.

Exxon's valuation is pretty good. The trailing P/E is at 29.9, and the forward P/E is at 21.2. The price to cash flow ratio is at 12.2, and the total debt to equity ratio is low at 0.25. Moreover, the Enterprise Value/EBITDA ratio is at 15.41, and the PEG ratio is low at 1.12. The PEG ratio - price/earnings to growth ratio - is a widely used indicator of a stock's potential value. It is favored by many investors over the P/E ratio because it also accounts for growth. A lower PEG means the stock is more undervalued.

Dividend

While waiting for another significant recovery in the price of oil, investors can enjoy the generous dividend. Exxon has increased its annual dividend payment to shareholders for 33 consecutive years. Even during the global economic crisis in the years 2008-2009, Exxon continued to grow its dividend. The current dividend yield is pretty high at 3.23%, and the payout ratio is at 94%.

The current yield is historically high, which indicates that the stock is undervalued, according to some dividend assessment theories. The annual rate of dividend growth over the past three years was pretty high at 9.7%, was also high over the past five years at 10.6%, and over the last ten years was also high at 9.7%.

1-5 2016-07-06 10_50_08-XOM 5-7-16 Pitch - Microsoft Word

Source: company’s reports  *assuming same dividend rate for the year

Conclusion

In my view, the fact that Exxon is continuing to explore in deep water which is more costly than onshore drilling demonstrates Exxon's belief in the recovery of oil prices, and the new major Guyana offshore discovery could bring more developments in the region. Oil prices have already shown a significant rebound in the last five months, and the increase in oil and natural gas prices should have brought profit to Exxon's upstream segment in the second quarter. While waiting for another significant recovery in the price of oil, investors can enjoy the generous dividend, currently yielding 3.23%. The average target price of the top analysts is at $100.50, an upside of 8% from its July 6 close price. However, in my opinion, shares could go higher.

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  • I do not have any business relationship with the companies mentioned in this post.
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