- ExxonMobil is extremely well managed and is the most cost-effective among large oil producers.
- I anticipate that oil prices will recover due to an OPEC agreement, improvement to demand and seasonality by 2H'16.
- Exxon 2H'16 estimates are beatable at $45/barrel, and a large earnings/revenue beat will be at $60/barrel over the current fiscal year.
Given the recent recovery in oil prices, strong execution by Exxon Mobil (NYSE:XOM) management and improving production of oil well sites, the Exxon stock seems better positioned as a value recovery play going into the second half of 2016. Furthermore, ExxonMobil returned to free cash flow positive by the second half of 2015 through $6.5 billion in CapEx reductions. The management team anticipated that CapEx will be $23.2 billion in FY’16, which compares to CapEx of $26.49 billion in FY’15. So, further reductions are on the way, translating to a higher operating efficiency despite depressed oil prices/revenue.
ExxonMobil will focus on improving pre-existing sites to maintain growth in oil production while also expanding exploration (near term) in the Permian Basin and Bakken Formation despite a weak market environment. These two on shore regions have low break-even points, which is why they’re given higher priority. Furthermore, the company has reduced its operating expenditures in terms of SG&A/R&D by $6.264 between FY’15 and FY’14, which translates to higher operating margins as oil prices recover.
Some of the cost improvements are due to lower procurement costs, recapturing of marketing costs in the downstream and higher oil production in pre-existing oil fields. As such, there’s a lot of potential for value recovery assuming oil prices recover, as revenue is highly sensitive to oil pricing. Furthermore, I don’t believe Exxon engages very heavily in energy hedging as the company reported that the net value of derivatives was $21 million, which implies a very low notional value of derivative hedges given the company’s annual revenue/daily oil production volume.
Currently, the analyst consensus anticipates ExxonMobil to report revenue of $45.31 billion (33% below prior fiscal year) and EPS of $0.31. These expectations seem somewhat reasonable given the guidance on expenses and recovering oil prices.
The company maintains a high rate of profitability among its peer group of large oil and gas. I’m anticipating the price of oil to recover due to seasonal demand in the back half of 2016, reduced tensions in the middle east and a broader consensus among oil producing nations on oil exports, and improved consumption growth in emerging market economies.
Recent efforts by 18 oil producing sovereigns to come to an agreement haven’t yielded much in the way of results. On the 17th of April, the oil producing member states met in Doha, and while expectations were low going into the meeting, it was broadly anticipated or hoped that Iran would make an appearance at the meeting, which it did not. Furthermore, it’s broadly anticipated that Iran will be boosting its production, and expectations are for Iran to negotiate a 4 million barrels/day ceiling with Saudi Arabia looking to reduce that figure to perhaps 1.5 to 2.5 million barrels/day.
Currently, ExxonMobil forecasts that crude oil demand tends to increase at an annual rate of 1 million barrels/day with supply exceeding demand by roughly 1.5 million barrel/day in the first half of the year. Therefore, Iran’s plan to increase production by another 2 million barrels/day could have broadly negative implications. But, given the early response of other member nations, and declining production in the United States pricing relief is on the way.
From what I understand, Kuwait has already made progress to reduce its daily oil production to 1.1 million barrels/day, which compared to 2.7 million barrels/day prior to a reduction of 1.6 Mb/d. Furthermore, North America production has slowed in response to lower prices, and since the beginning of 2016, the oil production in the United States has declined from 9.6 million (all time high mid-2015) to 8.95 million in the most recent week, according to EIA. Therefore, there’s already pricing pressure coming from the United States and confirmation of a deal at the Vienna meeting (June 2nd) could prompt a massive curtailing in production in the Middle East.
Furthermore, rig counts have continued to decline this week, according to the latest Baker Hughes figures. The rotary rig count is currently 471 in North America, which translates to a 540 rotary rig decline or roughly 53.4% as of the latest figures. Therefore, production will continue to decline as new oil fields are coming online at a slower pace than declining production from pre-existing wells. Given all of these factors, there’s some bullish bias going into 2H’16 as seasonality tends to increase oil demand.
Source: Credit Suisse
When working off of the most recent projection on oil demand from seasonality. The current expectation is for demand to reach 96.8 million barrels/day, which translates to a 2 million barrels’/day increase in consumption between Q1’16 to Q3’16 (due to seasonality and growth in consumption). Over that timeframe supply is expected to reduce by several hundred thousand barrels, which should create demand/supply imbalance thus eating into days’ inventory supply by several days (perhaps days’ inventory drops to 65 rather than sustaining at 70 days). The forward indicators to watch for is the futures pricing curve, as a curve inversion is bearish (contango) whereas a normalized pricing curve is bullish (backwardation).
The biggest x factor to Exxon’s full-year results is oil pricing, as the market recovery has lifted the stock somewhat, but a sustained movement in oil prices beyond $50 is perhaps driving analyst models, as revenue is expected to increase sequentially from Q2’16 to Q3’16 by 12.31%, which is due to pricing. I haven’t developed an exact price model, but with analysts anticipating revenue of $45.31 billion in Q1’16 and Q3’16 estimates of $56.27 billion, revenue is expected to grow 24.1% cumulatively in the 9-month period.
Exxon’s revenue declined by 38.33% between FY’14 and FY’15 whereas oil prices declined 60.57% (roughly) over the same time frame. When using that logic, Exxon’s sensitivity to oil prices is roughly .63, so if oil prices recover by 100%, Exxon’s revenue will recover by 63% over the same timeframe. Therefore, for XOM to grow sales by 24.1% over the next two quarters the price of oil will need to recover by 33.74% from Q1’16 pricing, i.e. $46.36 per barrel. This scenario seems extremely attainable despite choppiness in pricing, as spot crude oil is currently in the low $40s. I believe XOM will beat current analyst models if oil prices stay above $45 over the next 6-months, but making accurate price projections is difficult for any commodity.
$60/bbl is the magic number for Exxon shareholders, as it would drive significant sales momentum over a relatively short period of time. Investors will want to see backwardation of oil futures, and an agreement among OPEC nations reached at the Vienna meeting on June 2nd. These two factors could drive oil prices to $60, which would imply significant analyst model revisions. So oil is the key factor, and anything above $45 confirms analyst estimates.
I’m initiating my coverage on ExxonMobil with a buy recommendation. If oil prices recover at a much quicker pace and sustain momentum beyond $45, I will be moving to high conviction buy as there will be a massive disconnect between consensus expectations and actual results in Q2’ or Q3’16.