- Oil has printed a cycle low meaning that in all probabilities a new cycle has begun. We should see higher prices for the next month or so.
- Exxon stock did not participate in the strong rally crude oil went through since mid-February but dividend investors will do fine.
- Exxon is a defensive oil major and has held up well in the downturn. However, it will underperform in a rising oil price environment.
Crude oil prices rallied well past $37 on Thursday and since Thursday's high was well past the April 4th high ( when oil printed its low for this cycle), I believe the bottom is in for oil as Thursday marked the start of a brand new cycle which should last at least 40 days. The stock market also printed a daily cycle low and a rising stock market along with rising energy prices is a bullish set-up for energy stocks going forward.
Many are attracted to Exxon Mobil (NYSE:XOM) as it is the biggest company by far in this space with a market cap of $341 billion and also for its credit rating which continues to be triple A status. However, in an up-trending market (one I believe is already in motion) Exxon will under-perform other oil majors due to its integrated model and sheer size of its downstream division. Exxon is an excellent defensive oil stock which protected investors well during the down turn. However, now that markets have turned around, it may be the time to redirect capital within your energy portfolio. Exxon stock, in my opinion, is not the place to be. Here are 3 strong reasons why.
Firstly, as the chart below shows, crude oil prices went from under $40 a barrel in 2009 to $106 a barrel in June 2014 which is almost a 200% move. However, Exxon stock in this time period only rallied around $27 to over $100 a share which turned out to be a 36% move over the 5 year period. Earnings or net income rose by 68% from $19.28 billion in '09 to $32,520 billion in 2014. Furthermore, in this time period, the stock's earnings multiple went from 17.1 to 11.6 which makes sense due to the cyclical nature of this industry. Exxon's current price to earnings ratio is 21.65 which is the highest it has been in more than a decade.
Exxon's earnings multiple fell to 8.9 in 2012 when the oil major reported a whopping EPS of $9.7 (from $3.98 in 2009) but the better valuation also failed to move the stock meaningfully to the upside. Exxon's failure to meaningfully add annual production constantly and its slow shift into liquids (which is changing) definitely has affected the share price performance in recent months. Furthermore, capex has been reduced substantially which will keep growth prospects muted - the most important metric the market wants to see.
For a company like Exxon Mobil, it's all about growing production which has proved difficult in recent years due to rising resource nationalism and the like. In fact, geopolitical risk is always associated with a stock such as Exxon Mobil given the sheer size of its reserves and the countries in which it operates. However, the oil major only replaced 67% of its reserves in 2015 so the notion of sustaining reduced capex investment over the next few years must be taken with a pinch of salt.
The company recently raised $12 billion from a debt sale which will probably be put towards acquisitions in order to replace lost reserves. The oil major must constantly participate in an never ending cycle of asset accumulation. However, Exxon's assets on its balance sheet have remained basically flat over the last 5 years (around $340 billion) which is why the market is not valuing this stock higher (Production is expected to be flat through 2020 at 4 to 4.2 million barrels per day equivalent).
In fact, huge capital intensive projects invariably bring execution risks and geopolitical risks - risks that smaller players do not have to contend with. I'm of the opinion that every large cap oil company has a limited life cycle due to huge demand for reserves, which are becoming increasingly more expensive to develop. For income investors, Exxon Mobil is a proven dividend aristocrat but meaningful share price gains will always be a risk due to the demands of its business model.
One area of future strength will probably be free cash flow despite production being expected to remain flat over the next 4 to 5 years. The ongoing shift to liquids along with its ever improving downstream and chemical divisions will ensure that shareholders continue to get paid through a rising dividend. However, the growth rate of the dividend remains uncertain due to shrinking cash flows as a result of capex reduction.
In fact, the oil major is predicted to cut capex by a further 25% this year, which will keep cash flow levels elevated but also put future reserves under pressure. Exxon is predicted to increase the dividend again next month but I can't see anything above 5% considering a whopping $12 billion+ was paid out in 2015. Furthermore, because buybacks have been dialed back (the float currently is 4.15 billion), you are still looking at, at least, a $500 million extra payout which is bound to spike the pay-out ratio especially when you take note of 2016 EPS estimates.
Therefore to sum up, investors may be attracted to Exxon Mobil stock because of its balance sheet strength but any project this company undertakes is huge which always brings more spending and more risk if the projects are being developed in unstable countries. Furthermore, production is expected to remain flat through 2020 which illustrates the problems the oil major is having in this area. Expect Exxon Mobil stock to under perform if oil prices rally meaningfully from here.