- Oil price could have bottomed on the 24th of August. Exxon stock has underperformed since then, in comparison. We also saw this pattern in 2008, when oil shot up to $147 a barrel.
- Exxon's relentless hunt for more production will definitely bring more risks to the table. While Revenues have been flat now for many years, margins should improve from the company's shift to liquids
- A rating cut by leading rating agencies could cause Exxon stock to sell off from current price levels. This would provide an opportunity for a long term hold in my opinion.
Exxon Mobil (NYSE:XOM) seems to be the favorite pick among investors in the energy space due to its sheer size and triple A credit rating (only oil major to have such a rating). Furthermore the stock is even gaining more attention at present because it has rallied 8%+ since the 24th of August. Do I think Exxon will keep rallying? Yes, but I think there are more favorable stocks in this space at the moment. Investing in energy at the moment all depends on your take where oil prices are going. Crude oil has rallied hard out of its August 24 low and is now approaching $50 a barrel (see chart)
I believe we have printed a firm bottom in the entire commodity sector and not just oil. The Jefferies CRB Global Commodity ETF, which holds a basket of commodities (both hard and soft), also has rallied sharply since August, which reinforces my assumption. Furthermore, investors must consider that commodities have rallied hard in the past month in the face of a strong dollar. The dollar, surprisingly, has not sold off (which would have boosted the commodity rally even more) after the poor US job numbers recently reported for August. Expect to see a major reversal at next month's announcement (as I believe these numbers can be doctored by the powers to be), but it still won't be enough for the Fed to raise rates because the economy is still fundamentally weak. Sooner or later the currency markets will extrapolate that the Fed will never raise rates which should cause a dollar sell off.
So what does all of the above mean for Exxon? Well, rising oil prices will undoubtedly make its stock rally (as we have seen recently) but upstream companies should significantly outperform integrated companies from here going forward.
Firstly lets look at how the stock performed in the past when oil prices were rallying hard (2007-2008 when oil prices went to $147 a barrel). In the chart below, Exxon Mobil underperformed other upstream producers such as EOG Resources (NYSE:EOG) and Hess (NYSE:HES). It also underperformed Chevron (NYSE:CVX) because Chevron, although being also integrated, has a far smaller downstream division compared to its upstream activities.
One could do similar research since oil bottomed on the 24th of August this year and similar results will be found. What's the takeaway here? Exxon provides security as its huge downstream division ($5,401 million in the first half of 2015 - an increase of 58% over the same period in 2014) acts as a powerful hedge against falling prices. Nevertheless its downstream profits will become smaller as oil prices rise. Therefore, if you believe oil prices will be back over $70 a barrel within 12 to 18 months, then Exxon in my opinion would not be a prudent choice. On the contrary, this stock because of its strong balance sheet, stock buybacks and dividend history is an excellent play if prices don't rise as quickly as many are anticipating.
Secondly and following on from my first point, I see Exxon stock more as an income play instead of a capital gain play because of its struggles over the years in boosting production and consequently revenues. Revenues are expected to come in at $300 billion this year (see chart below) which will be less than the 2006 numbers. I acknowledge that the carnage in the energy sector over the last 15 months has been unprecedented, but revenues at Exxon have been dropping since 2011, which is to be a concern going forward. Desperately trying to increase production undoubtedly brings its own inherent risks especially in international jurisdictions where the company has already had problems ( Russia, Nigeria, Venezuela, etc...). Furthermore, with rising resource nationalism, Exxon will find it increasingly difficult to acquire new assets going forward. One thing the company has definitely done right in recent years is shift its portfolio mix from gas to liquids. In the last 5 years or so, Exxon didn't take advantage of the high oil price environment as much as its peers. Liquids normally gives higher price realizations so profits should definitely get a boost from this initiative going forward. This again should boost free cash flow figures which should keep buybacks and dividend growth elevated going forward for income investors.
Finally on a valuation basis, I just think there is better value in the energy space at the moment. Hess has a present price to book ratio of 0.81 and Chevron has a PB ratio of 1.06. Exxon on the other hand, protected by its huge downstream division over the past 15 months, has a PB ratio of 1.89. The fact of the matter is that Exxon will participate less in rallies and declines compared to its competitors, due to the huge integration its business model possesses. It was interesting last week to see Standard & Poor give Exxon Mobil a negative outlook going forward. Exxon Microsoft (NASDAQ:MSFT) and Johnson & Johnson (NYSE:JNJ) are the only companies that have a triple A bond rating. Many investors are invested in Exxon for this very reason. Its debt (bonds) is extremely safe for bond holders. When the company issues debt, there is usually big demand for its bonds as they normally pay higher than the present 10 year US bond, which currently yields just over 2%. I will definitely be watching this space in the near term to see if indeed the rating agencies cut their ratings for Exxon. Would this cause a sell off in the stock?. If it did, I believe it would be an over-reaction and would be a good time to buy Exxon stock. However until then, I will be sitting on the side-lines.