- Exxon Mobil delivered great results, as it beat on both sales/earnings.
- Given Exxon Mobil's superior unit economics, I still prefer the name over other oil operators.
- Furthermore, if oil prices recover Exxon will outperform the broader index despite the stock pricing in roughly $50/bbl.
Exxon Mobil (NYSE:XOM) came out of earnings with fairly solid results, but the key theme to watch for is oil prices despite some earnings/revenue from downstream offsetting weak performance in the upstream business. That being the case, Exxon seems to be concentrating investment into readily economically viable projects within the shale oil/gas formations in the Permian basin (Bakken), which creates some upward bias to production in the second half of the fiscal year. Of course, the incremental production does very little to actually goose sales, so the company’s fundamentals have a high dependency on the price of oil. As there are many oil fields with spuds, so once prices recover production will quickly ramp.
Oil fundamentals are driven heavily by North America production, as much of the global oil production growth came as a result of the four major unconventional formations/basins (Eagle Ford, Bakken, Wattenberg and Permian).
Source: Bank of America Merrill Lynch
However, the balance of supply/demand in crude oil can be realigned assuming OPEC countries are able to arrive at arbitrary production targets at the Vienna meeting on June 2nd, 2016. Production is expected to decline, as many of the producers within the United States are looking to time re-entry of oil supply upon prices recovering. Many of the major/minor oil operators are able to remain economically viable in onshore unconventional at $30/BBL with some exceptions at $40 to $45/BBL in STACK-SCOOP (South-Central Oklahoma Oil Province and Sooner Trend Anadarko Basin Canadian and Kingfisher Counties). However, I’ve had some conversations with smaller regional operators that can maintain reasonable unit economics at $30/BBL even within the STACK-SCOOP, so the on-going development of these other regional plays could be another unanticipated source of supply once pricing recovers beyond $50/bbl.
ExxonMobil continues to execute on cost recapture, as it already reduced OpEx and CapEx by $16 billion y/y with management mentioning that it’s on-track to reduce costs at a similar trajectory. While the company is relentlessly focused on reducing costs, it’s not reckless and anticipates that these reductions will be net additive in the form of higher efficiency per employee as opposed to outright reductions in labor efficiency. Since Exxon scaled back development at the peak of the prior cycle, it’s not tied to as many “new” oil field leases, as opposed to Chevron which has to develop oil resources across unconventional, shallow water and conventional resources at a blended breakeven of roughly $30 to $40/bbl as opposed to Exxon which has a current break-even of roughly $25/bbl. The difference in unit economics and the company’s AA+ credit rating gives me upward bias due to heightened margins coming out of the trough parts of the cycle.
The company’s coveted AAA rating was taken down a notch, and here was the official statement from S&P, which I received directly from their rating services:
We believe Exxon Mobil's credit measures will be weak for our expectations for a 'AAA' rating due, in part, to low commodity prices, high reinvestment requirements, and large dividend payments. The company's debt level has more than doubled in recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow.
At this point, it’s all relative and it’s been noted that Exxon has actually been reducing its CapEx for the past couple of quarters. Some of the bigger operators are still developing oil field resources, but that’s a given as the major producers invest in every part of the cycle. I don’t anticipate Exxon’s investment grade spread to widen too significantly, as the company’s balance sheet is strong when compared to other operators.
United States supply will likely be capped in 2016 due to constraints on supply re-entry. Here is some key commentary that was released by RBC Capital Markets in an in-depth report:
With nearly 270 horizontal oil rigs currently active in the field and indications that another 100–150 horizontal rigs could be reactivated in short order, our estimated 2016 maintenance production rig level of 400–425 horizontal rigs seems possible at first glance. However, after factoring in a small timing lag, we believe it would be difficult to average over 400 horizontal oil rigs during 2016. In fact, RBC’s Oil Service team is estimating an average of 311 oil rigs and an average of 344 horizontal rigs running in 2016. For 2017, however, we do not see rig availability and staffing as a limiting factor for a resumption of oil production growth.
Furthermore, the visibility on oil prices remains quite low with some seasonal uptick creating serendipity for markets, but not enough to declare a bull market for oil prices. Demand for utility vehicles/trucks is at new all-time highs as evidenced by Ford’s recent earnings report, so a resurgence in big vehicles will be additive to oil demand as we progress through the balance of the year.
The company reported revenue of $48.71 billion and Q1 EPS of $0.43, which was below consensus estimates of $45.35 billion and $0.31 respectively. The consensus modeled revenue estimates on assumptions of appx. $45 oil prices for the next two-quarters, which could prove to be conservative, as investors are still piling back into energy and are paying a slight premium to participate in the recovery trade. There’s also a lot of private equity activity within the energy space (KKR mentioned that they’re getting really aggressive in energy at a recent investor conference), so it’s not surprising to see buy side momentum prior to full oil price recovery.
Here was some key commentary from the major investment banks coming out of the earnings report:
1Q EPS beat expectations, largely on tax, though FCF was positive despite working capital headwinds, a continued differentiator for XOM. Looking ahead, we see XOM potentially covering its dividend in full in 2Q if oil prices average $45/bbl. On valuation, we raise our Dec-16 price target to $97/share (from $82/share), largely on a higher price deck ($55/bbl Brent in 2018+). – Phil Gresh from J.P. Morgan
Following above-consensus 1Q2016 results, we reiterate our Conviction Buy on ExxonMobil. We raise our XOM 12-month, multiples and yield based price target from $91 to $94 on higher estimates. Our 2016-2018 EPS estimates increase from $1.54/$5.05/$5.59 to $2.17/$5.19/$5.75. XOM is well positioned to continue to raise its dividend. Unlike other majors, XOM was able to raise its dividend by 3% earlier this week. Given an estimated Brent oil price required to cover the dividend of only $45/bbl in 2017 and one of the strongest balance sheets in Energy, we believe XOM can raise the dividend by another 5% next year. – Neil Mehta from Goldman Sachs
In Q1, XOM beat our cashflow expectations, helped by chemicals, and seems to be running below the 2016 capital budget. We raise our TP to $78/sh. XOM is well prepared for the down-cycle, but we continue to find the shares fully valued. We raise our TP to $78/sh. EPS estimates for 2016 and 2017 increased to $2.45/sh and $4.25/sh, respectively. – Edward Westlake from Credit Suisse AG
To conclude, I continue to reiterate my buy recommendation on ExxonMobil. There’s not enough tangible evidence that oil prices will sustain recovery, but assuming prices move beyond $50/bbl in FY’16, the stock will outperform the benchmark by a significant margin. As such, I still see some upside left to the name. I’ll be modeling a multi-year projection on earnings/sales at a later date. Creating a reliable financial model remains difficult given the volatility in commodity prices.