- Exxon Mobil has decided to drastically cut its capex budget in 2016 to $23.2 billion.
- Exxon Mobil stock should have been cheaper after nearly an 80% drop in the price of oil since June 2011. Its triple A credit rating, balance sheet and dividend are keeping the stock elevated
- Exxon Mobil is a play for the investor who wants dividend security and downside protection in the energy sector.
Fourth quarter earnings in the energy sector demonstrated that even the behemoths will have to seriously pare back capex commitments in order to cover cash outflows. Many analysts and investors alike had favored Exxon Mobil (NYSE:XOM) above all other contenders ever since the price of oil started to collapse in June of 2014 as this company historically has always invested through the cycle irrespective of the conditions it encountered. Well, even Exxon didn't initially think that oil prices could have stayed this low for so long but they have and it is crippling the balance sheet of many companies. ConocoPhillips (NYSE:COP) had to finally succumb by cutting its dividend by 66% which basically illustrates that strict upstream companies cannot afford dividend payouts in this market.
Conoco decided to spin off its downstream refining business some years ago (now trading as Phillips 66 (NYSE:PSX)) when oil was trading up around $100 but that decision has ultimately come back to haunt them. Marathon Oil (NYSE:MRO) is another company that wanted to cash in on its upstream operations but it ended up meeting the same fate as Conoco - a 76% dividend cut back in November. Exxon, with its thriving downstream division acting as a hedge presently against low oil prices, doesn't have this problem despite downstream earnings not being able to entirely offset the impact of lower oil prices. Nevertheless, Exxon has other concerns which investors should be aware of.
Firstly many investors are taking it as a positive that Exxon stock is only down around 20% since June 2014 compared to an 80% collapse in the price of crude (see chart below). However Exxon stock is trading at higher valuations now than it was in early 2014 (when crude was trading around $100 a barrel) So the respective investor has to ask himself whether Exxon Mobil is a good investment at this point in time? From a valuation standpoint, I would say no.
From a dividend perspective, I would say yes to a point. Why? Because since Exxon stock hasn't dropped to where it should have dropped (remember earnings were halved to $16 billion in 2015 and top line sales were almost $100 billion lower), the dividend yield hasn't spiked like other oil companies. Exxon's dividend now stands at 3.6% but there are many stocks in the S&P500 that have this yield and have substantially lower multiples. Something to think about.
Secondly, if oil prices remain muted, Exxon will find it difficult to keep increasing the dividend robustly due to the shortfall in company's operating cash flows $30.3 billion. Exxon in 2015 needed to divest of $2.4 billion in assets, take on an extra $7.6 billion in debt and tap its cash balance by around $1 billion to ensure capex and shareholder distributions could be met.
In total, the shortfall was $11 billion (see below) which is unsustainable but Exxon has taken swift action. The $500 million per quarter share buyback program has been cancelled which will save the company $2 billion a year. Secondly, the company has slashed its capex budget by a whopping $10.8 billion in 2016. These two measures alone should mean that operating cash flow should be big enough in 2016 to fund cash outflows but Exxon may face problems in the near term.
The three potential problems I see for Exxon in the near term are as following. Upstream could get even more battering in the first quarter of 2016 as oil prices (averaging around $30 a barrel) are 20% down from fourth quarter's average. Upstream pain may get worse before it gets better. Secondly, even though downstream revenues more than doubled in 2015 ( to $6.56 billion), crack spreads are down $5 on average this quarter compared with the fourth quarter of 2015 meaning downstream earnings will probably take a hit in the near term or at the very least until spreads can rise once again. Then you have the quarterly dividend which almost certainly will be raised in May of this year to at least $0.77 a share. If all of the above takes place, it's going to put more pressure on Exxon's balance sheet which investors should be aware of.
In saying all of the above, the one advantage that Exxon stock has (especially for dividend investors) if it really cuts capex in 2016 and 2017 is that free cash flow levels should increase meaningfully after 2016. Exxon is predicting to do 4.3 MMBOED in upstream numbers by the end of 2017 which is almost a 5% hike from 2015 levels. Therefore, the increase in production along with lower capex should mean larger cash flows for the company. Exxon's constant shift of its portfolio into liquids for the extra margins should also impact cash flow numbers over time. However remember these are short term benefits to a longer term problem. Cutting capex will help cash flows in the near term but if the street doesn't see growing production guidance, it may ultimately take a negative view.
To sum up, I believe the main reason why investors are invested in Exxon stock is for the dividend which looks safe especially when you consider that the company will not want to give up its dividend aristocrat status. However, its valuation is a bit rich with the oil price at $30 a barrel. Furthermore, with oil continuing its slide this year, US upstream will most probably report even heavier losses this quarter.
Downstream also may not be able to keep its momentum going as crack spreads have dropped significantly already this quarter. Since the oil rout began, investors thought that it would be Exxon who would be buying up cheap assets and not selling them but if the present carnage continues, even Exxon will have to bury its pride and shrink its balance sheet fast.