- Fundamentally Exxon's integrated business model protects investors from downside risks.
- Technically oil is still making higher highs. I think crude will bottom out at $50 a barrel.
- Selling option premium in a low volatility stock like Exxon is a great way to magnify returns.
Many investors flock to Exxon Mobil (NYSE:XOM) because of its balance sheet and dividend safety. This stock is by no means a high flyer. But that doesn't mean it shouldn't be invested in. The beauty of Exxon's integrated business model is that the downside is very much protected compared to other energy stocks and the commodity itself. We saw this firsthand with its performance over the past 24 months. The stock is only down 17% since its peak in June 2014, whereas crude oil is still down by well over 50% since the slump started.
Furthermore, many analysts attempt to include earnings and sales multiples in their analysis. For a stock like Exxon Mobil, this is fruitless in my opinion, as things outside its control (such as refining margins and crude oil prices) essentially change the value of its assets and earnings.
As a dividend investor, cash flow and dividend payouts should be the main metrics to watch closely. In the last quarter, Exxon brought in $1.7 billion in net income but paid out $3.13 billion in dividends. Obviously, this is not sustainable even though Exxon would be able to withstand low oil prices much better than other companies due to its low debt to equity ratio (17%). On the upstream side, all Exxon can do is to get its own house in order, which means cutting costs which over time cuts the firm's cash flow break even point.
I Expect The Cash Flow Shortfall To Decrease In Forthcoming Quarters
In terms of fundamentals, investors should also monitor oil inventories as it will ultimately be the supply imbalances that will eventually drive Exxon's stock. Exxon Mobil, along with other integrated and upstream companies, has meaningfully cut its capex budget in order to keep operations going. With 2 quarters reported now in 2016, Exxon has shelled out $8.9 billion on capex and $6.2 billion on dividends ($15.1 billion in total). Cash flow from operations came in at $4.5 billion in the second quarter, which means $9.3 billion in total was the cash flow operations figure for the first six months. The only way the shortfall can be made up is with debt and asset sales which the company has had to do up until now.
The Longer Capex Budgets Keep Reducing, The Better
Now although this looks worrying, we have to compare Exxon with other integrated companies. Why? Because I am of the opinion that sooner rather than later reduced capex budgets are going to spike crude oil demand which will turn into rising prices. Furthermore because Exxon has the best balance sheet in this sector, it can keep on reducing cap-ex which invariably will bring down its cash flow break even for the price of crude a barrel. Yes, shale producers may keep crude tagged at $50 but Exxon will be able to increase its dividend, which is obviously crucial for income investors. With respect to Exxon's peers, no other company is closer to cash flow neutrality, with maybe the exception of BP Plc (NYSE:BP), which has more leverage than Exxon Mobil.
Crude Oil Is Still In An Uptrend
In terms of crude oil's fundamentals, I believe we are still in an up-trending market at present. What many investors overlook is that the mean price of crude oil is well over $70 a barrel. Will we get back there? Difficult to say with new fracking technology, but Exxon would only need to get to around $50 to remain profitable in the near term. Personally, I believe many asset classes bottomed over the last 8 months (Gold, Oil, Stocks) and are going to go higher from current levels. On the oil chart, we continue to make higher highs. The line in the sand is the $40 level that was printed at the start of August. Exxon Mobil investors should align this support with a stop loss in Exxon Mobil if one is worried about oil continuing in a bear market.
Boost The Current Dividend Yield Through Covered Call Selling
Therefore income investors could use the stability of this stock to bring in extra income through covered call selling every month. The current yield is 3.55%, which is currently $300 in annual income on an investment of 100 shares today ($8,460) . One could sell the the October-14 $86-call for $108 (1 lot of 100 call options at $1.08 per option) at present, and even if you managed to only initiate 3 of these trades over a 12 month period, your income yield would automatically translate to 7.3%.
Covered calls are an excellent strategy to increase income in stable stocks. Exxon Mobil fits the bill in my opinion because the risk of losing one's shares is small compared to other stocks. Here is the breakdown of how you can double your yield. The table is based on income over 12 months based on 100 Shares Bought today. Aim to sell a call option a few strikes out of the money to ensure you don't get assigned.
|Dividend Income||$0.75 x 4 (quarters) x 100 (shares) = $300|
|Options Income||$108 x 3 (Monthly Cycles) = $324|
|Total Income||Income Total = $624 or 7.3% based on today's share price|
Exxon Mobil has been in the news recently due to ongoing investigations into its climate change research. I don't think this will amount to anything in the long run, which is why I would use weakness in the stock to get long. Fundamentals for crude and Exxon are both bullish. Exxon has the best balance sheet in the industry. The dividend is safe and its cash flow break even point is coming down every quarter. Use the stability and range bound trading nature of the stock to bring in extra income.