Published October 7th, 2017 by Bob Ciura
There are just two energy stocks on the list of Dividend Aristocrats. One of them, Exxon Mobil (XOM), is the largest oil company in the U.S.
The Dividend Aristocrats are a group of 51 stocks in the S&P 500 Index, with 25+ years of consecutive dividend increases.
Oil and gas production can be a “boom-and-bust” industry. Profits are highly dependent on commodity prices, which can fluctuate wildly in any given year.
But Exxon Mobil has been a pillar of stability. It traces its roots to Standard Oil, which was founded by John D. Rockefeller all the way back in 1870.
With an operating history over 100 years, and a 3%+ dividend yield, Exxon Mobil is on our list of “blue-chip” stocks. You can see the full list of blue chip stocks here.
This article will provide an in-depth look at the founder of Big Oil, Exxon Mobil.
In its early days, Standard Oil came to dominate the U.S. oil and gas industry. It did this with a laser-like focus on drilling innovation, production growth, and limiting costs.
Standard Oil was almost too successful—it grew at such a rapid pace, that in 1911 it was dissolved by the U.S. Supreme Court on antitrust grounds. Standard Oil was broken up into 33 smaller companies, many of which became giants on their own, such as Chevron (CVX).
Many of the same business practices used by Standard Oil, are still used today by Exxon Mobil. Specifically, the company focuses on high-return projects that allow for profitable growth.
The company generates a high return on invested capital, a key measure of a management team’s ability to effectively deploy capital.
Source: 2017 Annual Meeting of Shareholders, page 4
Exxon Mobil has consistently generated industry-leading returns on capital employed.
The company operates three large business segments:
- Upstream (42% of earnings)
- Downstream (31% of earnings)
- Chemicals (27% of earnings)
The Upstream segment includes oil and gas exploration and production. Downstream activities include refining and marketing. Manufactured chemicals include olefins, aromatics, polyethylene, and polypropylene plastics.
The climate for oil and gas majors remains challenged, because oil prices are down by roughly half, from the peak levels of 2014.
Fortunately, Exxon Mobil is an integrated company. Its upstream and downstream businesses complement each other well.
When oil and gas prices decline, upstream profits fall. But, downstream tends to benefit from sharp fluctuations in oil prices.
This helps Exxon Mobil’s profits hold up relatively well, compared with other oil and gas majors. Earnings-per-share have more than doubled over the first half of 2017.
Source: Q2 Earnings Presentation, page 23
Exxon Mobil has also boosted cash flow, with cost discipline. Capital expenditures were cut by 21% over the first six months.
Despite a weak pricing environment, Exxon Mobil still generated $8.5 billion of free cash flow in the first half. This was more than enough to continue paying the dividend, and also providing a modest dividend raise in 2017.
Going forward, future earnings growth would be accelerated with higher oil and gas prices. But growth will also come organically, from new projects.
Source: Q2 Earnings Presentation, page 17
Exxon Mobil has a massive project pipelines, consisting of more than 100 new projects.
Among Exxon Mobil’s most significant new projects are Papua New Guinea liquefied natural gas, offshore Guyana, and its gas fields in Mozambique.
At its 2017 Analyst Meeting presentation, Exxon Mobil gave guidance for annual production to rise to 4.0-4.4 million barrels per day by 2020. This represents a roughly 5% increase from 2016 production.
Competitive Advantages & Recession Performance
Exxon Mobil enjoys several competitive advantages, primarily its tremendous scale, which provides the ability to cut costs when times are tough.
It also has the financial strength to invest heavily in new growth opportunities. The company has allocated billions to R&D in the past few years:
- 2014 research-and-development expense of $971 million
- 2015 research-and-development expense of $1.0 billion
- 2016 research-and-development expense of $1.06 billion
Another competitive advantage is Exxon Mobil’s industry-leading balance sheet. It has a credit rating of AA+, which helps it keep a low cost of capital.
Exxon Mobil’s integrated business model allows the company to remain profitable, even during recessions and periods of low commodity prices. The company saw volatility during the Great Recession, but still remained profitable:
- 2007 earnings-per-share of $7.26
- 2008 earnings-per-share of $8.66
- 2009 earnings-per-share of $3.98
- 2010 earnings-per-share of $6.22
Continuing to generate steady profits allowed Exxon Mobil to keep raising its dividend each year.
Valuation & Expected Returns
At first glance, Exxon Mobil appears to be greatly overvalued. According to Value Line estimates, the company is expected to generate earnings-per-share of $3.50 in 2017.
This means, based on its current share price, Exxon Mobil stock has a price-to-earnings ratio of 23.3.
However, it is important to remember that Exxon Mobil’s earnings are depressed right now, because of weak commodity prices. Even a modest recover in oil and gas prices, could cause Exxon Mobil’s earnings to soar.
Value Line analysts expect the company will earn $8.15 per share in 2022, which would be more than double projected 2017 earnings. With that kind of growth, a price-to-earnings ratio of 10 based on 2022 earnings, could actually be cheap.
As a result, Exxon Mobil’s future returns depend highly on its ability to grow earnings. If Value Line’s estimates are accurate, Exxon Mobil would generate approximately 15% compound annual earnings growth, from 2017-2022.
Much of this depends on the direction of oil and gas prices, which are difficult to predict. To account for this uncertainty, investors may want to err on the side of caution, when forecasting future earnings growth.
With that in mind, a potential breakdown of long-term returns is as follows:
- 8%-10% earnings growth
- 3.8% dividend yield
Exxon Mobil’s operating earnings could reasonably increase by 6%-8% each year. Adding in share repurchases, could elevate total earnings growth to 8%-10%. In this assumption, total returns would reach approximately 12%-15% per year, including dividends.
Of course, earnings growth is not likely to be this smooth, and are subject to change depending on oil and gas prices. Still, it appears that Exxon Mobil stock is undervalued.
Exxon Mobil has had a difficult past few years. It is not immune from falling oil and gas prices. However, it has performed better than most other energy stocks in this time.
And, Exxon Mobil has a bright future. The company has many promising new projects nearing completion, and it generates more than enough cash to continue raising the dividend.
As a result, Exxon Mobil stock appears attractive based on valuation, and also dividend growth.