I came across Exxon Mobil (XOM) while writing an (article) for Seeking Alpha. I uncovered that Warren Buffett has 70% of his assets in only 4 stocks; American Express Company (AXP), Coca Cola (KO), International Business Machines (IBM) and Wells Fargo & Company (WFC). No fund manager would ever put 70% of their assets in just 4 companies. Unless of course they fully understood what Warren is really doing. Warren calls these his "Inevitables", his term for global giants. Basically Warren relies on the ... before I go further with Warren's investment strategy let's go over Exxon's financials to make sure they are solid.
Let's start with Exxon's reported financials for the (latest quarter).
Exxon's earning had fallen to $9.57 Billion from $10.33 Billion a year ago. Revenues fell 8% to $115.7 Billion. Oil and Gas output declined 7.5% to 3.96 million barrels of oil equivalents per day. Exxon's exploration and production business had a profit drop of 29% to $5.97 billion. The only bright spot was in Exxon's global refining business which more than doubled to $3.2 billion. Exxon's latest quarterly financials explain its current drop.
Exxon's (balance sheet) shows it has $8.9 billion in long term debt and $13 billion in cash. Cash and debt both seem low for the largest oil company in the world.
Exxon's past and present financials are very misleading in regards to its future financials. The catalyst for Exxon's healthy financial future can be summed up in one word, "Shale". Exxon saw before anyone else the U.S. shale oil and gas revolution and bought in 2010, XTO Energy for $30 billion. Exxon has been on a buying binge in North America and Russia for shale fields with proven oil and gas reserves. I take the International Energy Agency (IEA) report that states that the U.S. will become the world's largest oil and gas exporter within the next 10 years with a grain of salt. I do see U.S. shale oil and gas production and refining giving the U.S. a significant domestic advantage in lower utility and manufacturing costs. Domestic manufacturing output, especially in chemical and steel production will give those industries an advantage in global competitiveness. Low energy costs in manufacturing might explain Apple's recent decision in manufacturing one entire computer line in the U.S. How long will this shale bonanza last? Hard to say, but 5 to 10 years should be a safe time horizon.
Which brings me back to Warren Buffett's investment strategy. As I stated earlier Warren calls his global giants, "Inevitables". Basically Warren relies on the stock price stagnating while a major new catalyst steadily increases profits over a long period of time. The stagnation in price, while revenues increase steadily year over year causes the company to increase share buy backs and or increase dividends in a never ending attempt to keep the stock price up. Exxon is a perfect example of an "Inevitable" that consistently is able to raise its dividend and buybacks due to new revenue catalysts, but which is so colossal in size that even these new large revenue catalysts are not significant enough to advance the company's share price to new levels over many years. The 10 year dividend/price chart below for Exxon clearly shows Warren's favorite "Inevitable" principle at work. Note that presently the share price is below the dividend, which is an ideal time to initiate a new large position in Exxon before the new revenue catalyst of shale oil and gas starts showing up in its financials.
When will U.S. natural gas prices start rising and benefiting Exxon's bottom line? According to Exxon's CEO, Rex Tillerson (who spoke at length during the Council on Foreign Relations this past summer) the reason for the natural gas glut in the US, "We underestimated just how effective that technology was going to be, and we also underestimated how rapidly the deployment of that technology would occur. We grossly underestimated the capacity of both the rocks, the capacity of the technology to release the hydrocarbon, natural gas from the shale gas and now oil from tight oil rocks." Exxon and other gas producers in the U.S. have been shutting down gas wells and its effects are evident in the latest EIA weekly natural gas storage report below.
Chart courtesy of U.S. Energy Information Administration
My biggest concern for Exxon shale revenue stream is its use of fracking to extract the gas and oil from the shale deposits. Again, Exxon CEO Tillerson enlightens with his comments on fracking;
"Honestly. Any mishaps that could happen around a well being fracked are mishaps that are not life-threatening, they're not long-lasting, and they're not new. They are the same risks that our industry has been managing for more than 100 years in the conventional development of oil and natural gas."
Exxon CEO Tillerson addressed concerns about all the water used in fracking and its environmental impact, "More freshwater flows out of the mouth of the Hudson Bay in eight seconds than all the water we used to hydraulically fracture all the wells last year. That's how much water is available. It's a question of how we use it," says Tillerson.
Tillerson also addressed the fracking waste water; "In conventional oil and natural gas production, you always produce a lot of formation water, and it's crummy water. It's real salty. It's got heavy metals in it. It's got bad stuff in it," Tillerson says. "We have been handling and managing that water system for decades."
This of course is not to say that communities that are near U.S. shale sites would not fight Exxon in court to prevent or require Exxon to take extra precautions to avert a BP size oil spill disaster.
What has been and will be the economic impact of shale gas to the U.S. economy?
The chart below from a paper called (The Arithmetic of Shale Gas) researched and written by a group of Yale economics graduates led by Yale Professor Emeritus Paul W. MacAvoy estimates that the economic impact to the U.S. economy will be $100 Billion a year as long as present production rates are maintained.
Chart courtesy of Yale energy study group.
This year natural gas bottomed out at $2.50/mcf. As more shale wells are taken off line and demand increases Exxon as the largest natural gas producer and refiner stands to profit handsomely from its Shale fields and more importantly from its refineries.
According to (Nerdwallet.com) Exxon paid only a 2% tax rate in the U.S. versus their stated tax rate of 42%.
Exxon is currently trading below its fair book value of $108.42 with a 2.6% dividend rate.
Exxon can be invested in several ways, but my preference is to invest in Exxon as a Warren "Inevitable" selling below its fair book value with an enormous shale revenue catalyst that is just beginning to percolate that will pay increasing dividends for years to come.