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Introduction

There are too many articles on Seeking Alpha on the top five oil companies by marketing capitalization - Shell (NYSE:RDS.A), Exxon Mobil (NYSE:XOM), BP PLC (NYSE:BP), Chevron (NYSE:CVX) and Total (NYSE:TOT). They have a very similar story to tell. They are selling at relative price multiples that are below or close to the industry average. These companies are selling at an attractive dividend yield. Their performance was poor during the recession years (2008-2009), but is now recovering. There is a positive trend in the cash flows they are generating. They are reducing their asset bases and hence are relatively more cash-rich than they have been at any time in the last five years.

There are many articles (for examples, read Shell, Chevron and Total) on Seeking Alpha which make a case for buying these stocks on the basis of the above facts (supported by other information, of course). However, the more important question is which is the best bargain among the five stocks? There is limited analysis comparing the oil majors on similar parameters, even though many analysts are making separate arguments built along the same lines.

Performance of These Giants

Almost all analysts are basing their arguments for buying one of these stocks on the multiples below. This article presents a comparison of the financial performance of the companies and assesses the possibility of picking the best bargain from among them.

EPS

P/S

P/B

P/E

Dividend Yield

Shell

0.5

1.2

8.2

4.36

Exxon

0.8

2.3

9.2

2.3

BP

0.3

1.1

7.5

4.76

Chevron

0.9

1.6

8,9

3.23

Total

0.5

1.2

8.4

4.81

Industry Average

0.7

1.5

9.8

3.1

Data from Morningstar on Dec 28, 2012

The discounted earnings plus equity model, developed by EFS Investment Partners and applied to the five competitors, suggests the following: currently four stocks (TOT, CVX, XOM, BP) are undervalued. In addition, EFS's fair stock price valuation indicates that these four stocks are trading at an attractive discount. Exxon offers the most favorable stock price to be a buy option.

TOTCVXXOMBPRDS.A

Current Price

$51.46

$106.42

$85.14

$41.21

$68.5

Estimated Fair Value Range

$76-$118

$189-$257

$137-$174

$54-$91

N/A

Stock Valuation

Undervalued

Undervalued

Undervalued

Undervalued

N/A

Upside Potential to Reach a Fair Stock Value

48%

78%

61%

30%

N/A

Let us start by comparing the owner earnings for the five companies. Owner earnings are calculated as net income + depreciation and amortization - capital expenditure (including working capital).

All amounts are in millions of dollars

Owner Earnings

2007-08

2008-09

2009-11

2010-11

2011-12

TTM

Shell

10,934

−4,973

−10,257

−1,197

10,530

854

Exxon

29,852

30,223

403

9,570

16,342

17,259

BP

5,488

−8,58

−2,865

−13,918

14,673

2,190

Chevron

5,927

8,631

−2,552

6,729

7,096

2,735

Total

4,074

−2,32

−1,570

6,26

−2,358

−3,415

The metric does not favor any company, and the low price multiples seem justified. Shell and Total seem to be doing particularly badly, with negative owner earnings in three of the periods and low owner earnings in the last twelve-month period. Exxon is apparently doing better than the others, even though owner earnings are still below the levels seen in 2007 and 2008.

Analysis of return on invested capital -ROIC - for the five companies, also favors Exxon, as its profitability is only marginally less than Chevron in the group.

ROIC

2007-08

2008-09

2009-11

2010-11

2011-12

Shell

11.63%

9.30%

4.28%

6.24%

8.96%

Exxon

16.78%

19.83%

8.26%

10.07%

12.40%

BP

8.83%

9.27%

7.03%

−1.37%

8.77%

Chevron

12.56%

14.85%

6.37%

10.30%

12.84%

Total

11.61%

8.95%

6.61%

7.36%

7.48%

To further understand the profitability of the companies, consider the breakdown of ROIC into turnover and margin. Exxon's higher profitability is largely due to higher turnover, reflecting better asset utilization by the company, while the higher profitability of Chevron is due to its higher margin.

ROIC = margin *turnover

2007-08

2008-09

2009-11

2010-11

2011-12

Shell

Margin

8.81%

5.73%

4.39%

5.32%

6.38%

Turnover

132.03%

162.31%

97.59%

117.23%

140.33%

Exxon

Margin

10.04%

9.47%

6.21%

7.95%

8.44%

Turnover

167.11%

209.32%

133.11%

126.68%

146.93%

BP

Margin

7.21%

5.79%

6.80%

−1.23%

6.65%

Turnover

122.40%

160.23%

103.39%

111.12%

131.87%

Chevron

Margin

8.46%

8.77%

6.11%

9.28%

10.60%

Turnover

148.47%

169.39%

104.26%

110.91%

121.12%

Total

Margin

9.63%

6.61%

7.53%

7.53%

7.37%

Turnover

120.51%

135.52%

87.79%

97.74%

101.52%

Another measure of profitability, ROE (PAT / net worth), favors Exxon as well. Exxon has been more profitable than its competitors for the larger part of the last five years.

ROE

2007-08

2008-09

2009-11

2010-11

2011-12

Shell

25.28%

20.64%

9.18%

13.60%

18.24%

Exxon

33.35%

40.03%

17.44%

20.74%

26.59%

BP

22.25%

23.17%

16.31%

−3.92%

23.06%

Chevron

24.24%

27.62%

11.41%

18.10%

22.16%

Total

29.38%

21.62%

16.07%

17.50%

18.04%

The industry average debt equity is 0.6. Exxon and Chevron are the companies which appear to be most conservatively financed. A simple credit analysis (using the two most important ratios for credit analysis) is presented below.

Shell

Exxon

BP

Chevron

Total

Debt / Equity

0.2

0.1

0.4

0.1

0.3

Interest Coverage Ratio (Average CFO / Interest Paid)

23.8

72.4

16.3

176.4

9.7

Average Market Value of Firm / Debt ( on balance sheets )

16.6

39.7

19.4

29.4

24.9

If we assume that oil companies would be comfortable with a coverage ratio of 4, and that the company can service this debt at a 5 percent interest rate, we can estimate the value of a company by calculating its debt capacity. For example, for Exxon Mobil, whose average cash flow from operations has been $48 billion (approximately), the company can comfortably service an interest of approximately $12 billion (coverage ratio of 4). Debt capacity of the company is $243 billion, as it can pay interest of $12 billion (which is an approximate 5 percent coupon on debt of $243 billion). Using the formula stating the value of the company is 175 percent of debt capacity plus cash on the balance sheet (an old valuation rule from the value-investment school of thought), the value of the company can be estimated to be $461 billion, which is 13 percent more than the current value. This calculation is summed up in the table (all dollar amounts are in millions) for Exxon, as well as the other oil companies. By this measure, Exxon is the only company which comes out undervalued.

Shell

Exxon

BP

Chevron

Total

Typical Interest Coverage Ratio in the Sector

4

4

4

4

4

Maximum Interest Paid in Last 5 years

1373

673

1547

166

1786

Average Cash flow from Operations (NASDAQ:CFO)

32797.6

48784.6

25258

29287.8

17354.4

Interest Rate on Debt Issued by Corporation

10%

5%

10%

10%

10%

Five-Year average CFO / Typical Interest Coverage Ratio (Interest that can be readily serviced)

8199.4

12196.15

6314.5

7321.95

4338.6

Debt Service Capacity (Interest that can be readily serviced) / Interest Rate on Debt)

$ 81,994

$ 243,923

$ 63,145

$ 73,220

$ 43,386

Value of Business (175% Debt Capacity + Surplus Cash) as Percentage of Market Capitalization

68.09%

113.25%

85.00%

63.90%

66.96%

Final Words

Thus, while the other oil majors are also selling at cheap valuations and attractive dividend yields, the case is a little stronger for Shell on many parameters. If an investor has a highly diversified portfolio of up to fifty stocks, they may consider buying all five companies discussed in the article. Except for Shell, all stocks are well undervalued and worthy of investor attention. However, if the investor has fewer of stocks, Exxon would be our pick from the five companies. The recent shale field acquisitions by Exxon might be the catalyst for unlocking this value over the next decade.

Source: Too Many Oil Bargains: Which Is The Best Bet For Now?