Exxon's High Valuation Is Hard to Comprehend

Note: You can click through on any of the graphs to see a larger image.

The above graph shows West Texas Intermediate (WTI) oil prices for about the last four years.

Last October, I wrote that the valuation of Exxon Mobil Corporation (XOM) looked compelling because its share price of $62.36 was at the lower range considering the then prevailing West Texas intermediate (WTI) oil price of about $77.70 per barrel. Now that the share price has appreciated by about 25 percent to $77.57, and WTI oil prices have depreciated by nearly 50 percent to about $40 per barrel, my view has changed.

Before updating my view, I will review two earlier points:

1. As the graph above shows, there are two overlapping clumps of share prices. In the first clump, the share price is highly sensitive to oil prices. And, in the second clump, the share price is relatively insensitive to share price.
2. The NYMEX WTI Oil Futures curve has shifted downwards. February, March and April are all below $50 per barrel. The price steadily rises to $79.33 in December 2017.

I will provide two updated charts, and then I will discuss why I believe that Exxon is now overvalued. First, an updated WTI price chart.

First, we note that the oil prices have come down substantially since last October. Next, we note that during the last four months, Exxon's share price has been largely insensitive to oil price movements. In the above graph, the blue diamonds show the historical relationships from 2004 to August 2008. The red squares show the recent four month relationship between September 2008 and early January 2009.

For oil companies, oil prices are usually the single largest value driver. Of course, there are production, reserves, operating costs, and other important factors. During the last four months, these other factors have remained reasonably stable for Exxon, whereas oil prices have remained volatile.

Slightly beyond our dataset, last Friday, 9 January 2008, Exxon closed at $77.56 and WTI was about $40 per barrel. If we look at the older data represented by the blue diamonds, we see that $77.56 is far above what could be reasonably expected.

Other financial commentators have commented that they don't understand Exxon's valuation. I am in that group as well. Some have commented that Exxon's stock price is governed by futures, index, ETF, and program trading. As stated, I don't understand Exxon's high valuation.

Because I think Exxon is overvalued, I must think it is a great short, right? Wrong. Exxon stock tends to remain immune from oil price movements. If you watch the stock in realtime, you will note that as soon as Exxon begins to spike, so too does the S&P index. Often Exxon will increase more than the S&P index. Yet, intuitively you would think that if oil prices (and thus Exxon) were spiking, that would be bad for the general economy.

I have been trading around Exxon recently. That is, when it spikes higher, I sometimes short a small quantity of shares, usually only to watch Exxon go yet even higher. In those instances, I need patience before covering my position for a gain. And when Exxon spikes lower—even though it still seems overvalued—I sometimes purchase a small quantity of shares. And sometimes I will throw options into the mix just for some added fun.

If you are bullish on oil prices longer term, I don't think Exxon is a great stock to purchase. By looking at the above charts, I don't think Exxon will go much higher with higher oil prices. Other oil and gas companies, however, will go much higher with higher commodity prices.

In conclusion, using oil prices as the key value driver, I judge Exxon overvalued. Even though it is overvalued, I do not think Exxon is a good short candidate. Its recent stock price movements are reasonably insensitive to oil price movements. Moreover, its stock price often goes up more than the S&P 500 general index, which is counterintuitive because higher energy means more of a cost burden on an already overburdened and scared consumer.

Disclosure: I have no position with respect to Exxon Mobil Corporation. This could change at any time, however.

Update

The Online Wall Street Journal has an interesting article Feeling Flush, Exxon Fuels Speculation Deal Is On Tap (subscription required).

Comments

[Ron Mahabir08:]

Interesting analysis. In the long-run, Exxon is way overvalued as their reserves are questionable, particularly with recent changes in oil reserve accounting. In the short- to medium-term, however, reserves can be overlooked as oil prices increase. The stock is a staple in many managers' portfolios, so the volatility is relatively low. With limited new investment, the discounted cashflow value of this decreases, yet with low oil prices in the short-run, there is upside when prices recover. Agree with you that valuing this stock is very tough.

Jan 12 05:14 AM

[epeon:]

I have always had at least one big oil in my portfolion, usually at about 10% of my portfolio's value. However, I tend to view all the majors as approximately the same and usually pick the one with the biggest dividend. Pretty simplistic, I admit. But, it has worked for me. I bought COP when it was cheap because it paid a good dividend. When the price got high and the dividend became low, I sold it and have moved to BP now.

Jan 12 09:11 AM

[joes:]

Exxon is has multiple business lines with margins that vary dependent on the price of oil, production gains when oil is high, refinery profits when oil goes lower. I'm not able to tease the exact ratios apart but it is my feeling that they keep Exxon cash flow healthy at various oil prices.

Jan 12 10:00 AM

[jse17:]

Additionally and more likely than not, XOM no longer holds a key to the White House front door!

Jan 12 10:11 AM

[Gravity404:]

Great comment jse17! Are you referring to Clinton??

Jan 12 10:23 AM

[Mmarrkk:]

Ron: your comment on XOM's reserves being in question due to the new reserves accounting rules is ludicrous. Perhaps you'd like to elaborate? XOM's reserve accounting under today's existing rules is extremely conservative. The new rules will actually loosen things up a small amount, but almost all changes are voluntary. XOM can stick with the existing rules if they please (and they probably will except for year-end pricing vs monthly average pricing). So again, your comment doesn't hold water so please illustrate where I'm wrong!

jse17: what a lunatic! and I guess you believe all of that hope and change shucking and jiving? Every campaign promise that Obama made is now being pulled back. He admitted so on Stephanopilis' show Sunday. He blames it on the bad economy. But everyone knew the economy was bad in October and November but he was still promising a tax cut for 95% of Americans (even though only 40% pay taxes!!), cap and trade (which he now says uhhhh maybe not) and universal healthcare ("well, uh, um, duh, we may have to wait on that"). What a joke. Everything he promised is being fudged on. But this will only surprise the sheeple that voted for him. Hope and change. Yeah, right. We're getting the change part, alright...changing his mind and his promises! He's a loser. I am, however, overjoyed that most of his promises WILL NOT be going forward! I hated all of them. I just hate that people bought his line of crap and voted for an inexperienced talking head because of a pretty story and affirmative action.

Jan 12 10:37 AM

[Mmarrkk:]

You also realize that a huge portion of XOM's production is natural gas, not just oil, right?? and that gasoline refining and marking make up a very small portion of their net income, right? So you need to factor in natural gas somewhere in your equations.


On Jan 12 10:00 AM joes wrote:

> Exxon is has multiple business lines with margins that vary dependent
> on the price of oil, production gains when oil is high, refinery
> profits when oil goes lower. I'm not able to tease the exact ratios
> apart but it is my feeling that they keep Exxon cash flow healthy
> at various oil prices.

Jan 12 10:39 AM

[Wadhamite:]

ExxonMobil makes 70 percent of its money outside of North America, and the economics of the world are better at the moment than the economics of America. To a substantial extent, ExxonMobil is a play on the world's overall financial strength. Remember also that Mobil has a substantial position in premium lubricants worldwide and significant plays in China and southeastern Asia. It's a pretty safe stock.

Jan 12 11:45 AM

[WayneS:]

On Jan 12 11:45 AM Wadhamite wrote:
> ExxonMobil makes 70 percent of its money outside of North America,

It should be added that ExxonMobil has paid $16 billion more in taxes than they made in the US over the last 4 years.

ExxonMobil is buying heavily right now. Lower stock prices would be good for them.

Profit takers must love XOM since its stock jumps up and down $5 every week to month.

Jan 12 01:14 PM

[Kevin Stecyk:]

>>They have the cash flow to keep buying their shares which would scare anyone dumb enough to try and short them.

To some degree, offsetting the share repurchase programs is falling production. Compare current production with that from one year ago. It's about nine percent lower.

Moreover, if you look at the last four months in the last graph, the red squares show that Exxon is reasonably insensitive to oil price movements. Oil price has fallen from over $100 to about $40. Share repurchases have not compensated for that change in oil prices.

Jan 12 02:01 PM

[WayneS:]

Actually, Getty was bought by Texaco and Lukoil. Exxon was Standard of New Jersey and merged with Humble (Texas) and Carter oil (Okla?). Mobil was Standard Oil Company of New York. (SOCONY) Don't forget Chevron and a half dozen other Standard companies still out there.
There are over 500 oil companies in the US. I don't know if Nancy Pelosi wants to nationalize (ala Chavez) all 500 or just XOM. XOM has sold most of their oil fields in the continental US and all of their gas stations.

Jan 12 02:14 PM

[Phenom1:]

XOM production reserves are not an issue as they are valued very conservatively, and selling their own reserves @$38/bbl makes little sense when they can sell entire fields in the anti-oil US for $120+ oil-equivalent.

They have $36 billion in cash and another $200+ billion in Treasury stock which they purchased on the open market at less than half its current value...their stock repurchase rate is about $8 billion/ quarter...do the math, at this rate, they can take the company private in a little over 12 years!

Jan 12 04:15 PM

[henarl:]

XOM is an excellent holding to sell out of the money covered calls against.

Jan 12 05:14 PM

[vodka_tonic:]

people hold XOM because it's a big oil company....that's including mutual funds....ur model does not factor in that 3rd sense human factor, that's why it's flawed (somewhat).

Jan 13 04:19 AM

[shblack2:]

XOM is still a major player in many areas of the world, including the United States. If you have read and listened to many of their reports of late, you will know that XOM stashed a whole lot of cash ($176B, I think) to use during the downturn when the cost of expansions, production is cheaper. They are involved in many of these activities with quite a few more planned throughout Wyoming and Colorado just to name some. They were wise in building their reserves when income was at its highest and therefore able to continue growing while surviving a downturn in the oil and gas industry. We all also need to seriously remember that oil is not their only industry. They have maintained a diverse product mix to help them weather the slump in oil prices.

Jan 13 08:02 AM