On January 8, 2013, I published a report entitled, "Why You Should Accumulate Shares of Exxon." Since that report, shares of Exxon (NYSE:XOM) increased in value and have since begun to decline. Thus, the share price is at roughly the same level that I recommended purchasing the shares. While the broader market rallied substantially, Exxon was a laggard. I was anticipating a breakout in crude oil prices that never materialized. Crude oil, however, didn't decline substantially in price. Thus, that investment thesis remains in tact for a later date.
In this report, we'll determine how Exxon investors should be positioned. As usual, my goal is to increase alpha or generate better risk-adjusted returns. I generate alpha through correctly forecasting the share price.
In this report, we'll take a look at a number of model inputs that impact Exxon's operational metrics. We'll examine the proved reserves, and realization prices; we'll also take a look at the financial performance and position. The report will include the forecasted financial performance and valuation as well as a forecast for the U.S. unemployment rate. Lastly, we'll see what the charts are telling us and determine the appropriate investment stance based on the evidence.
Investors should reduce long-equity exposure to common equity shares of Exxon: the valuations are near a peak. Next, we'll discuss the proved reserves, and realization prices.
Proved Reserves and Realization Prices
Reserves are a key component of energy firms; Exxon operates in both the crude oil and natural gas markets. Reserves tell us how much the company estimates that it has left in the ground. We'll compare Exxon's reserves to BP's (NYSE:BP) reserves. We'll also look at the realization prices. Some analysts use reserves to value energy firms.
The item disclosures are different for BP and Exxon; thus, we'll compare the areas that are directly comparable. In 2011, BP reported an average liquids realization price of $96.34; Exxon's four-quarter average realization price was $99.01 (both numbers are from U.S. operations). In 2012, Exxon's four-quarter average was $97.67 and BP's was $96.35. In 2011 and 2012, Exxon had higher liquids realization prices.
Both firms also sell natural gas. In 2011, Exxon's four-quarter average realization price was $3.94, and BP's was $3.34. In 2012, BP's average realization price was $2.32, and Exxon's was $2.72. Natural gas prices declined substantially in 2012. Also, Exxon had higher average U.S. realization prices both years.
For Exxon's proven reserves, data for only 2012 is available. Exxon has more than twice as much crude oil, bitumen, and natural gas liquid as BP. Also, Exxon has twice as much natural gas as BP. In terms of market capitalization, Exxon is worth three times as much as BP. Thus, I would say that the total proved reserves are reflected in the relative valuation.
To summarize, Exxon is able to sell crude oil and natural gas at higher prices. Also, Exxon has substantially higher total proved reserves, a fact that is reflected in the market capitalization valuation.
In this section, we'll analyze the historic financial performance; we'll use growth rates and margins to analyze the income statement. Also, we'll compare Exxon's financial performance to competitors Chevron (NYSE:CVX) and BP. Financial performance is a key input to equity analysis, including valuation.
Exxon's revenue growth slowed in 2012 as oil prices and natural gas prices remained relatively stable. After a 27 percent increase in 2011, revenue declined about 1 percent in 2012. Since 2003, revenue increased at an annual compound rate of 8 percent. Net income including non-controlling interest continued to grow. In 2012, net income increased 13 percent after increasing 34 percent the previous year. Since 2003, net income increased at an annual compound rate of 9 percent. The income before income taxes margin increased from 14 percent in 2010 to 16 percent in 2012. Exxon capitalized on rising energy prices.
We'll use sales and other operating revenue to measure BP's sale growth, but we'll use total revenue for the margins. BP's sales and other operating revenue declined 1 percent in 2012 following a 26 percent increase in 2011. Profit before taxes declined over 50 percent in 2012 while the margin contracted from 10 percent to 5 percent. BP's sales and other operating revenue increased at an annual compound rate of 9 percent between 2003 and 2012; net income, during the same period, was roughly flat.
Chevron's revenue declined more than its peers in 2012. Sales and other operating revenue declined 5 percent in 2012 after increasing 23 percent in 2011. Income before income taxes didn't decline as much as sales and other operating revenue. The income before income taxes total revenue margin increased from 16 percent in 2010 to 19 percent in 2012. Chevron has the highest pre-tax margin.
Exxon's performance was the best of the peer group: the growth rates were the best. Chevron does have the higher pre-tax margin, but Exxon's pre-tax margin is improving. The financial performance justified investor optimism the last few months.
We'll examine the financial positions of Exxon, BP and Chevron. We'll take a look at the liquidity and solvency trends. To do that, we'll use the current ratio, cash ratio, long-term debt-to-equity ratio, total-debt ratio, and financial-leverage ratio. Adjustments have been made to some of the financial ratios to get a truer picture of the solvency position of the firms.
First, we'll take a look at how Exxon's financial position changed between 2010 and 2012. Exxon's liquidity position improved: the current ratio increased from 0.94 to 1.01, and the cash ratio increased from 0.13 to 0.15. The solvency position improved: total-debt ratio declined from 0.10 to 0.07, and the financial-leverage ratio declined from 1.98 to 1.94. Exxon is in a solid financial position.
Next, we'll take a look at BP's financial position. BP's liquidity position improved: the current ratio increased from 1.12 to 1.43, and the cash ratio increased from 0.22 to 0.25. The solvency position improved: the total-debt ratio declined from 0.52 to 0.45, and the financial-leverage ratio declined from 2.84 to 2.52. BP is in a decent financial position, but I would like to see the financial-leverage ratio decline to below 2.25.
Finally, we'll examine Chevron's financial position. Chevron's liquidity position improved: the cash ratio increased from 0.59 to 0.64. The solvency position improved: the total-debt ratio declined from 0.11 to 0.09, and the financial-leverage ratio declined from 1.75 to 1.69. Chevron is the most liquid and solvent of the three firms.
Exxon is in the middle of the peer group. The solvency and liquidity position isn't as good as Chevron's, but Exxon is in a solid financial position. Next, we'll discuss my 2013 forecast and the forward valuation.
Valuation is a critical component of equity analysis. We'll use the price-earnings, and price-sales ratios to value the firms. We'll also use time-series relative valuations, absolute valuations, and comparisons to the mean valuation. We'll value BP, Chevron and Exxon.
I'm forecasting 5 to 12 percent revenue growth in 2013 for Exxon; revenue should be between $506.4 billion and $540.2 billion. The forward price-sales ratio should be between 0.76 and 0.71; the current price-sales ratio is 0.83. Net income should increase 7 percent to 15 percent in 2013; net income should be between $51 billion and $54.8 billion. The forward price-earnings ratio should be between 6.99 and 7.51; the current price-earnings ratio is 8.42.
BP is valued at 0.21 times 12 trailing months revenue. Chevron is valued at 1 times sales. Thus, the average current price-sales ratio is 0.68. According to this metric, Exxon is overvalued. On an absolute basis, Exxon is fairly valued, but on a time-series relative valuation basis, Exxon is near previous peaks in value. The valuation metrics are conflicting, but I give the most weight to the time-series relative valuation, which says Exxon is overvalued. Next, we'll cover my forecast for unemployment.
A key part of forecasting financial performance of energy firms is forecasting the U.S. unemployment rate. When the unemployment rate is below the natural rate of unemployment and the economy is operating above potential output, the economy is in an inflationary gap. Thus, energy prices increase when the unemployment rate is below the natural rate of unemployment. An unemployment rate below the natural rate would boost Exxon's financial performance.
I'm continuing to forecast the unemployment rate to drop to 7.1 by the end of 2013 and 6.4 by the end of 2014. By the end of 2015, the unemployment rate could drop to 5.7 percent. Thus, we could start to see some inflationary pressures in 2014 and 2015.
Professionals use technical analysis to manage practical risk. In this section, we'll do some trend analysis using the moving averages, momentum indicators and Dow theory. At the end, we'll reach an investment recommendation based on the technicals.
The share price of Exxon is in an intermediate-term bear market and a primary bull market. The momentum indicators are confirming the intermediate-term bear market and forming negative divergences at the primary-trend level. We remain in a Dow theory defined bull market and throwbacks may be limited in size.
The technicals are suggesting that investors reduce long-equity exposure to the share price of Exxon. Next, we'll conclude this report with an investment recommendation and suggestions for further research.
The time-series relative valuations are near a level of previous peaks and inflation is expected to remain subdued until at the earliest 2014; investors should reduce long-equity exposure to the share price of Exxon. That recommendation applies to short-term, intermediate-term, and long-term investors.
Further research should add more depth to the analysis of Exxon and the industry.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.