We continue to be quite impressed with Exxon Mobil's (XOM) performance. During 2012, return on capital employed surpassed 25%, while the company's reserve replacement hit 115%. The ROCE number was the best among peers. But what about its valuation? After all, isn't that the most important thing investors should ask: What's a company worth? Let's calculate Exxon's intrinsic value in this article.
Our Report on Exxon Mobil
• Exxon Mobil's business quality (an evaluation of our ValueCreation™ and ValueRisk™ ratings) ranks among the best of the firms in our coverage universe. The firm has been generating economic value for shareholders with relatively stable operating results for the past few years, a combination we view very positively.
• Exxon Mobil is involved in the exploration and production of crude oil/natural gas, the manufacture of petroleum products as well as the transportation and sale of crude oil, natural gas and petroleum products. It also makes commodity petrochemicals.
• Exxon Mobil has an excellent combination of strong free cash flow generation and low financial leverage. We expect the firm's free cash flow margin to average about 5.3% in coming years. Total debt-to-EBITDA was 0.1 last year, while debt-to-book capitalization stood at 6.5%.
• We were quite impressed with Exxon Mobil's 2012 performance. Return on capital employed surpassed 25%, while the company's reserve replacement hit 115%. The ROCE number was the best among peers, and the firm has been consistently replacing reserves.
• The firm sports a very nice dividend yield of 2.9%. We expect the firm to pay out about 31% of next year's earnings to shareholders as dividends.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Exxon Mobil's 3-year historical return on invested capital (without goodwill) is 15.1%, which is above the estimate of its cost of capital of 9.7%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Exxon Mobil's free cash flow margin has averaged about 5.1% during the past 3 years. As such, we think the firm's cash flow generation is relatively STRONG. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website at Valuentum.com. At Exxon Mobil, cash flow from operations increased about 16% from levels registered two years ago, while capital expenditures expanded about 28% over the same time period.
Our estimated fair value of $95 per share for Exxon represents a price-to earnings (P/E) ratio of about 9.8 times last year's earnings and an implied EV/EBITDA multiple of about 4.7 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 2.6% during the next five years, a pace that is lower than the firm's 3-year historical compound annual growth rate of 15.8%. Our model reflects a 5-year projected average operating margin of 13.8%, which is above Exxon Mobil's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 3.9% for the next 15 years and 3% in perpetuity. For Exxon Mobil, we use a 9.7% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $95 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Exxon Mobil. We think the firm is attractive below $76 per share (the green line), but quite expensive above $114 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Exxon Mobil's fair value at this point in time to be about $95 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Exxon Mobil's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $116 per share in Year 3 represents our existing fair value per share of $95 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements