It is rare to see companies missing their target EPS for the quarter by a margin as large as 15% and not be punished on "the Street" but Exxon Mobil (NYSE:XOM) seems to have gotten away with it. The company posted highly disappointing results for the second quarter but, by now, we have learned that high oil prices do not automatically result in higher profits for giant energy companies especially if operations are integrated. It is surprising that the stock was punished so little and it would seem that investors have ignored refining operations, which were primarily responsible for the poor performance and concentrated on the much bigger upstream exploration and production activities, which continue to be profitable. Naturally, the company will continue to remain a good bet for income investors looking for exposure to the energy sector but it does seem that other energy stocks should now be seriously considered for investment.
Exxon Mobil reported its lowest quarterly profit since 2010 as the energy behemoth struggled to increase production against the backdrop of weak refining operations. Net income declined by 57% to $6.86 billion from $15.9 billion in the same quarter of the previous year though the figure for the previous year included extraordinary gains from the sale of its lubricants business in Japan as well as other assets. Excluding the extraordinary gains in 2012, net income still realized a decline of 19%. EPS came in at $1.55 versus the consensus analysts' estimates of $1.90 per share. Revenues plummeted by 16% to $ 100.5 billion compared with $126.4 billion in the previous year with the company attributing the decline to the sluggish U.S. economy, the continued weakness in Europe, and lower growth in China. This led to a $10 per barrel decline in the prices of Brent crude compared to the previous year. The company last posted a profit of under $7 billion in the first quarter of 2010, when oil prices were an average of $79 per barrel compared with $94 in the second quarter of 2013.
On the upstream operations, the lower earnings were a result of higher drilling costs while production was flat or declining. For the second quarter of 2013, oil and gas production declined by 1.9% making this the ninth consecutive quarter in which production has declined. This also raises questions about Exxon's chances of reaching its production targets between 2014 and 2017. The refining operations were affected by the narrower operating margins resulting from oil prices rising faster than the prices of gasoline. These narrower margins resulted in a reduction in operating profits by $510 million and with the lower production, because of maintenance at the refineries, resulted in a further reduction of $370 million.
Though problems with refining stood out prominently, the company had problems right across the board. The chemicals business earnings decreased by 50% to $756 million as a result of the restructuring of the Japanese operations, lower margins and volumes, and problems with the product mix.
Exxon's weak points
It is very well for the company to brag that it only thinks in the long term but it cannot fully control the factors that will determine its performance for the next 10 years. For instance, it is supposed to have an advantaged position in refining within the United States because of its Midcontinent exposure but this did not show up in the results for the second quarter. Moreover, its position as the largest producer of natural gas in North America is not particularly useful when prices are low and cannot be offset by profits from other businesses. Finally, the consideration that does not find favor with many investors is the fact that of its 51% liquids share of its reserves, about half is in assets that produce bitumen and syncrude.
The bottom line
In judging the investment value of energy companies, growth in production is only one of the factors that should be taken into consideration. What is at least as important is the maximization of profits per barrel and theoretically, Exxon is well placed to do this because of its refining and chemicals operations in addition to exploration and production. However, in my view, the jury is still out on the merits of integrated energy producers particularly in view of the outstanding performance of ConocoPhillips (NYSE:COP) in the second quarter. I would have to conclude that Exxon stock is fully and fairly valued at the current price and my rating would be a Hold.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.