Exxon Mobil's Hidden Source Of Value

| About: Exxon Mobil (XOM)

This article is part of an ongoing series that highlights specific companies that are on sale. It helps me to document my thought processes when I add to my holdings or initiate new positions. Please provide your feedback in the comments section below.

Exxon Mobil (NYSE:XOM) is currently offering investors an opportunity to buy portions of the company at under $88/share. The stock has been steadily declining for the past few months since reaching its 52-week high, but has been ramping up these past couple weeks and may provide a good entry point. Right now, XOM is about seven percent off the 52-week high, hit a few months ago at almost $95 per ownership interest. This few month pullback and recent ramp provides long-term investors with a good opportunity to initiate a position. Essentially, XOM has earned a whole quarter's worth of profit and repurchased an entire quarter's worth of shares, yet the price is lower than it was a quarter ago.

Exxon Mobil has a business model that is simple and sustainable, and it has continued to thrive ever since being broken up from John D. Rockefeller's Standard Oil. They explore for, produce, and transport oil, gas, and derivatives of those products. According to the 2012 Annual Report, net income came in at $44.9 billion, an increase of over nine percent year over year and an increase of almost 50% from 2010! They also had operating cash flow of $56 billion and an industry-leading return on capital employed of over 25 percent. Total debt declined by over 30 percent down to $11.5 billion.

Despite the growth, I believe that XOM trades at a discount to its true valuation. XOM currently trades at 11 times ttm earnings and 11 times projected next year earnings. EPS is expected to grow over 6% next year. Exxon Mobil will be reporting earnings on October 31st, and I believe that it will have a positive surprise. I believe that this will be the catalyst that will propel Exxon Mobil's stock higher. In the meantime, I am content to accumulate shares at this perceived discount.

Also, XOM is a cannibal! XOM has been buying back its own stock at a pace that dominates most companies and affects the bottom line. Just two years ago, there were over 5 billion shares outstanding of XOM. Today, there are 4.4 billion shares. In less than three short years, Exxon Mobil has retired 12% of its outstanding share volume! From 2010 to 2012, XOM repurchased over $55 billion of its shares. They are using their free cash flow to buy out other shareholders, which further adds to the gains of the remaining shareholders.

With Exxon Mobil buying so much of their outstanding shares, let's look at how that will affect earnings. Analyst expectations are very low. Exxon Mobil is set to report its earnings on October 31st, and analysts are expecting a consensus EPS of $1.87, which is substantially lower than the prior year's EPS of $2.09. It doesn't appear that analysts are expecting much, if anything, from XOM. With XOM's large share buyback activity, it wouldn't have to make more in total earnings to affect the bottom-line EPS. I believe that Exxon Mobil will have a positive surprise, and this is the catalyst that will cause XOM to break out from its downward trend and close substantially higher at the end of 2013.

Let's take a quick look at a couple of XOM's competitors, Chevron (NYSE:CVX) and British Petroleum (NYSE:BP). Exxon has less debt to equity than both of them, with XOM boasting 0.12 versus Chevron's 0.14 and BP's 0.36. Debt is a drag on free cash flow as it encumbers cash for the interest payments. For every dollar spent servicing debt, that's one less dollar for dividends, share buybacks, or reinvestment. Exxon Mobil also spends its money better. Exxon's ROA, ROE, and ROI are all higher than its two competitors. This is the type of company that I want to own for the long haul.

Exxon Mobil also has a solid yield. You literally get paid to wait. XOM has a current yield of 2.9%. During the financial crisis, Exxon Mobil did not cut its dividend. In fact, it raised the dividend. Exxon Mobil is a Dividend Champion and has raised its dividend every year for 31 years. XOM is both a buyback king and a dividend king!

Combined with their earnings growth and share buyback activity, there is one other catalyst. According to the Stock Traders Almanac, the price of oil tends to weaken during the fourth quarter. Since the stock price of most oil majors is directly correlated with oil prices, we might expect XOM to pull back here over the next month or two, presenting yet another buying opportunity. As oil prices would be expected to rebound in the first quarter of next year, XOM would be expected to increase. I want to be adding to my position before then. XOM has low debt, with a debt/equity ratio of only 0.12, and it earns a ROE of over 20%, which is very strong. Proved oil and gas reserves additions of 1.8 billion oil-equivalent barrels, replacing more than 100 percent of production for the 19th consecutive year. As sales growth and increasing cash flow is used to buyback shares, its financial position will only become stronger. I believe that Exxon Mobil is one of the strongest companies out there, which is also evidenced by its AAA credit rating.

As always, this article represents my opinions at the time of writing. You should do your own due diligence before making any decisions. However, I believe that Exxon Mobil represents a quality company that is trading hands at a discount.

Disclosure: I am long XOM, CVX, BP. 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.