In a quarterly regulatory filing, Warren Buffett's Berkshire Hathaway (NYSE:BRK.B) disclosed a 40.1 million share stake in Exxon Mobil (NYSE:XOM). At Thursday's close, that position is worth $3.74 billion. Based on this size, it is clear that Buffett and not one of his portfolio managers decided to make this purchase. Buffett, while possibly the greatest investor in history, has an imperfect record when it comes to the major oil companies. He famously bought 84 million shares in ConocoPhillips (NYSE:COP) from 2006-2008, ramping up purchases as oil prices soared to unsustainable levels in July 2008 and sold much of the position near the lows in 2009, costing Berkshire several billion dollars. So should investors follow Buffett into Exxon?
In many ways, I believe the underpinning thesis for Exxon is similar to that of IBM. Both companies have had difficulty growing revenues but return a significant amount of cash to shareholders, increasing earnings per share by decreasing the float rather than growing net income. In the last quarter alone, Exxon returned a total of $5 billion to shareholders, including repurchasing 34 million shares. In the past twelve months, the company has bought back 202 million shares or 4.4% of existing shares. With $55 billion in annual operating cash flow against $35 billion capital expenditures, investors should continue to expect significant returns of capital every year.
However, I would not expect too much growth in Exxon. The company has struggled to grow its production for years. In the past quarter, the company was able to grow volumes by 1.5% year over year, though there was a sequential drop of 1.4%. This 1.5% growth annual rate was a really positive surprise after years of struggling to grow at all. The fact that 1.5% growth was stunningly positive illuminates their difficulties since 2008. Still, I would not bet on Exxon being able to consistently grow production. This past quarter was more of an exception than the norm, and until Exxon is able to grow production in several quarters, I would not simply assume its days of production declines are behind it.
Over the past five years, Exxon's growth has significantly lagged that of Conoco and Chevron (NYSE:CVX), yet it is trading at 11.7x 2014 earnings while COP is 11.5x and CVX is 9.96x. Given their better growth profiles, I think there is no reason to pay a premium for Exxon, especially as declining refining margins will impact its earnings without hurting Conoco, which has divested downstream opportunities. Similarly, Exxon added significant natural gas exposure through acquisitions near the top, and it may be several years before we see a rebound in nat gas pricing due to the massive increase in U.S. production, which will likely leaving it lagging CVX.
No doubt, Exxon is a fantastic company, and at an 11.7x multiple, it is not an expensive stock, but I do not believe it is the most attractive of the major oil stocks. Over the next five years, I believe Exxon will be fortunate to generate 1-2% annual production growth while CVX and COP should be growing in the 3-5% range with relative ease. Further, COP yields 3.7% while CVX yields 3.3% compared to 2.8% for Exxon. All three firms are generating significant operating cash flow with the potential to increase dividends and buybacks. By investing in either CVX or COP, investors will benefit from production growth and capital returns to shareholders while XOM shareholders will derive the majority of their returns from capital returns.
While I believe Buffett is wise to invest in a diversified oil company, Exxon is one of the weaker choices because of its multi-year battle against declining production. Despite this problem, Exxon trades at a premium to Conoco and Chevron. At 12x earnings, Exxon is trading at a slight premium to historically normal valuations and is fairly valued here. Despite Buffett's endorsement, I would still buy shares of CVX or COP before XOM because they remain relatively cheap despite superior growth profiles.
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.