- The expected production volume decline and capex increase in 2014 would weigh on near-term share price performance.
- The company is likely to rely on additional borrowings to fund its dividend and share buyback programs in the coming years, putting pressure on shareholder value.
- Given Exxon's premium valuation relative to its peers and that there is a lack of visibility into future production growth, the risk is to the downside.
Management now expects total production to be 4.0 mmboe per day in 2014, representing a 4% year-on-year decline from the level in 2013. Management also lowered their long-term production expectation from the previous 4.8 mmboe per day to 4.3 mmboe per day. On the capex front, the revised guidance was also a negative. The company now expects the capex level to peak in 2014 rather than in 2013 and guided a total capex of $39.8B for 2014, which is higher than the actual level of $38.2B in 2013.
I have performed an analysis to evaluate XOM's liquidity condition in 2014 and concluded that the company will need additional borrowing to fund its dividend and share buyback programs even with no growth in size. XOM spent a total of $26.9B in paying dividend and buying back shares in 2013 ($16.0B for share repurchase and $10.9B for dividend). Assuming that this level stays unchanged in 2014 and management's 2014 capex guidance ($39.8B) holds, the company will need a total of $66.7B cash to finance these activities from internally-generated funds and/or external borrowings. Given the expected decrease in production volumes in 2014, it is believed that XOM would not see notable improvement in operating cash flows in the year. As such, I assumed operating cash flow to grow by 5% in 2014 to $47.2B from $44.9B in 2013. Further, as XOM only has $4.6B in cash and the level has reached its 10-year low (as the company's capex in the past few years continued to exceed operating cash flows), I wouldn't expect management to be able to deploy any cash from balance sheet in 2014. As such, the required debt funding is approximately $19.5B (the difference between $66.7B and $47.2B), and this suggests that total debt level should increase to approximately $42.2B by the end of 2014. Assuming there are no major changes in XOM's enterprise value and cash balance, the higher debt balance would have more than negative 3% impact on the share price. It should be noted that this analysis does not account for any growth in dividend and share buyback in 2014. The negative impact on share price would be about 5% if management elects to increase both dividend and share repurchase size by 10%, apparently not a good sign for shareholders (see charts below).
Over a longer term (i.e., between 2015 and 2017), management expects average annual capex to remain below $37B. Assuming that capex declines to $33B in 2017 and there remains no growth in 2013 dividend and share buyback at $26.9B, total cash needed to fund these activities would be $60.0B. In order to internally fund these activities in 2017, operating cash flow should rise by 10% CAGR from $44.9B 2013 to $60.0B in 2017. Given that there remains no sign of notable improvement in production volumes beyond 2014, I view the 10% operating cash flow CAGR to be aggressive, which means that XOM would probably need to continue raising debt beyond 2014.
Despite the above, XOM still enjoys a premium valuation relative to its mega-cap peers. The stock now trades at 12.3x 2015 estimated EPS, which is 25% above peer average at just 9.9x. Factoring in XOM's consensus long-term earnings growth estimate of 5.1% (compared to peer average at 5.9%), XOM trades at 2.4x PEG, which is 29% higher than peer benchmark. Some investors may argue that XOM's premium valuation is warranted given its above-average return on common equity. However, the metric has trended down considerably in 2013 and was near its historical level in 2009, when the financial crisis happened. Moreover, XOM's current dividend yield is also the lowest among the mega-cap peers and its dividend growth prospect appears to be weak given my analysis above (see charts below).
In summary, share performance of XOM is likely to be weighed by the company's near-term headwind and premium valuation. Until the company can demonstrate some visibility of production improvement, investors are recommended to stay on the sideline or pursue other better opportunities in the O&G space.
All charts are created by the author, and data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.