- Free cash flow will likely grow by double digit CAGR in the next few years driven by greater profitability and lower capital spending.
- Dividend per share may grow at single digit CAGR in the next few years due to lower EPS growth relative to free cash flow growth.
- Current valuation has priced in a reasonable dividend growth assumption.
The share price of Exxon Mobil (NYSE:XOM) has appreciated by almost 10% over the past 3 months, outperforming a 5% gain for S&P 500 Index. The company has recently announced a 10% dividend hike, leading many investors wonder whether XOM can live with the double-digit dividend growth going forward. In this article, I will provide readers some perspectives on XOM's future cash flow and dividend trends through some projection analyses.
I performed free cash flow projections to gauge XOM's capacity for future dividend growth. The analysis started with consensus revenue estimates which predict the top line to decrease by 2.3% CAGR from $422.6B in 2014 to $403.4B in 2016. XOM's operating cash flow margin trended from 10.3% to 14.1% in the past 5 years. I assumed the operating cash flow margin to expand by 100 bps from 12.3% (5-year average) in 2014 to 13.3% in 2016. It should be noted that current consensus view expects about 300 bps EBITDA margin expansion over the current and next 2 fiscal years, meaning that my margin assumption here could be somewhat conservative (if EBITDA to operating cash flow conversion remains stable). For capital expenditure, I used management guidance which calls for $39.8B spending in 2014 and an average annual spending of $37B in 2015 and 2016. Based on these assumptions, free cash flow was projected to increase by 16.8% CAGR from $12.3B in 2014 to $16.7B in 2016 (see chart below).
As XOM is now expected to pay out an annual dividend of $2.70 per share in 2014 ($0.63 in Q1 and $0.69 in Q2-Q4), I estimated that XOM would incur approximately $11.6B dividend spending in the year based on my share count projection (discussed later), representing a year-over-year growth of 6.9%. Hence, XOM's free cash flow dividend payout ratio in 2014 would be about 95%, Given my projected free cash flow CAGR at high double digit from 2014 to 2016, the company should see its free cash flow dividend payout ratio decrease during the forecast period as growth in dividend spending is unlikely to be at double digit level. Assuming the same dividend spending growth of 6.9% in 2015 and 2016, XOM's free cash flow payout will decrease from 95% in 2014 to 80% in 2016. In this case, the company's excess free cash flow will increase from just $622M in 2014 to $3.4B in 2016, which can be used for share buybacks (see chart above).
I then assumed the company to spend $12B annually in share repurchase from 2014 to 2016, which is in line with consensus estimates which are generally in a range from $11B to $13B. Based on an annual growth assumption of 10% for share repurchase price starting from $100, I projected that average share count will be reduced to 4.1B by 2016. Hence, dividend per share was projected to grow by 9.4% CAGR from $2.70 in 2014 to $3.23 in 2016. Compared with consensus EPS estimates from 2014 to 2016, my dividend per share forecasts imply that earnings dividend payout ratio will increase from 35% in 2014 to 41% in 2016. The increasing earnings payout trend is largely due to the lower EPS CAGR relative to my projected dividend per share CAGR. Even though XOM's consensus long-term EPS growth estimate of 4.1% is higher than its near-term growth estimate, it is still notably below my 9.4% dividend CAGR forecast, meaning that the earnings payout ratio will continue to rise over a long run, which is not a sustainable trend (see chart below).
Nevertheless, a positive sign is that XOM may see a strong free cash flow growth in the next few years driven by greater profitability and decreasing capital expenditure. In addition, the company's balance sheet is much less leveraged compared to other global integrated oil peers, implying an ample room for additional debt borrowings (see chart below).
The two factors together would suggest that XOM could spend more on share buybacks than what market currently expects ($11B-$13B per year). If that is the case, potential EPS growth may exceed current consensus estimates due to additional share count reduction that is not being factored in the expectation. This would create room for dividend per share growth as the earnings dividend payout ratio will become a less constraint factor. Therefore, I expect XOM's annual dividend per share growth in the next few years to be just slightly below 9% (likely 7%-8%).
Based on current annualized dividend of $2.76 per share and 10% cost of equity, the Gordon Growth Dividend Discount Model suggests that the current share price of ~$102 has priced in a dividend growth rate of 7.0%-7.5%, which is in line with my expectation (see chart below).
In conclusion, as long as management plans to maintain healthy/steady free cash flow and earnings dividend payout trends, I would expect the dividend per share to grow by 7%-8% over the next few years, which is supported by strong free cash flow growth and continued share buybacks.
All charts are created by the author, and historical data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.