## Summary

- Exxon Mobil consistently outperforms competitors with respect to returns on capital.
- Returns are high even when using the Chevron/Shell definitions.
- Exxon Mobil talks the talk and walks the walk.

## Introduction

Exxon Mobil (NYSE:XOM) has consistency delivered higher returns on capital than competitors over the last 5 years. Being a non-GAAP metric, return on capital can be calculated using different methods so it is important for us to compare apples to apples.

*Source: 2013 Exxon Mobil Annual Report Page 4

XOM calculates things a little differently than Chevron (NYSE:CVX) and Shell (NYSE:RDS.A) with respect to equity companies but their number still comes close to the number using the CVX/RDS.A logic. In order to compare apples to apples, we will look at the returns using the Chevron/Shell logic for all 5 companies.

Return on Capital is a percentage so it doesn't matter that the Total SA (NYSE:TOT) numbers are in millions of Euros and the numbers for the other companies in the group are in millions of US dollars.

It isn't surprising that XOM outperforms competitors when using their definition of returns on capital employed. In this article we show that XOM also outperforms when we use the CVX and RDS.A definitions for returns on capital employed.

Looking at the group, BP doesn't talk about return on capital much in the annual report. CVX, RDS.A and TOT talk about it but they don't deliver results as high as XOM.

**Exxon Mobil Calculation**

XOM defines capital employed as equity plus short and long term debt. The big numbers come straight off the income statement and the balance sheet but some of the small numbers get a little tricky because of non-controlling interests.

XOM calculates ROCE as 17.2% for 2013.

*Source: 2013 Exxon Mobil Annual Report Page 44

*Source: 2013 Exxon Mobil Annual Report Page 45

Looking at the last 2 items above from the Debt and Equity Perspective, those don't factor into the equation using the Chevron/Shell methods. In other words, the (2,443) and 6,109 aren't used. These are relatively small numbers but they do make a little bit of a difference.

Looking at EDGAR, we can see this same ROCE logic going back to the 2002 10-K. This 2002 10-K does the calculation going back to 2000.

XOM breaks down ROCE by segment on page 5 of the annual report:

Upstream: 26,841/152,969 or 17.5%

Downstream: 3,449/24,430 or 14.1%

Chemical: 3,828/20,665 or 18.5%

Corporate (1,538)/(6,489) - N.A.

*Note that the sum of the parts is consistent. In other words, 26,841 + 3,449 + 3,828 - 1,538 is 32,580 which is the same earnings figure used throughout the report for ROCE. Likewise, 152,969 + 24,430 + 20,665 - 6,489 is 191,575 which is the same average capital employed figure used throughout the report.

Using the CVX/RDS.A methods, we get a slightly different number for Exxon Mobil's ROCE.

Numerator: 32,580 + 5 interest expense after tax = 32,585

*32,580 is from the income statement. The tax percentage is 24,263 income taxes/57,711 Income before taxation = 42%. 9 interest expense*..58 = 5 interest expense after taxes.

Denominator:

Notes and loans payable: (15,808 + 3,653)/2 = 9,730.5

Long-term debt: (6,891 + 7,928)/2 = 7,409.5

Equity: (174,003 + 165,863)/2 = 169,933

*above 3 lines are from the 2013 and 2012 balance sheets

The Denominator is 9,730.5 + 7,409.5 + 169,933 or 187,073

32,585/187,073 = 17.4% ROCE for XOM in 2013 using the CVX/RDS.A methods (within 2/10ths of one percent of XOM's method).

## Chevron Calculation

CVX explicitly defines ROCE in the annual report:

Return on capital employed (ROCE) Ratio calculated by dividing earnings (adjusted for after-tax interest expense and noncontrolling interests) by the average of total debt, noncontrolling interests and Chevron Corporation stockholders' equity for the year.

[2013 Chevron Annual Report Page 8]

The 2013 annual report doesn't show any interest expense in the Financial Highlights on page 4.

Numerator: 21,423

*from the income statement

Denominator:

Short-term debt: (374 + 127)/2 = 250.5

Long-term debt: (19,960 + 11,966)/2 = 15,963

Equity: (149,113 + 136,524)/2 = 142,818.5

*above 3 lines are from the 2013 and 2012 balance sheets

The Denominator is 250.5 + 15,963 + 142,818.5 or 159,032

21,423/159,032 = 13.5% ROCE for CVX in 2013.

## Shell Calculation

Like CVX, RDS.A gives a straightforward explanation of their return on capital employed logic:

Return on average capital employed (ROACE) is defined as annual income, adjusted for after-tax interest expense, as a percentage of average capital employed during the year. Capital employed is the sum of total equity and total debt.

[2013 Shell 20-F Page 21]

The company makes it very easy for investors to see how the numbers come together:

*Source 2013 Annual Report Page 51

RDS.A calculates ROACE as follows:

Numerator:

16,526 Income + 808 Interest Expense After Tax = 17,334

*16,526 is from the income statement. Interest expense on the income statement is shown as 1,642 but page 51 of the 20-F shows the after tax interest expense amount as just 808. The tax percentage is 17,066 Taxation/33,592 Income before taxation = 50.8%. 1,642*.492 = 808 interest expense after tax.

Denominator:

Current Debt: (8,344 + 7,833)/2 = 8,088.5

Non-current Debt: (36,218 + 29,921)/2 = 33,069.5

Equity: (181,148 + 176,182)/2 = 178,665

*above 3 lines are from the 2013 and 2012 balance sheets

The Denominator is 8,088.5 + 33,096.5 + 178,665 or 219,823

Per the above screen shot, the company noted that about 31% of the capital employed did not generate revenue (exploration). This lowered the return by about 4%.

17,334/219,823 = 7.9% ROACE for RDS.A in 2013.

## Total SA Calculation

The 20-F shows a combined ROACE of 13%.

Capital employed is defined as:

Non-current assets and working capital, at replacement cost, net of deferred income taxes and non-current liabilities.

[2013 20-F Page F-19]

The company shows ROACE by segment:

*Source: 2013 220-F

Using the CVX/RDS.A method, we get a vastly different number.

Numerator: 8,440

*from the income statement

Denominator:

Non-current debt: (25,069 + 22,274)/2 = 23,671.5

Current borrowings: (8,116 + 11,016))/2 = 9,566

Equity: (72,629 + 71,185)/2 = 71,907

*above 3 lines are from the 2013 and 2012 balance sheets

The Denominator is 23,671.5 + 9,566 + 71,907 or 105,144.5

Factoring in debt, we get a larger denominator this way which means the percentage drops.

8,440/105,144.5 = 8% ROACE for Total S.A. in 2013 using the Chevron/Shell methods.

## British Petroleum Calculation

Unlike the other companies in this group, British Petroleum (NYSE:BP) doesn't explicitly use the "return on capital employed" phrase in the annual report.

Page 3 of the annual report defines operating capital employed for the Downstream segment as follows:

Operating capital employed is total assets (excluding goodwill) less total liabilities, excluding finance debt and current and deferred taxation.

Here is what BP says about capital allocation:

And we aim to make disciplined financial choices, so we can achieve continued growth in operating cash from our underlying businesses and disciplined allocation of capital.

[BP Annual Report Page 13]

BP does talk about capital employed but the verbiage is different:

This strategy is about winning sustainably in the markets where we choose to participate. We seek to outperform the best competitor in a region and do it safely; investing to strengthen our established positions while maintaining overall capital employed, and still seeking to shift the mix of participation and capital employed from established to growing markets. We do this while operating within a stable financial framework to deliver attractive returns and growth in earnings and cash flow.

[BP Annual Report - Downstream Section Page 31]

We can calculate ROCE ourselves for BP using the Chevron/Shell method.

Numerator: 23,451

*from the income statement

Denominator:

Current Finance debt: (7,381 + 10,033)/2 = 8,707

Non-current finance debt: (40,811 + 38,767)/2 = 39,789

Equity: (129,302 + 118,546) = 123,924

The Denominator is 8,707 + 39,789 + 123,923.5 = 172,420

23,451/172,420 = 13.6% ROCE for BP in 2013 using the Chevron/Shell methods.

## Closing Thoughts

Charlie Munger noted that return on capital is extremely important for long term investors:

Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns six percent on capital for forty years and you hold it for that forty years, you're not going to make much different than a six percent return - even if you originally buy it at a huge discount. Conversely, if a business earns eighteen percent on capital over twenty or thirty years, even if you pay an expensive looking price, you'll end up with one hell of a result.

[Poor Charlie's Almanack Page 206]

It is beyond the scope of this article to determine whether Exxon Mobil is selling at a huge discount, an expensive looking price or something in between right now. That said, I think I'll be happy as an owner as long as the company can continue to outperform its peers with respect to return on capital.

Rex W. Tillerson became Exxon Mobil Chairman and CEO on January 1, 2006. The 2004 Letter to Shareholders is signed by both Lee R. Raymond (Chairman and CEO) and Rex W. Tillerson (President). Like more recent letters from Mr. Tillerson, the 2004 letter specifically mentions average capital employed, noting that it increased to 24 percent that year. I believe ROCE is deeply ingrained in the company and it will continue to be a priority regardless of who is in charge. Exxon Mobil has done a nice job compared to peers over the last 5 years, hopefully they will continue over the next 5 years.

Sources:

**Additional disclosure:** Any material in this article should not be relied on as a formal investment recommendation.

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