Exxon Mobil & Devon Energy: Expected Return for 2007

A stock at a McDep Ratio of 0.98, like buy-recommended Exxon Mobil (XOM), would return 7% unlevered in 2007, plus 2% for an increase in McDep Ratio to 1.0. The return would be boosted by another 10% if equity investors were to believe that the long-term oil outlook was $66 a barrel, as futures investors price the commodity for the next six years, rather than $60 a barrel that is built into a McDep Ratio of 1.0.

Those returns are before adjustment for inflation. A conservative investor, moreover, holding bonds and cash in addition to stocks, could boost the equity return with replication of the leverage a hedge fund or private equity fund might apply, by holding less fixed income and more XOM stock. Expected return for a stock at a low McDep Ratio of 0.64, like buy recommended Devon Energy (DVN), would be 7% in 2007 plus 56% unlevered, possibly within a year, with an increase in McDep Ratio to 1.0.

Among other risks and depending on each company’s mix of operations, expected returns also depend on natural gas, which we believe eventually has sharp price recovery potential, and on refining margins near those currently being achieved.