With both Standard & Poor’s and Moody’s warning of a potential downgrade of the United States sovereign debt credit rating, and no credible federal deficit reduction plan in sight, investors are once again as in the crisis-ridden recent years, wondering where the safe heaven is for their capital. United States Treasuries and the dollar have so far been unquestionably the beneficiaries of any global crisis. For the lack of a substitute “safe-heaven” asset, money has flown to Treasuries and the dollar for no fundamental merits on the part of the issuer, and investors know this.
If a default by the United States government does come to pass, even just temporarily, Treasuries will lose its long-term prerogative as a “safe-heaven” asset. If the political wrangling in Washington leads to some sort of “stop-gap” measure before the debt limit's deadline on August 2nd, a more likely scenario, it would further strengthen investors’ resolution to seek the next “safe heaven” asset. Be it gold, or a basket of foreign currencies backed by fiscally sound governments and diversify away from Treasuries, knowing its status to be a ticking bomb that could explode in your face at any minute.
A recent article in the Financial Times reported that central bank reserve managers who collectively control more than $8,000 billion are disenchanted with the dollar as a global reserve currency, and the banks will gradually move toward backing a basket of currencies.(1) Slowly but surely, everybody is realizing that the old practice of leaving dollar bills under the mattress might not save you on a rainy day.
In my opinion, holding either the debt or equity of a rock-solid company such as Exxon Mobil (XOM), is safer over the next five to ten years than anything issued by the United States government. If the global economic recovery continues in the second half of the year, oil prices and XOM will continue to do well. If the United States economy weakens, the Federal Reserve will print more money, and the dollar will continue its journey of debasement.
XOM has gained 10% year to date, 29% during the last five years, and 92% during the last ten years, soundly beating the S&P in every time frame. It is financed conservatively with 93% equity and 7% debt. The company has increased its liquids reserves from 7,744 millions of barrels of oil equivalent (mboe)(2) in 2007 to 8,890 mboe in 2010, and natural gas reserves from 5,435 mboe in 2007 to 15,919 mboe in 2010.
XOM applies LIFO accounting to value its inventories, a practice prescribed by the U.S. GAAP, while XOM’s global peers apply FIFO, the only inventory accounting practice allowed by the IFRS (International Financial Reporting Standards). The FASB (Financial Accounting Standards Board) is likely to move toward FIFO accounting to be in full conformity with the international accounting standards.
If it does so, XOM’s earnings in 2010 would increase by $12.6 billion net of tax. Even without the inventory adjustment XOM’s annual return on capital was consistently above 15% from 2007 through 2010 although the crude price(3) fluctuated wildly between $119/barrel during the second quarter of 2008 and $36/barrel during the first quarter of 2009, and back to $93/barrel during the first quarter of 2011.
XOM currently has a dividend yield of about 2.3%, while a decent yield, hardly enough to preserve capital in today’s inflationary environment. The company earned a net income of $10,650 million in the latest quarter, and of that amount, $2,188 million was paid out as dividends while $5,653 million was spent repurchasing shares. That represents a 74% payout ratio to common shareholders.
XOM is undervalued at $83/share. If I apply a multiple of 13 to its rolling twelve-month earnings, I will calculate a share price of $91.
XOM’s stock-split adjusted price was $43 on July 13, 2001, about ten years ago. The company’s net book value per share, a metric that Warren Buffet uses at the beginning of his annual letter to shareholders every year, has tripled from $10.40 in 2001 to $30.47 during the first quarter of 2011. In 2001 the crude price was trading in the twenties, hardly a frothy level, so we can assume that XOM was probably not over-priced. Tripling the July 13, 2001 price would value XOM today at $126/share [$43 X (30.47/10.4)].
I will take advantage of the market volatility introduced by the debt limits uncertainty to purchase XOM low.(4)
- Dollar Seen Losing Global Reserve Status, June 27, 2011
- millions of barrels of oil equivalent
- XOM realized crude price in the United States, per quarterly earnings supplement.
- I own XOM only through mutual funds.