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Exxon Mobil (XOM) manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics and a range of specialty products. The company is a dividend aristocrat that has raised its dividend for 29 consecutive years.

A 10-year summary of Sales, Earnings Before Interest and Tax (EBIT), Earnings per share (EPS), yearly high and low stock price, corresponding high and low P/E (calculated by dividing high and low price by the EPS for the year), and average P/E (average of high and low P/E) is shown below in Table 1.

Year Sales (in Millions) Net Income (in Millions) EPS High Price Low Price High P/E Low P/E Average P/E
2010 370125 52959 6.22 73.2 56.57 11.8 9.1 10.4
2009 301500 34777 3.98 81.65 64.03 20.5 16.1 18.3
2008 459579 83397 8.66 94 62.36 10.9 7.2 9.0
2007 390328 71479 7.26 95 69.86 13.1 9.6 11.4
2006 365467 67402 6.62 77.3 58.1 11.7 8.8 10.2
2005 358955 59432 5.71 63.85 53.7 11.2 9.4 10.3
2004 291252 41241 3.89 51.97 40.29 13.4 10.4 11.9
2003 237054 31966 3.15 40.63 32.69 12.9 10.4 11.6
2002 200949 17510 1.62 43.85 32.4 27.1 20.0 23.5
2001 208715 23970 2.16 45.1 35.83 20.9 16.6 18.7

Table: Key 10-year data for Exxon Mobil.

From these data, we can plot Sales, EBIT, and EPS versus Year, as shown in Chart 1 below.

Chart: Sales (in Millions), EBIT (in Millions), and EPS versus Year for Exxon Mobil, from 2001-2010.

As evident from Chart 1, XOM has demonstrated reasonably predictable sales and earnings over the past 10 years, allowing us to predict EPS in the near future, say in five years (i.e. Year 2016), using the linear regression equation for EPS = 0.5553 (2016) – 1108.8 = 10.6848.

A conservative average P/E estimate for the stock can be obtained as follows:

Signature P/E: A well established stock has a signature P/E, an average P/E it commands in the market based on its business. We can calculate this by averaging the Average P/E over the past 10 years, excluding any outliers (values that fall significantly beyond the other data points). From Table 1, we see that the Average P/E of 23.5 for Year 2002 is an outlier, as it significantly exceeds the other data points, so we average the Average P/Es from the other nine years to arrive at a signature P/E of 12.4.

Average half of lowest High P/E: this takes the average of five lowest High P/Es of the 10 High P/Es from the past 10 years, to give us a conservative estimate of a high P/E for the stock we can expect. The five lowest High P/Es from the past 10 years (see Table 1) are 10.9, 11.2, 11.7, 11.8, and 12.9, which average 11.7.

Average half of lowest Low P/E: this takes the average of five lowest Low P/Es of the 10 Low P/Es from the past 10 years, to give us a conservative estimate of a low P/E for the stock we can expect. The five lowest Low P/Es from the past 10 years (see Table 1) are 7.2, 8.8, 9.1, 9.4, and 9.6, which average 8.82.

Average P/E estimate: this takes the average of Average half of lowest High P/E and Average half of lowest Low P/E, thereby giving us a conservative estimate of an average P/E for the stock we can expect. Averaging 11.7 and 8.82 gives us 10.26.

Multiplying our EPS projection for five years hence by the average P/E estimate gives us a projected average price for the stock: $10.6848 * 10.26 = $109.63. Compared with the current price of $86, this represents an annual stock price return = 6.26%. When we add in the 2.2% dividend yield, the total return expected is an annualized 8.46%, which means investment in XOM today is expected to double in about nine years.

Using a discount rate of 7%, our projected price of $109.63 in five years translates to a target price = $78.16 in today's dollars, which is about 9% below the current price of $86 for the stock. For a good margin of safety, investors are well advised to buy only if the current price is at least 20% below the target price. Since the current price is above our target price, this stock is not a buy right now. However, it is also not a sell, because it is still expected to return 8.46% per year over the next five years. A pullback to $62.53 would provide long-term investors enough margin of safety to buy the stock.

As an additional consideration, we should also determine how the stock's current P/E compares with its signature P/E, since established stocks tend to revert back to their respective signature P/E over time. Current EPS = 6.22, giving us a current P/E = 13.8. This is 111% of the stock's signature P/E of 12.4, which indicates the stock is currently overvalued. In general, we should look to buy when the current P/E is 80% or less of the stock's signature P/E. For XOM, that means a price target of $62.

Lastly, we calculate the Risk Index, calculated as (Current Price – Forecast Low Price)/ (Potential High Price - Forecast Low Price) to give an estimate of the risk: reward ratio. Risk index less than 20% is desired, which gives us +200% potential returns for every risk of 50% loss we assume.

The Forecast Low Price is calculated by multiplying the Average half of lowest Low P/E by the Forecast Low EPS, to give a conservative estimate of low price for the stock in 5 years, assuming zero EPS growth and low valuation. Forecast Low EPS is estimated by averaging the EPS over the past five years. For growth stocks with predictable earnings growth, EPS in five years should not be any lower than this conservative estimate. For XOM, forecast low EPS is equal to 6.548, so the Forecast Low Price = 8.82 * 6.548 = $57.75.

The Potential High Price is calculated by multiplying the Average half of lowest High P/E by the our projected EPS in five years, giving us a price target in five years if the stock should command a high P/E. For XOM, this equals 11.7 * 10.6848 = $125.01.

Thus, Risk Index = ($86 - $57.75) / ($125.01 - $57.75) = 42%. Since this is significantly above 20%, we have an unfavorable reward to risk ratio at the current price. Again, this argues against a Buy.

Conclusion

Exxon Mobil Company, currently selling at $86, has a target price = $78.16. Its current P/E of 13.8 is above the stock's historic P/E average of 12.4, and its downside risk outweighs its upside potential. Despite these negatives, the stock is still expected to return 8.46% annually over the next five years. Therefore, I rate the stock a Hold at the current price.

Disclosure: I am long XOM.

Disclaimer: Use this information as a starting point for your own due diligence, before buying any stock. If you do buy, be sure to read any annual reports (10-K) and quarterly reports (10-Q) to ensure that the fundamentals remain good and the stock is on target to reach its projected price. After holding for five years, repeat the analysis detailed in the article to decide whether to continue to hold, add, or reduce your position.

Source: Exxon Mobil: Stock Analysis