Exxon Mobil Update - Why I Downgraded It

| About: Exxon Mobil (XOM)

Summary

Since my last report on Exxon, the oil price has decreased by more than 40%, and the share price dropped by 10%. The competitors have performed much worse.

The reason for that is the fact that Exxon work hard to partially replace its profit-consuming upstream operations with the downstream.

The former VP's of Refining promotion to a President is a sign that the company is very concerned about the future price of oil.

The good efficiency ratios are declining. The growth metrics are going down, as well. The DCF model shows that the stock is overvalued based on my oil prices forecast.

The comparative and the zero-growth analyses show that the stock is traded at a discount. Hence, my analysis cannot produce a consensus. Hence, I issue a HOLD recommendation.

About three months ago, I wrote my last report on Exxon Mobil (NYSE:XOM). You can read it here. Since then, a lot has changed. The most important events that have taken place are:

  1. WTI has decreased by more than 35% - to about $30 per barrel. Brent has decreased by even more - in excess of 40% - to $27.79 per barrel at its lowest. Owing to Iran's return to the market, an increasing production in US, Russia, Saudi Arabia, and falling demand in China and the rest of the world, the horrific oil price decline wiped out trillions of dollars in the O&G companies' market values (especially in the upstream). However, most Exxon's operations are now situated in the downstream, so the decline in the company's value has not been very substantial - a little more than 10% -, while its closest competitors are down between ~12% and 18% (see Diagram 1).
  2. Exxon Mobil has announced its Q3 results. According to them, LTM revenue has decreased by more than 28%, LTM EBITDA has decreased by 33%, LTM net income has decreased by 39%, and LTM free cash flow has decreased by more than 51% (see Diagram 2). These figures are much worse than LTM results for the second quarter.
  3. Although the growth figures have declined, the operating ratios are still quite high. As you can see from Diagrams 3 and 4, the operating and net profit margins are still 3-8 times higher than the industry's averages, while the debt-to-equity ratio is lower than industry`s.
  4. Darren Woods, a former Senior VP in Refining, has become the President - one step closer to the CEO. According to that, we can make a conclusion that the company is pessimistic about oil prices in the short-term. We can infer that the company's focus will be set on the downstream operations, which are the primary source of Exxon's revenue now.
  5. The company got involved into a scandal with the global warming activists. They have accused the company of hiding the facts that its business has been terribly affecting the planet's climate. The state of California has announced that it would investigate the matter and conclude whether Exxon Mobil had lied about the climate change risks. If the company gets indicted, it may face substantial litigation expenses in the future.

Diagram 1

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Source: Yahoo Finance

Diagram 2

Source: data - Morningstar.com, infographics by author

Diagram 3

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Diagram 4

Source: data - Morningstar.com, infographics by author

According to this information, I have drawn two conclusions:

  • Exxon Mobil looks much better than its industry competitors in terms of efficiency.
  • The risks have increased. The oil price risk is the most significant one. Because the company's revenue is still pegged to an average oil price and the oil price is still going down, I think that the strong EPS and dividends are going to disappear in the near future. The same will happen to the market value of the company and its per-share valuation.

DCF analysis

My DCF model is presented in Diagram 5. In Diagram 6, you can see how different metrics of Exxon Mobil are expected to change during this period. I have made several assumptions, which can be easily seen in the "Assumptions" tab of my Excel file.

The main assumption is, of course, the revenue growth estimates. The company's revenue growth is well-correlated with average WTI price during the year, so it is possible to make projections based on the current macro situation. In my last article, I also laid out my revenue projections.

As you can see from Diagram 7, I have cut oil price forecasts considerably. Hence, the expected revenue growth rates have also decreased.

My model shows that, after subtracting the market value of debt, minority interest and adding back cash and investments, the market value of equity is around $248.4B in the Base scenario. Consequently, the fair value per share is $59 per share. It is more than 21% lower than the current market price (around $75 per share).

Diagram 5

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Source: data - Morningstar.com, DCF model by author

Diagram 6

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Source: data - Morningstar.com, infographics by author

Diagram 7

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Source: data - Finam.ru, model by author

Sensitivity Analysis

The sensitivity analysis is presented in Diagram 8. According to the Base scenario and the assumptions for the EV/EBITDA multiple and WACC, the price range is estimated to be between $54 and $65 per share. This represents a 13%-28% downside risk from the current market levels.

Diagram 8

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Source: data - Morningstar.com, model by author

Zero-growth Analysis

The Zero-growth analysis has been described in one of my articles. You can read more about it here.

According to this analysis, the current stock price shows some margin of safety. The valuation gives a fair market value of equity of $554.5B, which transforms into a fair price per share of around $132. This is 77% higher than the current price level. However, if we only used net income in the calculations, the result would be a fair value per share of only $70.6, which is 5% lower than the current market price. This means that the results of this analysis are inconclusive.

Comparative Analysis

My comparative analysis is based on three key ratios: P/E, P/S, and P/BV (see Diagram 9). The P/E ratio shows a significant upside potential corresponding to the results of the zero-growth analysis. The company looks cheap because the industry is on the downtrend. The P/S and the P/BV show that the company is overvalued by more than 50%. The current EV/EBITDA multiple is 6.7x, which is considerably below the industry's average of 9.0x (according to Damodaran). In light of these facts, I make a conclusion that the comparative analysis suggests a good discount for the stock. However, the risks of further declines on the oil market makes this alleged discount a risk-premium (you can call it a margin of safety).

Diagram 8

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Source: data - Morningstar.com, infographics by author

Opinion

Exxon Mobil looks much better than an average industry player at the present time. However, the new reality of declining oil prices will make the company's revenue stagnate. Free cash flow will follow the revenue, and dividends are going to be cut, as well. Hence, I see that overall risks have increased substantially. By promoting a former VP of Refining to President, the company clearly shows that it understands the situation well.

My DCF model with an updated oil forecast shows that the stock is overvalued. Despite that, the zero-growth and the comparative analyses show that the stock is traded at a significant discount. Although I rely on the DCF's results more, I simply cannot ignore the results of the other analyses. Hence, I issue a HOLD recommendation on this stock and set a target price range at $59 - $76 per share. This price range is translated into a (-21%)-2% upside potential for long investors.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.