The energy market continues to fray investor nerves with constant volatility. The direction of the price of crude oil should hold particular sway over the future path of energy producers' expected quarterly profits. For example, a spike in the price of crude oil would be a welcomed by producers as their profitability would increase. The article below will discuss Exxon Mobil's (NYSE:XOM) recent outperformance along with a discussion of the stock's divergence from the path of oil futures.
A discussion on the recent price action in the energy markets is essential in developing a comprehensive view of the challenges facing the industry. Crude oil as evidenced by the chart above detailing the price action of West Texas Intermediate (WTIC) continues to carve out new lows in 2016. Interestingly, WTIC marked a new low this past Thursday only to rally on a rumor of an imminent cutback in supply. Well, the story was proven to be partially correct, a deal was struck between Russia and Saudi Arabia for a production freeze, not a cut. WTIC predictably sold off on the news. Many thought a bottom was formed in mid-January, the market did rally for a bit, yet a new low was printed.
Exxon Mobil Divergence
An interesting divergence is shown on the charts. XOM typically follows the path of WTIC, with the equity hitting a low on January 19th right alongside WTIC. The theory should hold that XOM would sell off in sympathy with WTIC in February, yet that was clearly not the case. XOM continues to power higher, breaking through resistance at the 50-day moving average and 200-day moving average. The equity seems to decouple itself from the underlying trend in crude oil an interesting chain of events.
XOM Quarterly results
XOM is classified as an integrated oil company with assets in upstream (exploration and production) and downstream (refinery). The beauty of the business model is it allows XOM to smooth out some of the inherent volatility in the energy sector. Notice the comment about some, as we can clearly see from the slide above upstream drives the boat here at XOM. The precipitous decline in the price of crude continues to decimate revenue and year over year profit comparisons. Yes, that is not a misprint earnings were $3.8 billion dollars lower.
If we examine the WTIC chart above, the price of the commodity routinely traded above $40 per barrel in October and November while prices were in the mid $30's in December. Barring an unseen event such as Saudi Arabia announcing a sudden production cut, I do not see a credible case where WTIC trades in the $40 range in March. XOM's upstream results will come in weaker than the 4th quarter results adding further pressure on the company's finances. Interestingly, the credit agencies warned they could strip XOM of its AAA credit rating a testament of the stunning fall in oil prices.
XOM relied on asset sales to smooth over the stunning drop in revenue and profitability. The dividend is not at risk; the company will do whatever it takes to maintain the payout. The only way XOM would cut the dividend is if WTIC stays below $25 for the next couple of years, a scenario that I do not find credible. More than likely the price of WTIC will move higher in the second half of the year perhaps into the low $40 per barrel.
The Quest for Yield
My suspicion is trading in XOM is a recent "reach for yield." The share price of utilities and telecom providers with generous dividends have been bid up as investors pile into them. Take a look at the chart below of Consolidated Edison (NYSE:ED) and AT&T (NYSE:T), hardly growth stocks.
ED has run from $63 in December to $73 at one point this year. T is up from the low $33's to its current perch at $36.65.
XOM is currently yielding over 3.5% making it an attractive candidate for an investor seeking income. The question becomes whether the current quote represents an advantageous price to enter into a position in XOM. In my view, it is not. We have not hit a firm bottom yet in the underlying commodity, when this will happen is anyone's guess. Even if my hunch of $40 per barrel crude by the end of the year is proven correct, XOM finances will not meaningfully improve. I would not rush to purchase shares of the company at their current quote; a similar scenario unfolded last year where the energy companies were weak in February only to rally into the middle of the year and promptly give up their gains as the year progressed. For now, I will happily sit on the sidelines and watch events unfold; the energy market remains a fascinating sector to watch in 2016. I would like to thank you for reading, and I look forward to your comments.
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.