Exxon/Chevron Earnings: The Slow Recovery In The Price Of Crude Oil To $50 Per Barrel Should Help

| About: Exxon Mobil (XOM)

Summary

Exxon has remained free cash flow-positive through the crude oil collapse.

The company's cash-flow "breakeven" is thought to be in the $40 per barrel neighborhood.

Chevron has more delta to crude prices, hence it has been free cash flow-negative for the last year.

Buy Exxon and Chevron for the dividends and wait on crude oil prices.

Exxon (NYSE:XOM) and Chevron (NYSE:CVX) report their respective Q3 '16 financial results this Friday, October 24, before the opening bell.

Before this preview gets started on the particulars for each company, Goldman Sachs came out this morning and reduced its 2016 and 2017 earnings estimates for the S&P 500 for the next three years. This could be right, but my first thought was, "Let's see what Exxon and Chevron report Friday morning" and what happens to Q4 '16 and Q1 '17 Energy sector estimates after they report.

As a sector, Energy has been the biggest drag on the S&P 500 since crude oil peaked in August 2014 near $100 per share. At the time, the sector was roughly 13-15% of the S&P 500's market cap as a percentage of the entire index, which has since shrunk to roughly 7% as of September 30.

Exxon is the 3rd largest component in the S&P 500 (as of today, looking at Morningstar data, and the top positions within the SPY), which is roughly unchanged from this Energy article written in late August '16. (I started an S&P 500 earnings blog in mid-2012 to shed some light on the sector earnings issues.)

Exxon and Chevron are the two big dogs in the yard in terms of individual company importance to the Energy sector. According to this earnings article, Exxon - as of the end of August '16 - was roughly 85% of the earnings weight of the sector and 30% of the revenue. (See the Excel table at the bottom of the blog post.)

Now because crude has continued to rally since late August and the Energy sector stocks are rallying as well, these metrics could have changed slightly, but the "relative" scale still matters.

XOM EPS XOM Rev. CVX EPS CVX Rev.
Q3 '16 $0.58 $61.4 bl $0.37 $29.05 bl
Full year 2016 $2.16 $237.9 bl $1.17 $120.2 bl
Full year 2017 $4.34 $321.0 bl $4.46 $156.4 bl
Click to enlarge

Source: Thomson Reuters consensus estimates as of October 24

(bl equals billions of dollars)

Here is what the above numbers look like in terms of growth:

XOM EPS XOM Rev. CVX EPS CVX Rev.
Q3 '16 -43% -10% -66% -15%
Full year 2016 -44% -12% -65% -13%
Full year 2017 +101% +35% +281% +30%
Click to enlarge

Exxon's particulars:

When Exxon reported its Q2 '16, the numbers were pretty bad: EPS fell 59% y/y, while revenue fell 22%. Both upstream and downstream reported sharp declines, as downstream refining margins were worse than expected, and that was through the whole sector.

The big positive to XOM is that the integrated oil giant remains free cash flow-positive, even with the drop in crude from $100 to $28 in the spring of 2016.

That means the dividend was never in jeopardy of being cut, although share buybacks were eliminated or greatly reduced as of June 30, 2016. (The last billion-dollar quarter spent on buybacks for XOM was June 2015.)

For XOM, per the Street, its cash flow "breakeven" is $40 per barrel - pretty spectacular given the company's size. That $40 breakeven is one of the lowest in the sector.

Chevron's specifics:

Chevron will report next to Exxon come Friday morning, October 28, and like XOM, it had a tough 2nd quarter. Revenue fell 27%, and the actual EPS estimate of ($0.78) missed the $0.32 consensus by a whopping $1.10 - a pretty big miss, to say the least, but not unusual given the sector's conditions.

Chevron has been free cash flow-negative for about 18 months, maybe a little longer. But with the annual dividend about $8 billion in total dollars, the company has issued long-term debt to maintain the dividend.

The big plus for both XOM and CVX was that both companies came into the downturn with very little term debt on the balance sheet, and this really helped CVX, which has a higher breakeven price on terms of dollar price per barrel of crude than XOM.

With crude trading back over $50 per share, it will be interesting to see of CVX can generate positive free cash flow once again.

Here's a chart showing both Exxon's and Chevron's year-over-year growth metrics over the last 6-8 quarters since crude oil peaked:

XOM EPS XOM Rev. CVX EPS CVX Rev.
Q3 '16 (est.) -43% -10% -66% -15%
Q2 '16 -59% -22% -180% -27%
Q1 '16 -63% -28% -114% -32%
Q4 '15 -49% -31% -80% -39%
Q3 '15 -47% -37% -63% -37%
Q2 '15 -51% -34% -67% -30%
Q1 '15 -44% -37% -68% -35%
Q4 '14 -31% -24% -49% -18%
Q3 '14 +6% -4% +16% 07%
Q2 '14 32% +5% +8% +1%
Click to enlarge

Readers can see how revenue declines actually bottomed in late '15, early '16 and has been still negative but steadily improving, while EPS has gotten trashed under the 2 years of declining revenue.

Personally, I think this is about to change.

Valuation

Remaining free cash flow-positive, Exxon definitely gets the nod for the stock to own, but it could have less upside if crude oil starts to rise rapidly.

If readers look at the first table, you will see how calendar 2017 EPS and revenue is schedule to improve sharply, as the Energy sector will lap very easy compares in Q1 and Q2 '17. (In Q1 '17, basically all of the Energy sector's profits were wiped out.)

All the P/Es are distorted by the very low earnings growth, although over the next 3 years Exxon has a P/E of 25(x), while Chevron's is 41(x). However, these are irrelevant until we see the revisions in forward estimates.

Both XOM and CVX are trading at 14(x)-15(x) cash flow, and while XOM does have positive free cash flow, it is minimal. So, cash flow valuations aren't much of a help either.

Basically, today, you buy XOM and CVX for the dividend yields of 3.50% and 4.25% respectively and wait and see if crude oil can break above $52 per barrel. If so, we should see $60 by next spring '17.

Conclusion

Personally, I think the Energy sector is on the verge of a steady improvement in sector earnings and revenue growth from very easy compares to Q4 '15 and Q1 '16, and also from rising crude price.

Natural gas has had a steady improvement this year, as has crude after its bottom at $28 in the first 2 months of 2016.

Don't forget nat gas. Exxon bought XTO in late 2009, which gave the crude giant a significant nat gas presence, albeit at a very bad time, watching nat gas collapse since then. But lately there are signs of life in natural gas as its trades up through $3 per btu.

A break above $52 in WTI crude, and the prospects would look better.

Both dividends are safe, and I expect better quarters from both integrated oil giants when they report on Friday morning, October 28.

There are a total of 35 energy stocks in the S&P 500 (per Thomson Reuters), and the top five comprise nearly all the profitability. The top two - Exxon and Chevron - comprise the big share of those five.

Clients currently have a 9-10% weighting in the Energy sector comprising of XLE, IYE, and OIH. This is the clients' first material position in Energy in about 5 years, if that.

I think readers can own the sector through at least spring '17, with an eye on crude oil and nat gas until then.

Disclosure: I am/we are long XOM.

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.