Exxon Mobil: What Big Upside?

Apr. 5.12 | About: Exxon Mobil (XOM)

I read an article on Seeking Alpha discussing Exxon Mobil Corp. (NYSE:XOM) as offering "big upside in 2012 and beyond". I just can't disagree more with this statement. XOM is, at best, defensive, as a super energy conglomerate that does an excellent job of returning cash flow to shareholders and that should hold up better than the rest of the energy group in the event of a market collapse. However, the underlying fundamentals of Exxon's business aren't great, and calling for "big" upside seems to be very much a stretch when you consider:

  • High margin liquids production has been in decline for several years. The company's liquids proved reserves peaked in 2008, at 10,135 mmbbl, and has fallen for three years now, with year-end 2011 proved liquids (crude oil and NGL) reserves (both consolidated and proportional interests) standing at 8,469 mmbbl (I am excluding Bitumen and Synthetic Oil, as both are lower margin liquids production that is subject to greater commodities price risk). For "big" upside, wouldn't an investor expect a growing liquids reserve base? On a relative basis, there are a considerable number of stand alone Exploration & Production (E&P) companies that would offer a better play on "big" upside if you had a view on the sector. Even if XOM is able to improve the trend, aren't there better opportunities out there?

  • The company's total reserve mix is 11,673 mmbbl of liquids and 68,007 bcf of natural gas, or roughly 51% liquids and 49% natural gas. The natural gas exposure was amplified through the acquisition of natural gas focused XTO Energy, Inc. (XTO), an excellent and well-run independent E&P that was announced on December 14, 2009 (and closed mid-2010). While natural gas has an incredibly important place in the future of the U.S. energy mix, the price of natural gas should be expected to stay under pressure for several years out as a result of a variety of factors that I discuss here. With half the company's reserves linked to natural gas, and natural gas prices expected to remain under pressure for several years, how is it reasonable to think there is 'big' upside? Further, the most interesting play in natural gas at the moment is either (1) looking at (and owning) the distressed debt of natural gas players (a back door into the equity) or (2) high quality players in the space that could be take out candidates if a wave of consolidation hits the group (to which XOM is more a likely buyer than seller). Owning XOM for a natural gas recovery appears slippery.

  • The majority of the earnings come from the upstream segment, on the back of higher oil prices in 2010 and 2011). The earnings risk: Oil prices soften, the natural gas problem persists and margins in refining don't realize 2011 levels (which were good). None of those risks seem that far fetched, all things considered. As a result, calling for "big" upside in 2012 means that you believe oil prices are going much higher (soon), natural gas prices are at bottom now and recovering (again, soon) and margins in refining (and chemicals) will hold and maybe improve (in 2012). Seems like the upside/downside favors the downside risks, at the moment.

  • Why is a 2.22% dividend yield exciting? The S&P 500 dividend yield is 2.00%. There are plenty of utilities and telecom companies (see my article on Verizon (NYSE:VZ)) that pay a substantially higher dividend.

  • Finally, strategically, XOM has done a wonderful job returning cash to shareholders, in the form of dividends and share repurchases. However, the company hasn't done a great job in building up reserves over the past decade, and, despite a massive cash hoard and a supreme balance sheet, did not really "step up" in the heart of the 2008-2009 debacle as an acquirer (aside from XTO, which happened at the end of 2009 and, while a great company, XOM paid a fair price at the time and a very fair price considering what has happened to natural gas prices since). This point goes back to my thesis around XOM being defensive, as a mature company that is in return of capital mode and hasn't done much to really improve the business, which is why the stock hasn't done much beyond being a market correlation story for several years now (and this isn't likely to change).

Maybe if management breaks up the businesses, as ConocoPhillips Corp. (NYSE:COP) and Marathon Oil Corp. (NYSE:MRO) are in the process of doing, it could be interesting for shareholders- though it hasn't been announced or previewed. Maybe the company could raise the dividend and repurchases less shares, which would be nice. Or, maybe, XOM remains a "lazy" way to play the energy sector, with a high overall market correlation and a defensive bend. Regardless, if you are looking around in energy, this one is not a "big" upside call.

Disclosure: I am short XOM.