By R. Brian Tracz
Exxon Mobil (XOM) is a blue-chip company with a blue-chip management strategy. Exxon Mobil remains committed to a balanced production spread of gas and liquids. Though this might be an advantageous long-term strategy - gas prices will eventually recover from their 10-year lows - it is not exactly helping Exxon's short-term earnings potential. In the wake of its April 26 report, this is one of the reasons that its reported $2 earnings per share, missing the Street consensus projection of $2.09 earnings per share.
I argue for a hold position on Exxon Mobil over 12 months and a buy position on Exxon Mobil for an investment arch of three years or greater. A combination of the capital intensive approach required to extract liquids-rich assets and the present gas-heavy approach make Exxon Mobil an attractive blue chip but an unattractive short-term holding.
Given current earnings reports, Exxon is fairly valued. As I note below, Exxon Mobil is not making radical changes to its pattern of production. The price range over 52 weeks has been $67.03 to $88.13. Since shares are currently priced within a few dollars of the upper extreme of this range, I think that, though Exxon Mobil is likely slightly undervalued, it is unlikely to make any sort of price rally without more substantial moves to increase liquids production.
Buy the Oil, Hold the Diversity
Diverse, balanced production profiles don't pay-off at the moment. Chevron (CVX) churned out over $2.00 more in earnings per barrel than Exxon Mobil in fourth-quarter 2012. Furthermore, whereas Exxon Mobil earned $20.00 per barrel in first-quarter 2011, it only earned $18.83 in the first quarter of 2012. These numbers reflect that Exxon is sluggishly exploiting its available liquids holdings, whereas Chevron is tipping the scales more heavily toward liquids. Additionally, produced volumes outpaced the rate at which those volumes were sold. Granted, gas prices are eventually expected to double over the next two years, reaching $4.50 in 2015, but this is nevertheless not a versatile strategy for those looking for 12-month returns.
Exxon Mobil is committed to a strong and diversified presence in the oil and gas market both upstream and downstream. Unlike Marathon Oil (MRO) and ConocoPhillips (COP), which spun-off much of their downstream refining and chemical operations, Exxon Mobil management wants to maintain its overall presence in refining.
Give Me More Oil
Nevertheless, despite increased efforts by many E&Ps, there is still a lack of supply for oil. The cost of oil rose 14% during first-quarter 2012. Nevertheless, many oil companies like Hess (HES), Marathon, and ConocoPhillips have missed earnings estimates for the first quarter of 2012. Nearly all of the E&Ps have skewed their offerings toward oil, and this skewing translates into novel strategies and projects - all of which are capital intensive (hence the decreased earnings). Even Apache (APA), which has an even 50:50 split of proven reserves between oil and gas, is exploiting this low price of gas and high price of oil by shifting toward liquid-rich plays. And with even the largest companies failing to meet production estimates, and with global demand increasing with improving economic indicators, oil prices are likely to rise to the $130 range during 2013 to 2015.
Exxon Mobil is making meaningful progress in liquids-rich production, but rather slowly. In fairness, Exxon Mobil's underlying assets are quite strong. Production at the Kearl Oil Sands in Canada, are expected to begin in 2012, expected to produce 140,000 bpd initially and 345,000 bpd long term. Holdings in Angola and Nigeria will go into production later this year, totaling an expected 170,000 bpd. Capital expenditures will average $37 billion through from 2012 to 2016, according to management estimates.
A Big Blue Chip
"When you got it, flaunt it." With Exxon Mobil's enormous resource base of 87 billion boe of proven reserves, Exxon is able to throw its weight around in capital expenditures - the very cost-intensive exploration expenditures that can paralyze other companies. With Exxon Mobil's AAA debt rating from S&P, it will have no problem funding these expenditures if it needs to borrow. Exxon Mobil's finances are exceptional: Argus rates its financial strength as High, and Exxon Mobil maintains a 9.6% debt/capital ratio. Even among the blue-chips, Exxon Mobil has strong balance sheets and credit, using almost no debt to fund its projects.
Exxon continues to develop long-term projects, some of which focus on liquefied natural gas, which trades at a discount to WTI and Brent crude. Management projects liquids volume growth to average 2% to 3% over the next few years, while natural gas volumes will increase less than 1% year-over-year. With Exxon Mobil's extensive resource base, it stands to increase production at some of its larger holdings, which include state partnerships, deep-water exploration, and unconventional on-land holdings. Exxon Mobil's technology base will allow it to exploit techniques like horizontal drilling to increase production at already-tapped wells.
Exxon Mobil tends to return value to investors via stock buy-backs and less often in the form of dividends. The company will repurchase $5 billion in stocks per quarter through 2016 according to managerial guidance.
Over the short term, Exxon Mobil stands to benefit from its decline rate of 3%, which is a decrease from up to 5% in recent years. Thus, Exxon Mobil's wells are depleting at a slower rate - news that helps current production as much as long-term prospects. In Exxon Mobil's summary annual report, one gets the sense that the company is poising for macro-level increases in demand over the next several decades. Electricity demands will increase 80% by 2040, and world energy demand is likely to increase by 30% in the same period. Management therefore looks to meet this increase in demand - and potentially increasing decline rates - with a solid portfolio. In this effort, Exxon Mobil has over 120 upstream projects. It will be adding 21 more projects between 2012 and 2014, with the intent of adding 400,000 boe/d, most of which projects are liquids-heavy. Exxon Mobil, moreover, intends to increase its refining capacity in Singapore and elsewhere, creating a strong downstream capacity.
In all, Exxon Mobil's return on average capital employed is 5% better than the average competing integrated oil and gas company. This will surely deliver long-term value and profitability as Exxon Mobil vies to become the premier energy provider of the 21st century. However, this does not translate into substantial returns in a current 12-month projection. Competitors are nimbly weighing their portfolios toward liquids, a move that Exxon Mobil will not make all too quickly. But this is exactly what makes Exxon Mobil shares ideal for the long-haul.