Exxon Mobil (XOM) is an integrated oil and gas company, with $486 billion in revenue in 2011. Exxon is one of the world's largest companies with a market capitalization of nearly $400 billion. Its main competitors are Chevron (CVX), British Petroleum (BP), and Royal Dutch Shell (RDS.A),(RDS.B).
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Exxon stock has risen substantially from the mid-50s in the middle of 2010 to the mid-80s today, currently trading at $82.61. Here's Exxon's recent financial data.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Revenue | $404,552 | $477,359 | $310,586 | $383,221 | $486,429 |
| Operating Cash Flow | $52,002 | $59,725 | $28,438 | $48,413 | $55,345 |
| Capital Expenditure | $-15,387 | $-19,318 | $-22,491 | $-26,871 | $-30,975 |
| Free Cash Flow | $36,615 | $40,407 | $5,947 | $21,542 | $24,370 |
Capital expenditures have doubled since 2007, while operating cash flow has increased much more modestly. The company has guided for capital expenditures of about $37 billion annually going forward.
Owner Earnings
Owner Earnings is a better measure for valuation purposes than free cash flow. Warren Buffett defines Owner Earnings as follows:
These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.
I'll calculate Owner earnings by taking the Net Income and adding back various non-cash items, such as depreciation, and then subtracting the 2-year average Capital Expenditures. I'll also add interest payments adjusted for taxes since interest is tax deductible.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Net income | $40,610 | $46,867 | $19,658 | $31,398 | $42,206 |
| Depreciation & amortization | $12,250 | $12,379 | $11,917 | $14,760 | $15,583 |
| Investment/asset impairment charges | $0 | $-63 | $0 | $0 | $0 |
| Other non-cash items | $-2,121 | $-2,289 | $-1,978 | $-455 | $-1,574 |
| Interest Payments | $400 | $673 | $548 | $259 | $247 |
| Avg Capital Expenditure | $-29,000 | $-29,000 | $-29,000 | $-29,000 | $-29,000 |
| Owner Earnings | $21,969 | $28,272 | $906 | $16,856 | $27,357 |
Owner earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the Owner Earnings figures to determine Exxon's Cash Return on Invested Capital, or CROIC. This is the cash return generated by the company on invested capital, and is simply the Owner Earnings divided by the total invested capital. This is a better measure than ROIC because ROIC relies on earnings, which is a poor measure of profitability.
| (In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|---|---|---|---|---|
| Owner Earnings | $21,969 | $28,272 | $906 | $16,856 | $27,357 |
| Invested Capital | $242,082 | $228,052 | $233,323 | $302,510 | $331,052 |
| CROIC | 9.08% | 12.4% | 0.39% | 5.57% | 8.26% |
Exxon's CROIC has recovered since 2009, but large increases in capital expenditures puts into doubt the companies ability to reach pre-recession efficiency. Here is Exxon's latest balance sheet:
| Cash and Cash Equivalents | $12,664 |
|---|---|
| Investments | $34,333 |
| Debt | $38,140 |
| Pension Obligations | $24,994 |
| Minority Interest | $6,348 |
| Net Cash (Debt) | $-22,485 |
| Diluted Float | 4,843 |
| Cash/Share | $-4.64 |
Exxon has $47 billion in cash and investments compared to $38 billion in debt. I also include pension obligations of $24 billion and minority interest of $6.3 billion as liabilities, leaving $4.64 in net debt per share. With Exxon's interest payments being a minute fraction of their free cash flow, the balance sheet looks fairly strong.
Valuation
I use a discounted cash flow analysis to estimate the fair value of a company. I will use a discount rate of both 12% and 15% and use these two values to define a fair value range. You can read about my view on discount rates here. I will assume that owner earnings will grow at 9% next year and that the growth rate will decay over 20 years to a perpetual value of 3%, as per the growth table below.
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
| % | 9% | 8.7% | 8.4% | 8.1% | 7.8% | 7.5% | 7.2% | 6.9% | 6.6% | 6.3% |
| Year | 11 | 12 | 13 | 14 | 15 | 16 | 17 | 18 | 19 | 20 |
| % | 6% | 5.7% | 5.4% | 5.1% | 4.8% | 4.5% | 4.2% | 3.9% | 3.6% | 3.3% |
Using the above parameters, I arrive at a fair value range of $64.50 - $91.52 for a share of Exxon.
Conclusion
With Exxon currently trading at $82.61, the stock falls towards the upper end of my fair value range. The big concern going forward is whether the massive increases in capital expenditures will lead to comparable increases in cash flow. With capex taking up a larger and larger portion of revenue, it remains to be seen whether this behemoth of a company can deliver sufficient growth going forward. But given that demand for energy will continue to grow into the future and Exxon's enormous size and dominate position in the oil and natural gas markets, Exxon Mobil is probably the safest long-term bet in the energy industry.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
