Edited by Marianna Avilkina
Exxon Mobil Corporation (NYSE:XOM) is one of the largest integrated oil and gas companies in the world. As the world's largest refiner and petroleum marketer, XOM engages in oil exploration, production, and refining around the world. The company strives diligently to capitalize on rising oil prices. After Exxon's revenues jumped by 28% and profits soared by 35%, XOM moved into the top spot in the Fortune 500 in 2012. To meet the world's demand for energy in the future, Exxon Mobil has already ventured into gas production. In 2010, XOM purchased XTO Energy for $35 billion and became the largest producer of natural gas in the U.S.
As of September 23, 2012, XOM stock was trading at around $92, with a 52-week range of $67.93 - $92.50. It has a market cap of $426.2 billion. The trailing twelve-month P/E ratio of 9.7 is below the forward P/E ratio of 11.3. P/B, P/S, and P/CF ratios stand at 2.6, 0.9, and 8.0, respectively. The operating margin is 16% while the net profit margin is 9.1%. The company has minor debt issues, with a debt/equity ratio of 0.2 that is far below the market average.
Exxon Mobil pays solid dividends - the trailing yield is 2.26%, whereas the forward one is 2.48%. Upcoming dividends are expected to amount to $.57 per share. Over the last five years, the company has gradually increased its dividend amount by 63%. The five-year dividend history suggests that XOM is a strong dividend-growth company, as well as a regular dividend payer.
XOM has a 3-star rating from Morningstar. Out of five analysts covering the company, two have a "buy" rating, and the other three indicated a "hold" rating. This is good reason to suppose that Wall Street holds diverse opinions on the company's future. The average five-year annualized growth forecast estimate is 12.3 %. What is the fair value of Exxon Mobil given the forecast estimates? We can determine XOM's fair value using the discounted earnings plus equity model, as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of TTM EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($9.52 + $8.16) / 2 = $8.84
Wall Street holds diverse opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 12.3%. Book value per share is $35.27. The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for XOM is between $140 and $175 per share. At a price of about $92, Exxon Mobil is trading at a substantial discount. The stock has at least 52% upside potential to reach its fair value.
While there are many companies in the oil and gas industry, Royal Dutch Shell (NYSE:RDS.A) is probably the closest competitor of Exxon Mobil. RDS offers its investors a dividend yield almost twice as high as XOM's. Because Exxon ventured into natural gas exploration and production only two years ago, its margins are expected to be lower than that of RDS. In terms of profitability, RDS looks to be a rather attractive investment alternative.
Royal Dutch Shell
Return on Equity
The other noteworthy competitor, an oil and gas giant active across six continents - British Petroleum (NYSE:BP) - offers a considerably higher dividend yield of 4.33 percent. As dividend yield is a fairly influential factor in making investment choice, BP's dividend policy appears more attractive when compared to XOM's. BP's dividends have been fluctuating over the past five years, as opposed to the stable and consistent dividends paid out by XOM. The interests of Exxon's shareholders are better protected in the case of a business decline thanks to a reasonable debt philosophy.
Current Economic Outlook
XOM currently ranks second on the list of world's most valuable companies based on market capitalization. The company has opted for a long-term strategy incorporating oil and gas production into one system. As low gas prices are currently prevalent, this strategy has minimized current gains. In contrast to XOM, most competitors are reducing their involvement in gas production.
With energy production expected to double by 2020, XOM's venture into the gas market is probably a smart move for the long-term future. Management expects the company's long-term strategy to be fully in place by 2025. However, investors will keep an eye on Exxon's board until the promising long-term prospects actually materialize. While gas prices remain low, XOM's stock cannot be expected to significantly outperform the stock market in the short term.
Exxon Mobil's remarkable scale and its prudent investment philosophy make the company a safe and healthy investment option. Based on my FED+ valuation, XOM is currently undervalued, with at least 52% upside potential to reach its fair valuation range.
However, XOM's strategic decisions regarding involvement in gas production have had a significant impact on the company's economic growth since 2010. The company's gas operations are expected to be fully functional by 2025, at a time when gas demand is anticipated to be on par with oil. Until that time, I expect XOM stock to maintaining a stable performance, albeit unexciting, resulting in moderate earnings for investors in the near future.