Exxon Mobil Appears at Lower End of Valuation Range

Note: You can click through on any of the graphs to see a larger image.

The above graph shows West Texas Intermediate (WTI) oil prices for about the last four years.

During the past several months, I expressed my bullishness for commodities in general and oil in particular. I remain bullish on oil, even in the face of the market meltdown. Oil demand might moderate slightly, but even the International Energy Agency forecasts slight growth in oil demand next year. IEA's 10 October 2008 highlights state the following:

Oil demand forecasts for 2008 and 2009 were trimmed by 240 kb/d and 440 kb/d, respectively, given weaker OECD deliveries and the IMF's downward revisions to 2009 global GDP assumptions. World oil demand is expected to average 86.5 mb/d in 2008 (+0.5% or +0.4 mb/d vs. 2007) and 87.2 mb/d in 2009 (+0.8% or +0.7 mb/d).

Some might be inclined to believe that high prices were their own worst enemy. That is, high prices were unsustainably high, which caused a reduction in demand and that led to lower prices. I believe, however, it was not high oil prices, but rather the financial crisis that led to lower prices.

Increasing production levels remains challenging, especially if projects are having difficulty raising sufficient financing in this current harsh environment.

With that as background, I want to focus our attention on Exxon Mobil Corporation (XOM). Obviously, Exxon Mobil is a very complex company with many moving parts. If we had to pick a single driver, however, for value, we would all agree oil price is the most important. So using historical oil prices and share prices, I want to examine Exxon Mobil's valuation further.

Please note that I deliberately chose the end date as 29 August 2008. I wanted to exclude the recent financial turmoil from the graph. By looking at the graph, we note the predicted line is not a great fit. The data itself almost seems to exist in two clumps as shown below.

When looking at the first clump, where WTI prices range from about $40 per barrel to about $80 per barrel, we see that Exxon Mobil's stock price appears very sensitive to oil prices. And, if we look the first graph in this article, we know that these lower prices existed from 2004 through to late 2007. Now, if we look at the second clump (the two clumps overlap) of data from $60 per barrel to $150 per barrel, we see that Exxon Mobil's stock price appears almost insensitive to oil prices. Similar to our earlier observation, these higher prices existed from late 2005 onwards.

On Friday, 10 October, WTI closed at about $77.70 and XOM closed at $62.36. If we were to plot this information on the graph, the price seems to fit with the first clump in the lower portion of the graph. Note, however, the tremendous range in Exxon Mobil's stock price when oil prices are near $80 per barrel. Exxon Mobil's stock price ranges from the low $60s to the high $90s. Using this last graph alone, we could argue that the stock price is at the lower end of its range.

These are, however, extraordinary times, so I would exercise caution in relying too heavily upon these graphs alone.

If we were to use just Exxon Mobil's stock price and WTI price information, how could we improve our understanding? My answer is to add the WTI futures price information. Rather than just the existing WTI price, I would add WTI futures price five years out for every WTI data point. Five years is simply a convenient timeframe. The key point is to determine whether the market is optimistic or pessimistic about future prices, and how much so.

Not long ago, the NYMEX WTI future curve exceeded $100 per barrel all along the curve. As of Saturday (11 October 2008), the highest price is $88.83 in December 2016. Notice too that even the near month futures contracts are not plunging into the abyss. That is, the future contracts are not signaling a return to less than $50 per barrel or even less than $75 per barrel.

As mentioned at the outset, I have deliberately chosen just oil prices as my sole value driver for Exxon Mobil. Obviously, the company's valuation is much more complex than simply looking at oil prices. With that background, here are key points that we covered:

• Future demand, according to IEA, is not falling off a cliff, but rather the growth is moderating;
• The NYMEX curve is neither overly optimistic (above $100 per barrel) nor pessimistic (below $50 per barrel);
• If we were to add the NYMEX information to our current data set, it would yield better insights because it would allow us to capture the market's view of future prices; and
• Using just WTI oil prices and Exxon Mobil's stock prices over the last four years, Exxon Mobil's stock price appears to be at the lower end of the range.

Disclosure: I am long Exxon Mobil Corporation stock.

Comments

[User 201845:]

I believe that you need to look at the typical international agreement with major producing countries to gain an understanding of the data. Most agreements with major oil producing counties give a margin so to speak to the major oil company to cover operating costs and profit; therefore when oil prices are high (above $100/bbl) the producing country retains more of the proceeds from the oil produced and and the major oil company receives a lower percentage of the total oil reserves than when oil is in the $60-$80 range.

2008 Oct 12 08:32 AM

[Ferdinand E...:]

Interesting article, and I agree with the conclusions. Of course, we still don't know what is going to happen with financial markets and the global macroeconomy, but I don't have to look at any 'curves' to know that eventually oil demand is going to 'outrun' oil supply again, and for several reasons. How could it possibly be otherwise?

2008 Oct 12 09:16 AM

[Jimmy Lathrop:]

Energy stocks will continue to drop as institutions will continue to sell to raise capital, but yes, XOM and the other energy stocks are not trading at rational levels, and the time for slow accumulation is Monday, heavy emphasis on the word slow. Let someone else take the stocks off of the hedge funds hands until you can see sell orders covering the floor of the stock exchange. That's when you start buying. What's that? No more paper orders at exchanges? Shoot, I forgot. In that case, you can start slowly accumulating and when you see big institutions and money managers start to close down, that's when you pick up the pace.

2008 Oct 12 10:22 AM

[john s. gordon:]

if you ran a multiple regression analysis on this data set what kind of correlation coefficient would you get ?
> jack

2008 Oct 12 11:45 AM

[Exxon4life:]

I own a lot of Exxon and am generally of the opinion that the author is right and it is trading below a rational value. Then again, so are a lot of stocks. For reasons set forth below, I also LIKE Exxon as a company.

I inhereted a large amount of Exxon when my father passed in 2006. I took advantage of the steped up basis and sold 60% of the stock at $90 /share (with capital gains tax calculated at a basis of $64). In case you think you should write me for stock tips, don't. This was luck as, at the time, I expected to the stock to break $100 (which it never did) and I was selling to diversify as 80% of my late father's stock was in ExxonMobil.

I am holding the other 40% based on the fact that what is pushing this stock down is the actions of hedge funds and other forced sellers. That being said, I have a sell order in place for 80% of my stock at a price of $86 and might quickly drop that if the stock hits anywhere over $80 in an inevitable "suckers' rally"

Exxon has many great values: such as a modest but solid dividend and a huge amount of cash. People like Cramer keep bashing Exxon because it spent too much money on a stock buy back. Big deal. They still have 50 billion in cash. FIFTY BILLION. Cramer is all wet on that issue.

On the other hand, Exxon also has some risks. The Bolsheviks (ahem - I mean Democrats - and I can say that as a Democrat) seem to have a poster child hatred for ExxonMobil. When Lenin and Biden take the Winter Palace - ahem I mean White House - you can count on a windfall tax targetting the exact sort of production heavy energy companies like Exxon. On the other hand the energy policy of Sarah Plain, Queen of the Tundra Trash, is like that of a grubby Arab Gulf Potentate - buy support from the local tribesmen by extracting profit tribute from oil companies. McCain seems to think she is an "energy expert" (which is odd because she thinks dinosaurs and people were on the planet at the same time). So God knows what kind of confiscatory energy policy we would see from Old Man Mccain and the Dingbat. That leads to another issue. Exxon has too much of its value in resreves and production. Demand loss hurts XOM relatively worse than say Chevron or RDS.

Exxon is a strong company that is over sold. But I no longer think it is the best and only energy stock to own. Assuming, I can sell my shares in a suckers' rally I intend to get the cash into better energy stocks. I like LNG processing and distribution more than traditional Big Oil. I think they are going to get tax breaks and I think they will see superior profit increases in gas realtive to a giant like XOM.

Exxon is a part of this country. I own their stock, worked for them on a large project as an independent contractor and always try to buy my gas from their retail arm. In other words I like Exxon and see myself as part of their family. Having worked with a lot of Exxon employees I know they have a great corporate team and treat their people very well. My dad's admiration of Exxon and his fifty year investment in their business meant that he was able to go from being middle class to wealthy. Exxon's misdeeds are exagerated and its role in building the USA are ignored. Long term? I still think this is a very good stock and I intend to always own some Exxon. But my general long term bullish position on energy calls for as more diversified allocation in that sector based on gas more than oil and new energy technology along with fossil fuels

2008 Oct 12 12:23 PM

[tigris72poo:]

Let's forget about the numbers for a moment and think about investor sentiment since this market is driven by fear.
Exxon Mobil is by far the largest, most profitable and most financially strong company in the world. In the middle of a huge credit crisis, every company that relies on borrowed money (especially short term credit like commercial paper) or sells to consumers on credit (autos, housing etc) is justifiably getting crushed. But why is XOM getting punished? They don't need to borrow a dime to keep going. As a matter of fact they can invest in their business and have enough free cash flow to buy back $30 billion a year of stock and pay another $8 billion in dividends (rough numbers -I haven't checked carefylly). The knock against them is they are not growing fast. But they could show tremendous growth if they didn't care about return on capital. Remember that BP and RDS grew faster but then had to take huge writedowns which XOMs never has done. Then there is the fact that oil is a cash business. GM can "sell" a lot of cars by giving them away with no money down and zero percent financing for five years. But if you want oil you pay cash. XOM does not finance any of its customers.

Finally, there is a knee jerk reaction to sell commodities and cyclicals and buy staples. But has anybody stopped to think that oil and gas are a necessity not a luxury? And that oil is the only commodity that is neither renewable or recyclable? And that depletion is a relentless fact of life...We need to discover 4 or 5 MMB/D
every year just to keep production from falling.

Given all these facts, and that the government is borrowing trillions of dollars and debasing the currency to stave off financial collapse, would you seek safety in U.S. treasuries like all the lemmings or in XOM shares?

2008 Oct 12 01:17 PM

[WayneS:]

Politicians are pandering for votes. They want people to think that Exxon makes all of their money selling gasoline at ultra high margins. This is to distract them from the fact that the majority of the cost of gasoline is taxes. Obamo says "Oil companies are making a lot of money." Is he talking about all of the over 500 oil companies? Is he talking American of foreign oil companies? Is making a lot of money a good thing or a bad thing? He then says, "Gas prices are high." Is he saying this is good or bad? 1700 lives were saved by $4 gasoline. He doesn't say these two sentences are related, but people put 2 and 2 together and get 5. Nancy Pelosi thinks that OPEC and most recently Venezuela have the right idea. She plans on nationalizing the oil companies. She also doesn't say who these "oil companies" are. She leaves out that ExxonMobil pays more in taxes than they make in the USA. She doesn't want companies to send money and jobs out of the country, but wants to take away the assets of a company that brings more money into the USA than takes out. What does this mean? People are only thinking of their own pocketbook when it comes to voting and buying/selling stock.

2008 Oct 13 11:02 AM

[Wadhamite:]

Consider also that a substantial part of ExxonMobil's capitalization represents "wealth in the ground" and not just price hype. I regard my investment in the company as partly good business and partly a commodity hold.

2008 Oct 13 08:33 PM