Earlier this week, I added to my positions in integrated oil and gas giants, Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX), as the price of oil fell to between $66 and $67 per barrel on the day after Thanksgiving, sending shares of both companies down hard. I wasn't able to snap up shares on that day, but I got in on the following Monday. A lot of investors would question this action in light of falling oil prices, but I think it's a great long-term move. Below, I will offer my rationale as to why I think these two companies are excellent long-term investments.
Oil And Natural Gas Aren't Going Anywhere For A Long Time
As it stands right now, society can't function without the benefits of oil and natural gas. These commodities power our vehicles and heat our homes. In addition to that, take a look around wherever you are, and you'll probably see dozens of items that were made from petroleum byproducts. Plastics, for instance, come from petroleum. None of this is going to change any time soon.
Over the long term, demand for energy is going up. Energy demand in developing countries is expected to rise at a 2.2% annual clip from now through 2040, while energy use in the developed countries is expected to rise by 0.5% per year, in line with population growth. Developing countries are expected to account for 65% of the world's energy use by 2040, as the economies there grow at a faster rate, and as habits change due to people becoming more prosperous.
Add to the facts that there is a finite supply of oil and gas on the planet, and that a lot of it is relatively hard to get to. All of these things should contribute to the strength of oil prices going forward, and that will help companies like Exxon Mobil and Chevron.
Exxon Mobil and Chevron are both in a position to benefit from the long-term growth in demand. Exxon had 25.2B barrels of oil equivalent in reserves at the end of 2013, while Chevron had 11.2B barrels of oil equivalent. During 2013, Exxon Mobil had a reserve replacement ratio of 103%, marking its 20th consecutive year with a replacement ratio of more than 100%. Chevron has a three-year average reserve replacement ratio of 123% of net oil-equivalent production. This all means that both companies have so far been able to replenish their reserves after production.
Integrated Business Models And Geographic Diversification
Another positive that both Exxon Mobil and Chevron have in this current environment is that they are involved not only in the exploration and production of oil and natural gas, but also in the downstream activities of refining, in which they produce gasoline, diesel fuel, and jet fuel. Exxon Mobil is the world's largest refiner. Lower oil prices make it cheaper to manufacture those fuels, as well as other petroleum-based items like plastics and asphalt. During the third quarter, Exxon's refineries saw profits rise by 73%, while Chevron's refining profits more than tripled.
An integrated business model such as this helps to cushion the blows that can come to an energy company's earnings as a result of lower oil prices. This is an advantage that companies like Exxon Mobil and Chevron have in comparison to more pure-play exploration and production companies. Of course, if oil prices take off, the downstream segment will more than likely serve as a drag, but the gains from the upstream segments of these two companies should more than offset that.
In fact, Exxon Mobil's CEO said today that even if the price of oil falls to $40 per barrel, the company will still be fine, due to the fact that many of the company's projects have been tested to perform across a broad price range. The integrated business model helps with this as well.
Another item of interest is the fact that both Exxon Mobil and Chevron have their operations spread all over the globe. Chevron has extensive operations in more than three dozen countries. Exxon Mobil also has projects underway all over the globe. So, in addition to being operationally diversified with oil, natural gas, fuels, and chemicals, they are also diversified from a geographic standpoint.
Projects To Find More Oil And Natural Gas
Exxon Mobil and Chevron continue to move forward in the exploration and production of oil and natural gas. Just today, Chevron announced that production of oil and natural gas has begun at the Jack/St. Malo project in the Gulf of Mexico. Chevron estimates that over the next 30 years, this project should yield the equivalent of more than 500 million barrels of oil. Chevron announced last month that the Tubular Bells project, in which they have a 43% interest, has begun crude oil and natural gas production in the Gulf of Mexico. This project is expected to produce 50,000 barrels of oil equivalent per day. The company is also engaged in the development and ramping up of production from shale resources in the Permian Basin.
And, of course, I would be remiss if I didn't discuss Chevron's huge natural gas projects in western Australia: the Gorgon and Wheatstone projects. These two projects could yield a combined total of up to 50 trillion cubic feet of natural gas. The Gorgon project has the capacity to produce 15.6 million metric tons per year in liquefied natural gas. Shipments from this project should begin in the middle of next year. The Wheatstone project has an estimated capacity of 8.9 million metric tons per year of liquefied natural gas. Work on this project is still ongoing.
Exxon Mobil, meanwhile, is currently developing over 120 projects that represent 24B barrels of oil-equivalent production. The company is expecting a record ten new start-ups before the end of this year. These ten projects are expected to contribute 300,000 barrels of oil-equivalent production per day. These projects include an LNG project in Papua New Guinea, in which the company has a 33% interest. This project is expected to produce nearly 7 million tons of LNG each year for the growing Asia-Pacific market.
Next year will feature production at one of the world's largest fields, with an estimated 50B gross barrels, in Abu Dhabi. Production capacity here is expected to be 750,000 barrels per day. Exxon Mobil has a 28% interest in this deal. Another 160,000 barrels of liquids per day are expected from a company project in Angola. This particular project has produced 15 new discoveries so far, with a combined gross recoverable potential of 5B oil-equivalent barrels. Exxon has a 20% interest here.
Over the next three years, Exxon plans to start up production at 11 other projects, leading to an increase in total production of one million net oil-equivalent barrels per day by 2017.
Strong Records Of Earnings And Dividend Growth
Both of these companies have strong records of profitability and returning cash to shareholders in the form of dividends. From 2004 to 2013, Chevron's core earnings per share rose from $5.88 to $11.07, nearly doubling. Dividends per share grew from $1.53 to $3.90. Today, Chevron pays out an annualized dividend of $4.28 in quarterly installments.
Over the same time period, Exxon Mobil's earnings per share nearly doubled, from $4.01 to $7.74. Dividends increased from $1.06 to $2.46 per share. The company currently pays an annualized dividend of $2.76 per share, also in quarterly installments.
From this, it can be seen that both Exxon Mobil and Chevron have strong track records in the areas of profitability and dividend growth.
Strong Balance Sheets
Both of these two companies are in very good financial condition. This can be seen from their balance sheets. At this point, debt is hardly a factor for either company, as Exxon Mobil has a net debt to equity ratio of just 0.11, while Chevron's ratio is just 0.07. Over the last 12 months, Exxon covered its interest obligations by more than 800 times with its operating income. Chevron had no net interest expense. They currently have more than $14B in cash.
Neither company has any problem at all when it comes to paying its bills.
Dividends And Share Repurchases
As discussed above, both companies have a strong history of dividends. Exxon Mobil has increased its dividend every year for 32 consecutive years. Over the last 12 months, the company's free cash flow has been more than enough to cover the dividend. This is quite remarkable when considering the high capital expenditure environment in which these energy companies currently do business. Exxon Mobil currently yields 2.9%, at the high end of its five-year range.
Chevron has increased its dividend every year for the last 27 years. Management stated during the most recent conference call that the dividend, and the growth of it, is the number one priority of the company when it comes to using its cash. Due to high capital expenditures, the free cash flow was not enough to cover the dividend payments over the last 12 months. However, management said that they would use their balance sheet to help fund dividend payments until more of their projects start producing. Exxon Mobil is also in a position to do this if they have to. Chevron yields 3.8% at this time, near a four-year high.
Both of these companies buy back a lot of their stock. Share buybacks, when done at reasonable prices, create value for shareholders, as each share that remains after a buyback represents a bigger stake in the company and a bigger claim on the company's earnings. This is often reflected in the share price.
Here's where it gets a bit tricky for me. First off, Exxon Mobil trades at about 12 times earnings, while Chevron trades at about 10.5 times earnings. Neither stock trades at a nosebleed valuation at this time. However, it's hard to value these two companies based on future earnings, which are hard to predict due to the volatility in oil prices. Analyst estimates for both companies vary quite a bit.
You could do a discounted cash flow analysis that is based on the present-day value of future dividend payments. But, again, due to the volatility in oil prices, it's hard to predict a constant dividend growth rate over the next several years.
However, I do know that the strong dividends of these companies aren't going away, and will increase in the future. How much is anyone's guess. There is also this phenomenon with many blue-chip stocks that is known as yield support. When the stock price falls, the yield rises, and once that yield hits a certain level, investors bid the stock price back up. So, the yield can often act as a price floor for the stock in question.
This could be seen recently with both Exxon Mobil and Chevron. The yield of Exxon Mobil hit 3% last week, but shares have been bid up a little bit since. Chevron's yield hit 4%, but didn't stay there long either. However, the yields of both of these stocks are at their highest levels in more than four years. I only have data going back for five years, so I don't know if Exxon has ever yielded more than 3%.
Given that the yields of these companies are at multi-year highs, and the dividends are sustainable, I would say that both stocks are currently trading at attractive prices, especially from a long-term perspective.
I added to my existing positions in both Exxon Mobil and Chevron earlier this week for a number of reasons. The first reason is the simple fact that there will always be a demand for oil and natural gas in the future, and with their tremendous reserves and reserve replacement capabilities, Exxon and Chevron are both in great positions to accommodate this need. Another reason is the integrated business models that both companies have, which help to cushion the blow to earnings that these companies might experience due to a collapse in oil prices. Both companies have long histories of earnings and dividend growth, and with new projects coming online every year, there is no reason to believe that these histories won't continue over the long term. And, finally, these companies are currently offering attractive dividend yields that haven't been seen in a long time. For these reasons, I am long-term bullish on both Exxon Mobil and Chevron.
Disclosure: The author is long XOM, CVX.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.