Exxon Mobil: A Superior Allocator of Capital

| About: Exxon Mobil (XOM)
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Company Introduction

Exxon Mobil Corporation (NYSE:XOM) is the second largest publicly traded international oil and gas company in the world. The company is engaged in managing the entire production cycle of crude oil, from exploration and production of crude oil and natural gases, to the manufacturing, transport and sale of crude oil, natural gases and petroleum products. The company has manufacturing and marketing bases spread across six continents. Major competitors to the company include Chevron Corporation (NYSE:CVX), British Petroleum (NYSE:BP), ConocoPhilips (NYSE:COP) and Royal Dutch Shell (NYSE:RDS.A). The company is headed by Rex W. Tillerson, who serves as Chairman and Chief Executive Officer.

Growth and Performance

Exxon Mobil has been a consistent performer, barring a blip in share value in the market downturn years 2008-09. Recently, in April 2011, the company declared a dividend increase of 6.80% at 47 cents/share. As such, since the past decade, the oil giant has delivered an impressive 9.6% annualized total return to its long term investors. The company’s earnings per share (EPS) have risen steadily at 12.3% per year since 2001. The company reported earnings of $6.22/share in 2010 and consensus analysts estimates for earnings in 2011 and 2012 are $8.28 per share and $8.85 per share, respectively.

Long term Strategy and Vision

Exxon Mobil enjoys an enviable reserve replacement ratio, which indicates that the company has adequate oil reserves. The massive scale and size of Exxon’s operations ensure that the company receives huge advantages in terms of economies of scale, and is able to maximize production activity across its projects. Many national oil companies (NOCs) lack the resources and/or know-how to effectively explore for and develop reserves in their countries and therefore rely on partnerships with private industry. Exxon has become the preferred partner in these ventures. With a view to the long term, the company has made aggressive investments in developing high-efficiency projects worldwide; most notably in Qatar, Norway and the US.

Recently, Exxon has also been bullish on natural shale gas and forecasts increased demand for energy through natural gas resources. Keeping this view, the company is presently betting heavily on natural gas, and has accumulated significant natural gas assets, including XTO Energy, which will help increase its natural gas production capabilities by over 25%. Aside from the technical expertise, the XTO energy acquisition will also enable Exxon Mobil to effectively develop new shale field reserves worldwide. It is likely that such investments will complement Exxon Mobil’s core competencies and generate returns in excess of the cost of capital, as exploration and production of natural gas can be significantly lower, when compared with oil production.

While there are several really good companies in this space, Exxon Mobil is my favorite stock in the oil and gas sector due to its use of technology and operational efficiency. Exxon Mobil consistently delivers the highest returns on invested capital when compared to its peers and has the widest economic moat.

A cursory examination of valuation metrics indicates that several companies in the sector are somewhat attractively valued. For example, based upon a DCF-based valuation analysis, COP is trading at a ~17-20% discount to fair value compared to ~7-10% discount for XOM.

However, as we see in the above figure, if we examine the 10-year return on invested capital (ROC), we see that Exxon Mobil clearly has a durable competitive advantage over its peers. In my opinion, patiently waiting for XOM to come down to a 20-30% margin of safety is the best allocation of the retail investor’s capital.

Disclosure: Long XOM, (acquisition price $62.5 and $62.64)