Exxon Mobil (NYSE:XOM), the world's largest publicly traded oil company, has managed to weather the storm in energy markets thanks in large part to its strong focus on downstream activities, but that does not necessarily mean that shares represent bargain value even at current levels. While investors would be quick to point out a robust balance sheet, AAA credit rating, and among the highest dividend yields in the industry, upside potential in shares is not great considering current fundamental conditions in the energy market. With oil prices forecast to stay depressed for the next 4-years at the very minimum, and the slide not quite concluded, Exxon shares could face more pressure over the near-term especially as upstream revenues tumble.
Weathering the Storm
Exxon has managed to steer the ship effectively considering the forces the company is up against especially due to the sensitivity of the exploration and production business to energy prices. With the exception of Total (NYSE:TOT), Exxon has handedly outperformed other integrated oil and gas companies such as British Petroleum (NYSE:BP), Royal Dutch Shell (NYSE:RDS.B), and Chevron (NYSE:CVX). As one of the most popular holdings amongst income investors, the company remains a sought after blue-chip holding, helping to buoy shares.
Thanks to its downstream presence, Exxon has been able to actually see performance grow in the unit over the last year, adding over $1.0 billion in revenues thanks to the pace of refining considering the price glut. However, the sheer fall in prices saw upstream revenues by slide $5.1 billion year over year through the end of September. With WTI prices tumbling to the lowest levels in nearly 12-years, recently dipping below $30 per barrel, upstream is likely to see another drawdown in the fourth quarter.
Energy Price Concerns Real
Exxon is not immune from developments in the industry, especially the rout in oil prices with benchmarks expected to fall even further from current levels. While Exxon was aggressive with cost cutting measures in upstream activities, the continued supply imbalance in the global market combined with the knowledge that Iran will thrust open the production floodgates to make up for lost time foretells more pain for prices. Moreover, if total onshore storage fills in the coming months the real freefall in prices begins until all the marginal producers are wiped out.
Exxon will be able to weather these softer conditions in prices thanks to the integrated nature of the company. The question however remains if free cash flow will be enough to maintain and grow the dividend for shareholders. Right, dividend costs stand at approximately 64% of free cash flow. However, unless stronger refining margins are enough to make up for the losses in E&P, this rate is likely to rise rapidly. While Exxon is keep shareholders pleased right now, substantial dividend growth over the next few years is unlikely considering the forecast for oil prices. Income investors will be rewarded for their patience however with a 3.85% dividend yield that is likely to grow further as the company expands shareholder distributions.
When prices were especially high in 2013 and 2014, Exxon was especially persistent in its buyback efforts, even borrowing in the capital markets to repurchase shares at a substantial premium to current levels. With prices having fallen demonstrably over the past 12-months, this would be the ideal time to embark on a buyback spending spree. However, in an effort to preserve capital, the company has made the decision to slash spending on repurchases, hurting the one upside force buoying shares at the moment. Thanks to the company's expansive operations, free cash flow remains strong, something that will be useful as certain unprofitable companies begin to have asset fire sales in 2016.
Consolidation within the industry amid the current turmoil is not unlikely and Exxon is eager to set itself up for the eventual rebound in energy prices, should the day arrive. Ample free cash flows combined with the highest investment grade rating available means that Exxon has the ability to finance any future transaction at very attractive borrowing rates. Even though the outlook holds the promise of many opportunities, share prices will not benefit from these developments near-term. Without a price rebound to soften the blow to upstream production, upside in shares is capped.
The Bottom Line
As a general rule for 2016, dip buying is over. Exxon is no different, no matter how attractive prices may seem in the coming days and weeks. Until energy prices have bottomed, it will be difficult to call a reversal in the prevailing downtrend currently facing shares. Back in July, when we last wrote about Exxon, the argument was for shares to continue declining below key support at $78.63 before heading towards $75.00. Earlier in the week, shares touched $72.56 before rebounding modestly back alongside the rally in major equity indices. However, share prices are likely to retest these multi-month lows once more in the coming weeks especially if the carnage in equity markets continues to spread.
Although Exxon will likely outperform its other integrated oil and gas peers over the medium-term as the best bellwether within the industry, prices are likely to head back towards the August 52-week low of $66.55. For income investors, this is a great level to get involved to benefit from a dividend and hunker down for the storm facing stocks globally. The stability of Exxon should help the company navigate through difficult conditions, but it remains a least dirty shirt investment thesis. Even though it is an industry stalwart, the oil and gas sector is undergoing a rapid transformation that is leaving no stock unchallenged. The dip might look attractive now, but with no sustained rebound in energy prices, catching a falling knife remains a dangerous practice for value investors until the outlook is clearer.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.