Exxon: Is The Bottom In?

Summary

• Oil major posted mixed Q1 2018 results, forcing XOM investors to rush to the exit.
• Declining throughput and weak downstream performance overtook upstream earnings boost.
• Recent correction offers an interesting entry point for long-term buyers.
• In the short term, however, weakening investor sentiment may persist amid low Q2 seasonal output.

U.S. Oil and Gas giant, Exxon Mobil Corporation (NYSE:XOM), published mixed Q1 2018 results last week, missing analyst EPS estimates by $0.01 to $1.09 per share. With crude oil prices reaching higher highs and supply glut steadily diminishing, XOM pursues its investment growth and portfolio strengthening. The market is not prone to back management's long-term strategy after the recent sell-off in the share price and the mixed earnings release. Although XOM’s oil throughput and downstream revenues declined, the company’s resilience and its solid capital expenditures of $50 billion until 2025 will deliver robust growth in the coming years.

From a technical standpoint, XOM rebounded sharply from its solid $70 support level following the Q4 2017 earnings release punishment. At current trading levels and with oil near $80 per barrel, reserved Q1 2018 results represent an opportunity to acquire the biggest integrated U.S. Oil and Gas Company.

Source: Trading View

XOM’s stock plunge seems overdone following mixed Q1 2017 earnings release

XOM’s Q1 2018 earnings per share of $1.09 missed analyst expectations by a tinny penny, while revenue, up 16.2% to $68.2b, came in ahead of expectations. During the quarter, normalized field declines, Papua New Guinea outage of 25mboe/d as a result of March earthquake and slowing refined product demand weakened XOM’s earnings. However, XOM did a much better job at managing the outcome, namely through better cost control, down 4% to $60.9b.

Against this, the recent sell-off seems overdone given the above elements. With top line growth accelerating 2.5% to $68.2b and cash flow from operations posting a two-figure boost of 16.2% to $8.6b, XOM’s cash generation covers integrally its capital expenditures and dividend distribution. Meanwhile, free cash flow reached $5.1b, up 16.2%, in spite of stronger capital expenditures, which rose 16.7% quarter on quarter (qoq) to $4.8b.

Having said this, XOM net earnings jumped 16% qoq and 25.7% year on year (yoy) to $4.6b, following noisy Q4 2017 tax reform release, which included a $5.9b tax gain. With crude benchmark at a 3-year high and OPEC cartel pushing for a barrel between $80 and $95, XOM’s operating environment remains anchored in positive territory.

Upstream business surge was offset by weak downstream performance and overall declining throughput

During Q1 2018, XOM’s upstream earnings, including the $366m Scarborough sale in the North Sea, recorded a marked increase of 38.9% qoq and 123% yoy to $3.5b. Strengthening crude and natural gas prices over the period enabled the company to enhance its revenue stream in spite of oil-equivalent output decline, down 6% to 3.9m barrels per day.

Colder weather across the U.S. and Europe improved seasonal demand, thereby underpinning the strength in LNG and natural gas prices. In the meantime, Western Canada Select, Canadian heavy crude benchmark, accelerated its decline compared to U.S. standards following pipeline logistic constraints, bringing headwinds to XOM’s profits.

Source: Alberta Government

That said, upstream margins accelerated 5.1% in 1Q2018, compared to a 3.8% yoy increase. However, the trend could accelerate further given oil’s bullish momentum.

Chemicals results improved by 8% quarter on quarter to $1.01b, but plunged steeply by 13.7% year on year. Higher growth-related expenses associated with the startup and commissioning of new assets in Asia and U.S. lowered net margins, whereas prime product sales posted a slight decline of 2% to 6668 kt.

Meanwhile, downstream earnings suffered the most during 1Q2018, down 1.3% to $940m versus Q4 2017 and plummeted 38.6% yoy. This is mainly attributable to lower margins, ramping operational costs outside of the U.S. and seasonal petroleum sale weakness, which slowed by 3% worldwide.

Headwinds will persist in the short term given weakening investor confidence, but XOM’s current valuation represents a long-term buying opportunity

With declining overall throughput and weaker product sales in the downstream division, the market’s perception of XOM business prospects may continue to suffer. Greater capital expenditures compared to peers and the absence of a stock buyback program could explain why investors are rushing to the exit.

The company’s management addressed the issue during its Q1 2018 conference call, while attempting to proactively deliver its corporate message. However, it might not be enough to revert current negative market sentiment. With gas seasonality, XOM’s Q2 2018 output will likely continue to deceive and dip further compared to Q1 2018 amid natural gas maintenance start and declining natural gas sales.

Compared to its integrated peers, XOM stock’s lag reflects its low shale oil exposition and mega offshore projects, which are set to take years to complete and require intensive capital expenditures. Even if the development of U.S. unconventional acreage is progressing, with 27 operated rigs in the Permian and four in the Bakken basin, this will not be enough to offset the lowest output since the 1999 Exxon and Mobil merger.

Going forward, the company’s investor-friendly announcement of increasing the Q2 2018 dividend by 6.5% or $0.82 per share could help ease negative investor sentiment although a stock buyback seems to be necessary to fully offset the presently weak investor confidence. However, at current valuation and given the company’s plans to reinvest a massive $50b until 2025, XOM’s share remains a value bet for long-term holders.

Valuation:

With XOM’s momentum in freefall after the raft of bearish news, we contend that this might not be a perfect time to initiate a buy position. Apart from EV/EBITDA metric, which remains overvalued compared to its peers, the current price level of around $77 per share provides an interesting entry point in terms of both 2018 P/E and dividend yield. Consequently, long-term investors might wait until XOM’s price level reaches $70 per share, which corresponds to a strong support level and provides a sweet spot for playing XOM’s long-term equity story.

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Analyst’s 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.