Here's The Thing About Exxon Mobil

Summary

• XOM recently reported earnings and the Street has not been buying on the news.
• Huge capital expenditures led to lower earnings but XOM still is compelling for a long-term entry point, especially any time it is under the $80-mark.
• Investors need to watch segment-specific performance going forward. Based on year-to-date performance we have revised our 2018 expectations.
• This idea was first discussed with members of my private investing community, BAD BEAT Investing. To get an exclusive ‘first look’ at my best ideas, subscribe today >>

Exxon Mobil (NYSE:NYSE:XOM) recently reported earnings and the Street did not find much to like and has been selling on the news. We like to look at the name from a long-term perspective, and that means that we must have a solid grasp on the fundamentals of the name, especially since this is the one blue-chip we use as a measure for the health of the oil sector.

Here is the deal. We believe that XOM still is compelling for a long-term entry point any time it is under the $80 mark. The stock is there right now and has been offering this entry point a few times in recent weeks. At $70 oil, we still see a potential opportunity to get long the stock, but we need to keep an eye on the fundamentals. It is not just the top and bottom line which we need to watch either, but also the expenses of the company and the segment specific performance matters. In this column, we will discuss trends in several of the critical metrics you should watch for, in addition to updating our 2018 expectations.

Top-line growth strong

We all know that oil and gas are what drives revenue for the company. As such, the higher the commodity price, the more money that can be made. With that said, revenues have returned to growth over the last year plus thanks to solid energy prices. With the rise in oil and gas prices, there has been a direct correlation with increased revenues for the company. When examining trends in the top line over the last several second quarters, we see the rebound in the top line as oil prices began to rebound from 2016:

Source: SEC filings, graphics by BAD BEAT Investing

The trend is clearly positive here. Revenues were strong in the quarter and did rise as a whole significantly here in Q2 2018 vs. Q2 2017. Revenues hit $73.5 billion and rose a solid 26% over last year. What is most impressive is that we were expecting what we thought was a rather bullish $72.5 billion target for revenues on the back of higher energy prices. Our projections were even more bullish than the Street's consensus. Exxon surpassed our expectations by $1.0 billion, but crushed consensus by $1.83 billion.

Why revenues were up

Why were revenues up? Well, oil and gas prices have been pretty strong in 2018. Crude prices strengthened in the second quarter, while natural gas prices were mixed. Overall this price action benefited the company's upstream operations. This comes amid oil growth in the Permian and Bakken, reaching over 250,000 oil-equivalent barrels per day in Q2, an increase of 30% from last year. Overall though oil production was down as a whole, but the price of oil offset this decline.

On the Downstream side of things, global refining margins strengthened due to higher industry refinery maintenance activity and increased seasonal petroleum product demand. Further, growth in higher-value sales of retail fuels combined with "record quarterly sales of Mobil 1 lubricants in the U.S. and China" helped boost the top line above expectations.

As for the Chemical side of the business, Exxon had the best sales its seen in over a decade, with strong volumes in the U.S. and Singapore.

While revenues are improving significantly, earnings have seen a boost, but the issue is that high expenses have weighed.

Earnings improve but expenses weigh

Expenses were up heavily since last year. This was primarily a result of the increased investment into the company’s operations in a rising oil price environment. With oil prices at a level where increase spending to generate higher revenues makes sense, we have seen new operations come on line, we have seen the company funding more labor, etc.

We think the company was very successful through the low points of 2015 where, though spending was much higher than we expected in Q2. Why? Chemical saw higher feed and energy costs. There were also new rigs in the Permian and Bakken that were brought online. There were also a large number of investments made for future growth of the company and this really hit the overall earnings power. In fact, capital and exploration expenditures worldwide were $6.6 billion, up 69% from the Q2 2017 levels:

Source: SEC filings, graphics by BAD BEAT Investing

What is more, this was also up from the $3.9 billion just last quarter. We Were expecting growth here, but this was far and above what we thought the company would really register. Let us not forget is that these expenditures are investments for the future, but now the company has to show us it can deliver with these investments made. When considering the revenues and all sources of expenses, earnings per share rose from last year, but much less that we thought the company would generate:

Source: SEC filings, graphics by BAD BEAT Investing

There is no doubt that we were disappointed as we were expecting closer to $5 billion in earnings, or around $1.15 per share in earnings. As such performance missed our expectations because of the much higher than expected expenses. Of course, compared with last year the company saw an improvement. The company's Q2 earnings last year were $3.35 billion or $0.78 per share. This was disappointing relative to our projections, which were $0.23 per share higher than the actual results. Consensus estimates were for about $1.27, so the company also missed here. Let us turn to looking at each segment to get a little more color on earnings strength.

Segment-specific earnings

So, we saw earnings rose to $4 billion, but what we think investors have to be mindful of are the trends in each segment. Looking at the performance of each segment can inform investors where issues may lie.

There has been strong improvement in the Upstream segment earnings and they rose mostly due to higher prices for oil. There were higher expenses and lower margins in both Downstream and Chemical earnings. The higher expenses more than offset better volumes in Chemical. The decline in Downstream earnings to $724 million from $1.38 billion was a bit driven by lower divestments this year, which benefited the segment last year. That said, capex spending rose significantly across segments.

Looking ahead, we expect substantial improvement in all segments, and believe the ramp-up in spending will be a benefit. With the commodity pricing environment improving, including natural gas (which has been a bit volatile), we expect forward growth.

2018 projections

Given that we are now halfway through 2018, we are adjusting our projections for 2018 following these results. With the present trajectory of the company, we continue to expect substantial improvement beyond 2018. We are still basing our expectations on oil remaining in the $60-70 range. But given the earnings we have seen, we have narrowed our revenue expectations but trimmed lower our earnings expectations. Based on our assumptions and the performance of the company this quarter, we are targeting 2018 revenues for $290 billion to $315 billion, from $285 and $320 billion. As for earnings, we are looking for $4.75 to $5.60 per share from $4.50 to $6.10.

Our take on the stock

Revenues continue to be above our expectations on the top line, but the company has been on a spending tear, leading the company to see lower earnings. We are not thrilled with the action, but the company remains incredibly shareholder-friendly between raising its dividend and buying back stock. With the longstanding global presence of the company and the investments made for the future in recent quarters, we continue to like the stock below the $80-mark.

We welcome your comments.

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Analyst’s Disclosure: I am/we are long XOM. 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.