Exxon has faced revenue pressure from energy pricing, and EPS declines have been exacerbated by major spending projects.
There are several reasons to be excited surrounding recent investments.
Looking ahead and assuming stable oil, we see a return to EPS growth next year.
Get paid to wait.
In the high $60 range, we still believe that Exxon Mobil (XOM) is a strong buy. We think you need to get paid. You need to get paid that juicy and growing dividend. Make no mistake about it. Exxon has survived every major downturn in energy and emerged stronger each time. While pricing impacts revenues, expect Capex spending to focus on bringing new projects on-line, but these can be cut and done so dramatically if the situation worsens. With this flexibility, as we move forward we expect substantial improvement in all segments, as oil prices have stabilized and started to rebound. Investors will be further paid a near-5% dividend yield at these levels. Exxon reported earnings a few days ago, and despite some weakness on the headline print, the underlying fundamentals of the name remain intact. In this column, we will highlight and discuss trends in several of the critical metrics you should watch for, in addition to updating our 2019 expectations once again.
Naturally, the price of oil and gas is what pretty much drives revenue for the company, in addition to changes in volumes. As energy commodity prices move higher, Exxon makes more money. With that said, revenues have begun to fall this year along with energy prices. While volumes matter, as do movements in balance sheet line items, there is no denying the clear correlation with oil prices and revenues for the company. Oil prices rebounded from 2016 into 2019 but have since started facing weakness, particularly in Q2 and in this Q3. This weakness led to the first drop in Q3 revenues since 2015:
Source: SEC filings, graphics by BAD BEAT Investing
So of course, this result means a three-year streak of increases was broken. The trend was positive after recovering from the huge declines in energy prices in 2015-2016. Today's pricing environment is slightly better than it was in most Q3, but is still weaker than this time a year ago. The decline in oil prices directly led to revenue declines. Revenues fell to $65.05 billion from $76.61 billion last year, which is a decline of 15%. The results also missed the Street consensus by $810 million. Let's discuss why revenues were down.
The revenue decline
As you are likely aware, oil and gas prices were pretty strong in 2018 and have receded quite a bit in 2019. Crude prices were highly volatile, whipsawing up and down in much of the third quarter. Overall, they were lower versus a year ago, while natural gas prices were also down substantially. This low commodity pricing weighed on segment performance. The oil price action hurt the company's upstream operations versus a year ago, contributing to the overall revenue decline. This comes despite an increase in production upstream to 3,899 koebd.
When turning to the downstream side of things, industry fuel margins improved from the second quarter on stronger distillate margins in Europe and Asia Pacific. In addition, following completion of significant refinery turnaround activity during the second quarter, scheduled maintenance activity was lower in the third quarter, so there was less downtime. However, the downtime was noticeable in early Q3, and this action, of course, contributed to a decline in revenues as there were lower petroleum product sales, while margins were also lower on average. As for the chemical side of the business, Exxon had weak margins, and volume was hit by an event at the Baytown, Texas olefins plant.
Reasons to be excited moving forward
Despite these pressures, there is some reason to be bullish, especially if pricing stays stable (or increases). The company started production on its new high-performance polyethylene line in Beaumont, Texas. The expansion increased plant production capacity by 65%, or 650,000 metric tons per year. Exxon also is in a joint venture to construct the Wink to Webster crude oil pipeline in Texas. The new pipeline system is expected to commence operations in early 2021, providing more than 1 million barrels per day of Permian takeaway capacity. Exxon Mobil also announced the global launch of its Mobil EV lubricants offering, which features a full suite of fluids and greases designed to meet the evolving drivetrain requirements of electric vehicles. These investments are beneficial to volumes, and the latter helps Exxon diversify in a green economy.
Earnings followed revenues lower
Here is the thing. Expenses were up heavily since last year, while revenue was down. Double whammy, but those expenditures are setting the company up for future growth, and that is why we want to own shares here while they yield 5%. We will closely be watching the company's expense management as we move forward.
Obviously, if energy prices retract further, we expect Exxon will take severe cost-cutting measures like it did in 2015. That said, expect Capex to remain high unless the company is forced to cut back due to collapsing energy prices. Capital and exploration expenditures worldwide were $7.7 billion, up 17% from the Q3 2018 levels and the highest in years. This was a slight decline from the $8.08 billion just last quarter. We were expecting growth here, and actually thought expenditures would be well over $8 billion again.
When factoring in the revenue result and all sources of expenses, earnings per share fell from last year:
Source: SEC filings, graphics by BAD BEAT Investing
This was expected given the revenue hit, though we argue that the company can still do a better job of managing expenses. That said, despite the major pressure on revenues, the lower-than-expected expenditures led to the company beating EPS estimates. On an adjusted basis, EPS beat consensus estimates by $0.02, hitting $0.68. While this is down heavily from last year, the profit is clear. EPS was also up from the sequential quarter. Although the EPS trend in the charts looks bad, we are looking ahead to 2019 as a whole, and of course to 2020, and believe the stock is attractively priced.
Looking ahead, we really expect substantial improvement in all segments as oil prices stabilize, if not rebound. The increase in spending hurts right now, but we believe this will be a benefit so long as energy prices remain solid. However, pricing will be disastrous if we see $30-40 oil for an extended period of a few quarters. At $55-60 oil, we like the name, as it operates profitably. Obviously, the higher the commodity goes, the better. As such, oil and gas bears should pass on this name, but we still believe this is a solid name for traders to consider, as well as dividend yield hunters.
When we factor in YTD performance and consider there are no major catalysts one way or the other coming immediately, we see value under $70 per share. With oil in the mid- to high-$50 range, we still see a very profitable 2019. Based on our assumptions and the performance of the company in the most recent quarter, we are now targeting 2019 revenues of $265-275 billion. We also expect GAAP EPS growth from about $3.00 per share in 2019 overall to at least $3.50 in 2020. However, it does depend on energy.
This is a blue-chip stock that has suffered for years. That, in turn, has caused it to be hated by many. Like any name in the sector, the day-to-day trading is all about energy pricing. In our opinion, avoid Exxon if you see $40 oil coming. If you believe oil remains at these prices or higher, it is worth buying the near-5% yield to wait for an eventual rebound. The long-term investor should consider buying Exxon stock if it dips well into the $60 range, while traders can look to step in and scalp trades around a $70 handle.
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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.