Exxon Mobil: You Shouldn't Be Surprised By Performance (NYSE:XOM)

Summary

Exxon Mobil nearly doubles from its lows in September of last year when I first covered the company.
Even though the share price might be running ahead of fundamentals, the long-term thesis behind the business is still in place.
Fundamentals could continue to surprise on the upside as business standing improves and macro tailwinds persist.

It has been almost half a year since I laid out my investment thesis for Exxon Mobil (NYSE:XOM) in 'Exxon Mobil: A Textbook Example Of Mean Reversion'.

In my analysis I focused on the long-term mispricing faced by most of Oil & Gas majors and particularly XOM. At that time Exxon Mobil checked all the boxed for a classic example of a company that has been overlooked and oversold and due to experience a reversion to the mean in terms of performance.

While many people simply couldn't believe that XOM share price could deliver outstanding returns in the midst of the oil prices slump, raging pandemic and so exciting technological disruptions, here we are 6-months later and not only did XOM outperform the broad market, but the high flying tech sector as well.

For a number of months I kept on covering the opportunity behind the company and even took a more unconventional approach in comparing the performance of XOM to the stock that took its place in the Dow Jones Index - Salesforce (CRM).

Source: Seeking Alpha

It was almost unbelievable, how one of the struggling corporate dinosaurs such as Exxon could outperform one of the most 'future proof' and exciting tech companies out there, and yet here we are six months since I wrote my thought piece called - 'Exxon Mobil Vs. Salesforce - The Most Likely Scenario Ahead'.

As it often happens in markets, even the best companies could become too richly priced and even the worst ones could become too cheap.

Moreover, in the case of XOM and CRM these two businesses are far from being the worst and the best ones respectively, while their valuations at the time suggested that this should be the case.

True, there are many aspects of XOM business that I would not consider as the best practices and would love to see them changing, but no business is perfect. Most importantly, however, Exxon Mobil's management is also doing many things right and like it or not we as a society need many Oil & Gas majors, unless we want to turn the lights off.

The long-term thesis for Exxon Mobil

Although XOM is not as an attractive opportunity as it was six months ago, when I first covered it and the stock has probably gone up too fast, the long-term thesis in the company remains intact.

If you haven't done so already, I urge you to read my article on how long-term investment cycles in the Oil & Gas space often go against the more short-term nature of markets and how these could often result in opportunities hiding in plain sight. In addition to this more sector wide mispricing, XOM has some key competitive advantages.

As one of the largest players in the space, XOM has sustainable and almost impossible to replicate competitive advantages. The large scale, integration and low cost of supply projects allow the company to continue to invest in exploration, development and new technologies, in spite of the wild swings in commodity prices.

And while Oil & Gas will most likely not be an exciting growth industry, such as the electric vehicles space has been so far, it will most likely continue to be a vital part of the energy mix well into the future.

Source: ExxonMobil Investor Presentation

Why this is so important is that in addition to all the benefits that this energy will bring to the society, XOM will face increasingly less competition in the space as inefficient and poorly run competitors will most likely disappear. This way XOM low cost of supply upstream investments could offer attractive returns, even if they do not grow meaningfully.

Source: ExxonMobil Investor Presentation

This leads to XOM's another significant competitive advantage in two large segments of the energy market, which could easily become the new high-growth area of the market over this decade. Namely, these two areas are - Hydrogen and Carbon Capture & Storage (CCS).

Source: ExxonMobil Investor Presentation

Starting with transportation, investments in vehicle electrification hit stunning numbers, not only in United States and Asia, but Europe as well. From private capital to government initiatives, the segment has been the most popular investment space for many retail and institutional investors alike.

Source: transportenvironment.org

While this process could result in significant misallocation of capital, by benefiting less efficient and less innovative players proliferate on the back of the EV mania and cheap capital, it will surely bring significant benefits to the society in terms of lower cost and more efficient batteries.

More importantly, however, electrification of smaller and consumer oriented vehicles should lead to two other trends:

higher investments in power generation and infrastructure, which at the moment lag behind
electrification of larger commercial vehicles and decarbonization of energy intensive industries, mainly through hydrogen

Source: ExxonMobil Investor Presentation

Sooner or later, capital inflows into these underfunded areas will need to catch up with the more appealing to the consumer's shiny electric vehicles. And this is where XOM's CCS technology and hydrogen capabilities come into play.

At the moment hydrogen and CCS seem to offer the best solution to achieving carbon-neutrality of energy intensive industries, such as steel, cement and many other. That is why in its recent comments, the CEO of the largest North American flat-rolled steel producer - Cleveland-Cliffs (CLF) mentioned that their new Hot Briquetted Iron (HBI) plant is designed with future hydrogen utilization in mind.

Additionally, once hydrogen becomes commercially available, our plant is already capable of using up to 30% of hydrogen as a partial replacement for natural gas with no equipment modification needs, and up to 70% with minor modifications, which would even further reduce emissions from the baseline.

Lourenco Goncalves - President and Chief Executive Officer

Source: Cleveland-Cliffs Q4 2020 Earnings Transcript

Coupled with CCS implementation, where XOM has a leading spot, these two technologies could offer the solution to large commercial vehicles and energy intensive industries decarbonization.

A closer look at business fundamentals

While the long-term strategic view of the Energy industry favors XOM, current business fundamentals are also a key factor for the company's future success.

Exxon Mobil's massive loss for the last fiscal year was primarily led by impairments due to the slump in oil prices which amounted to $20.3bn in total.

Source: Exxon Mobil FY 2020 10-K SEC Filing

In addition, during the last quarter of 2020, West Texas Intermediate (WTI) was still trading at around $40 on average, which as we could see down below is a major driver of profits for XOM's upstream business unit.

Source: prepared by the author, using data from annual and quarterly reports and fred.stlouisfed.org

From the relationship above, Q4 2020 results adjusted for impairments were in line with expectations. However the average WTI prices for Q1 2021 will be close to or above $60, with current futures standing at around $66 per barrel.

Source: fred.stlouisfed.org

The last quarter when oil prices were at levels close $60 was during Q2 2019, when XOM was trading at around x1.2 sales, which could suggest that either XOM will need to become much leaner or oil prices will need to hover well above $60 to support current multiple of close to x1.5.

Of course, less correlated with absolute level of oil prices Downstream and Chemical segments should also be taken into account as they offer a key competitive advantage of any large integrated oil major - diversification.

Source: prepared by the author, using data from annual and quarterly reports

Cash flow from these business units allows XOM to continue to invest heavily into exploration, development and new technologies even as oil prices and profitability in upstream operations hit rock bottom.

In addition to everything said above, XOM management has also made the organization significantly leaner through its ongoing cost cutting measures.

At the same time we leveraged on the ongoing work in reorganizing our Upstream and Downstream businesses to significantly reduce costs and preserve value in an extremely challenging and uncertain market environment. We delivered on our cost reduction objectives and outperformed our revised plan, which we shared with even April.

Darren Woods - Chairman and Chief Executive Officer

Source: Exxon Mobil Q4 2020 Earnings Transcript

In order to further improve its free cash flow, XOM alongside all other majors has significantly cut its capital expenditures. After reducing its Capex spend guidance in response to the Covid-19 pandemic to £23bn for 2020, XOM ended spending $21bn during fiscal year 2020.

Source: Exxon Mobil Q4 2020 Earnings Presentation

Management has also committed to further reduce its capital spend as it focuses on more efficient parts of its portfolio.

ExxonMobil expects 2021 capital expenditures to decline 11-25% from 2020 levels as the company focuses on projects with lower breakevens amid an uncertain price environment, company executives said during a fourth-quarter earnings call Feb. 2.

Source: spglobal.com

All these initiatives, combined with higher oil prices and the successful projects in Guyana would allow XOM to significantly increase its free cash flow going forward.

Source: ExxonMobil Investor Presentation

With that in mind and Exxon's favorable debt repayment schedule, the company should not have any financial difficulties, unless there are more major shocks to the economy down the road.

Source: prepared by the author using Exxon Mobil 2020 10-k SEC Filing

Finally, the company's high dividend yield should also be mentioned. Although a dividend cut could disappoint many shareholders and have implications for institutional ownership as well, keeping the currently high rate of shareholders payment is a very unpopular move at a time of layoffs and cost cutting measures across the business.

On top of that almost all Oil & Gas majors need to improve their broader public image and show that they truly care about the community and the environment at a time when a growing wave of criticism against these business arising. That is why in my opinion shareholders, and management alike, should show solidarity and share the burden with employees and other stakeholders.

Conclusion

Exxon Mobil's stellar performance over the past six months does not appear surprising at all. Although it also came as a result of seemingly random political and macroeconomic events, business and industry wide fundamentals are also at play. The long-term thesis for oil & gas investments remains solid and XOM is a key player in this field. The company is also on track to become much more profitable and generate significant free cash flow over the coming years from its legacy businesses, while at the same time investing increasingly more in the technologies of the future - hydrogen and CCS. As short-term consolidation risk is also present, I still view XOM as a solid long-term investment opportunity.

This article was written by

Vladimir Dimitrov, CFA

5.26K Followers

Vladimir Dimitrov, CFA is a former strategy consultant within the field of brand and intangible assets valuation. During his career in the City of London he has been working with some of the largest global brands within the technology, telecom and banking sectors.

He graduated from the London School of Economics and is interested in finding reasonably priced businesses with sustainable long-term competitive advantages.

Vladimir is the leader of the investing group The Roundabout Investor where he teaches the process of evaluating roundabout investments; defined by potential high capital return, growth in free cash flow, safe dividends and conservative capital allocation. He offers weekly investment ideas, a model portfolio, a watchlist, macro outlooks, and sector deep dives. Learn more.

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

Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author's opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies' SEC filings. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

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