Exxon Mobil: 5.5% Dividend And Strong Upside Following Q3 Earnings

Summary

• Exxon Mobil released a fairly uneventful Q3 earnings report Friday.
• Don't let the lack of excitement fool you, however. Exxon Mobil is a tremendously profitable enterprise that's firing on all cylinders.
• The company's cash flows will allow it to speed up its share buyback program, accelerating share price upside heading into 2022.
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Exxon Mobil (NYSE:XOM) announced its Q3 earnings on Friday. The numbers topped expectations across the board:

Source: Seeking Alpha

However, it was a non-event as far as XOM stock went. Shares closed the day Friday up just a fraction of a percent. Zooming out, the stock has been in a trading range since this summer, and these results did little to change that:

Data by YCharts

Investors hoping for a flashy quarter from Exxon Mobil might be disappointed with these results. Everything was fine, but nothing really jumped off the page. The stock's muted move on Friday following the numbers reflects that point.

That's in stark contrast to, say, Canadian oil giant Suncor (SU) which leapt 15% on blowout earnings last week. Suncor doubled its dividend and announced a dramatic share buyback, among other moves, which reset the whole narrative around that company.

Exxon Mobil didn't and likely won't be able to achieve such a leap. However, that's not management's fault. For one thing, unlike almost all the other oil majors, Exxon Mobil never slashed its dividend during the 2014-2020 oil bust. Suncor's doubling of its dividend, by contrast, merely boosted that dividend back to where it was prior to COVID-19. Exxon allowed its current dividend yield to top 10% at one point in 2020 and never gave in to the analyst demands to reduce the payout in the face of extraordinarily weak energy prices.

Exxon Mobil has long prided itself on being an oil and gas company that retirees and income investors and rely on through thick and thin. It held to that standard even in a most grueling energy bust these past few years. The quarterly dividend hike from 87 cents to 88 cents recently hardly moves the needle, but it keeps the company's Dividend Aristocrat status intact and reinforces its broader income track record.

A Cash Flow Machine

Another thing with Exxon Mobil is that we're so used to hearing big numbers from the company that the earnings figures lose a little impact.

On a trailing basis, the company is back up to normal levels of free cash flow generation, that being around $15 billion per year. It did even higher figures than that back prior to 2014 when oil and gas crashed. 2022 FCF should be dramatically above that figure as well, given the current trajectory of oil prices. But for now, let's be conservative and assume that we aren't getting back to those glory days for the industry quite yet.

$15 billion in free cash flow is a lot of money. Sure. But there's a lot of dollars out there these days. Is Exxon really making that much money compared to the hottest and most glamorous new economy stocks of today?

Yes, as it turns out, $15 billion is still a lot, even compared to today's stars:

Data by YCharts

As you can see, of a varied group of popular stocks, only Amazon (AMZN) has been remotely competitive with Exxon in free cash flow generation over the past five years. And, ironically, despite everyone avoiding companies like Exxon for being cyclical, Amazon's free cash flow has just seen as abrupt a decline as you might expect from a struggling value company. It seems that when the economy turned, it caused major problems for Amazon in terms of labor costs, shipping, supply chains and so leading to a drastic decline in cash flow generation. Tech companies don't just print money endlessly either, contrary to some people's expectations.

Yet, comparing market caps, you'd think Exxon was the weakest cash flow generator of the bunch, rather than being the strongest:

Data by YCharts

Is a dollar of Exxon's cash flow generation worth the same as a dollar from Amazon or Nvidia (NVDA)? No. The latter deserve a higher multiple from being lower capital-intensive businesses. But is the correct disparity this great? Is Nvidia worth $640 billion to produce just $7 billion of FCF when you can pay $273 for Exxon and get $15 billion a year (and rapidly trending higher)?

Tesla's (TSLA) $1.1 trillion of market cap for $3 billion of annual FCF seems nearly indefensible. Tesla, like Exxon, is a cyclical low-margin industrial business that requires large amounts of capital to operate. Yet market participants think Tesla is worth a nearly infinite multiple on its free cash flow.

At the end of the day, a company's primary value to shareholders is its free cash flow, as that's ultimately what gets routed into dividends or share buybacks to return to the shareholders. Exxon Mobil is producing massive amounts of cash flow at a bargain price, while many trendy stocks of today produce much less cash at far higher entry prices.

The Next Few Years

At the current dividend rate, Exxon Mobil will be paying roughly $15 billion per year in dividends out to shareholders. Based on trailing operating results, that's covered out of free cash flow, though not with a lot of room to spare. Don't forget, however, that free cash flow already subtracts the company's investment in maintenance and new growth projects such as Exxon's massive Guyana field and its refinery improvements. So, based on Exxon's trailing results, the dividend already is supported without too much trouble.

And, to be clear, future returns should be much better than the past 12 months. Just look at the price of natural gas and crude oil if you need evidence of that:

Data by YCharts

When we're looking at quarterly results or especially trailing twelve month results, don't forget that those have a substantial lag to them. Q3 started in July, after all, when oil and natural gas hadn't really started to rip yet. Only in the last month of Q3 did prices really start to take off. So there should be a strong tailwind for better results in Q4 and heading into 2022.

It's not just oil and gas prices driving the improvement either. Exxon Mobil is an integrated major and it has retained a large business in refining and chemicals. Profit margins in these areas - especially chemicals - have surged this year as demand has soared. This has improved Exxon's overall profitability dramatically and reduced its breakeven product costs.

Indeed, in the Q3 conference call, management got a question directly on this subject and elaborated. Here's JPMorgan's Phil Gresh setting it up:

"And if I could ask just one more question on the buybacks, the strength in chemicals right now, the improving downstream environment, it would seem like you should be able to cover your dividend at about $50 Brent, looking at 2022, even if capex were higher in that $20 to $25 billion range. And if I were to layer in $5 billion of buybacks, that'd be about $10 in the oil price.

So, it would seem like the ratable plan could be covered at maybe $60 Brent and obviously prices are higher than that. I'm just curious if you think that math is reasonable and if it is right that maybe excess cash could still go to either more buybacks or towards more Balance Sheet deleveraging and just how you think about those."

Here's Exxon's CEO Darren Woods:

"I would say your break-even calculations are significantly higher than what ours are."

Gresh suggested that Exxon Mobil could maintain its dividend at $50 oil and pay for larger growth plans and $5 billion of share buybacks at a $60 oil price.

Woods said that even those attractive numbers were underselling Exxon's cash flow generation abilities going forward. He elaborated, noting that the company's efforts at cost savings among other things are reducing Exxon's breakeven costs even further than analysts had already modeled out.

In any case, it's a veritable windfall for current shareholders. After all, here's the price of Brent oil:

Source: Finviz

The price of Brent oil is up to $83 now, and straight from the CEO, we heard that they merely need an oil price in the $50s to deliver everything on the agenda for 2022. With a higher oil price, that sets the stage for even faster share buybacks or other initiatives.

Will Inflation Cost Exxon Mobil?

The flip side of higher commodity prices is higher input prices? Won't Exxon Mobil give back most of its gains because it will have to pay more things such as steel, electricity, and so on to run its business?

Not necessarily. For one, Exxon Mobil's larger scale and time horizon gives it inherent advantages compared to smaller industry rivals. For one, Exxon Mobil plans its growth projects on a many year time horizon. Most of what the firm is working on now, it started to prior to 2020. It paused much of that work during COVID-19 and have brought those operations back online subsequently.

By working with contractors for many years, according to Woods, Exxon Mobil was able to lock in much of its pricing on construction and infrastructure. Prices have now escalated to far higher levels, which hurts anyone trying to compete with Exxon Mobil with anything greenlit today or in the future.

For years, Exxon Mobil kept investing in Guyana in particular when analysts were begging oil companies to stop new capital spending altogether. It seems like just yesterday the mantra was "stranded assets;" the idea that oil would get left in the ground. In the late 2010s, everyone was quick to criticize for Exxon for keeping its growth plans in place as the price of oil melted down. Now, however, oil is suddenly back - as cycles tend to go - and everyone rushing to compete with Exxon Mobil to bring new supply online will now have to pay far higher prices for labor and commodity goods.

This isn't the only benefit to Exxon Mobil either. It also gets a scale advantage in areas such as refining since it owns the best assets in the industry. Here's Woods addressing cost inflation pressures at Exxon manufacturing facilities:

"We're advantaged in that space generally because most of our facilities are more energy efficient than our competitors and so while that's raising cost across the board with that advantage, we're able to stay below where the rest is. And of course, market prices move in these commodity markets based on the marginal cost for the suppliers but the last barrel supply. So that's we're able - I think that's being offset with the margins."

The price of a good tends to move toward the cost to produce the last marginal unit of it. In something like petrochemicals, that marginal cost of the last unit is far above Exxon's because competitors are running inefficient operations. Thus, this sort of broad-based cost inflation helps Exxon since it gets additional margin expansion. As Woods put it, this is a "target-rich" environment for Exxon Mobil on a profit margin improvement basis.

XOM Stock: How Much More Upside?

Exxon Mobil shares have more than doubled off the pandemic lows. So traders might start to wonder realistically how much more room there's to run. Exxon Mobil has a market cap north of $250 billion, after all, it's not some small-cap wildcatter oil company. Even so, it looks like there is plenty more in the tank:

Data by YCharts

Shares are still down more than 35% from their 2014 peak, even with oil closing back in on $100 again. And, as demonstrated above, Exxon Mobil is now in better position in comparison to its peers than it was in 2014.

Exxon Mobil kept investing through the cycle, enabling it to bring much in-demand oil, refining, and chemical supply now when the world needs it most. By contrast, most of the other oil majors have been selling assets, paring back budgets, and pivoting heavily into renewables. Exxon Mobil endured the pain in the late 2010s and now is one of the best-positioned majors for the decade ahead. Oil and gas are suddenly hot commodities again, and Exxon, more than most, still has the goods.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of XOM,SU either through stock ownership, options, or other derivatives. 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.