XOM - Exxon Mobil: Preparing For A Changing World

2023-12-31 05:19:00 ET

Summary

• Exxon Mobil's profits have been impacted by lower oil prices this year, but the company has used its strong cash flows to invest in the future.
• The company's earnings power is still strong, despite the drop in oil prices, and it has made strategic acquisitions to fortify its domestic production and improve its ESG practices.
• Shares of Exxon Mobil have been range-bound between $100 and $120, but there may be value emerging if they fall to the $90s mark.

Little over a year ago, I called the performance of Exxon Mobil ( XOM ) impressive. The company was firing on all cylinders, notably its exploration and refining activities, and while the diversified nature of the business served the company well, it remained heavily tied to the height of energy prices at large.

Profits were very strong, with cash flows furthermore being very strong as no large reinvestment boom was seen, with oil majors being hesitant to increase their capital spending budgets. Investors should be glad that the majors, including Exxon Mobil, showed restraint as lower oil prices have weighed on profits this year. Exxon has used its improved balance sheet following strong 2022 cashflows in order to invest into the future, both at home and in emerging technologies.

Some Perspective

In October of last year, the company reported third quarter results, which were very strong as oil prices traded over $100 per barrel at the start of that quarter. This was the driver behind very strong results, as the scale of the operations was hard to grasp, with quarterly sales reported at $112 billion at the time. The company posted operating profits of $20 billion, with quarterly earnings reported at $4.68 per share.

The driver behind the business was the upstream business, which produced 3.7 million barrels of oil-equivalent per day, with the refining segment seeing throughput of 4.2 million barrels of oil-equivalent. At last, Exxon owns a substantial chemical product business, although that this is just tiny in relation to the core business.

With earnings power trending at nearly $20 per share, valuations looked very cheap at 5.5 times annualized earnings, a very low multiple, but actually a premium multiple compared to many peers at the time. Superior profits furthermore allowed Exxon to cut net debt to just $15 billion as superior profits were furthermore accompanied by the fact that capital spending of $17 billion lagged depreciation expenses, which trended around $25 billion a year.

These huge cash flows were welcome as Exxon sees pressure from the external environment as well, being impacted by greater focus on ESG. This focus and a transition in the energy mix have made that capital spending of the majors at large, including Exxon, has been relatively modest, unlike previous episodes of booming oil prices.

High oil prices even triggered other social and political discussions, including windfall tax policies contemplated across many jurisdictions, and in some cases even being implemented.

With 4.18 billion shares trading at $110, the company commanded a $460 billion equity valuation, or $475 billion enterprise valuation after we factor in net debt at the time.

Range Bound

Since the fall of last year, shares of Exxon Mobil have been trading in a $100-$120 range as oil prices (and energy prices at large) have come down, with WTI prices down to $70 per barrel early this summer. After a temporary rise to the $90 mark in September, on the back of the unrest in the Middle East, oil prices are now back to $70 again.

The impact of these oil price developments quickly showed up in the results, with fourth quarter profits for 2022 being down to $3.09 per share, still supporting a decent earnings yield.

First quarter earnings fell further to $2.83 per share, but still substantial enough to provide fundamental support and further deleverage the balance sheet. This financial strength was used to acquire Denbury in a $4.9 billion deal in July, with the deal expanding the low carbon solutions of Exxon, in what really can be described as a strategic deal. However, with oil prices down further, second quarter earnings were reported at just $1.94 per share.

A Huge Deal

The big game changer came in October, as Exxon announced a huge $59.5 billion deal to acquire Pioneer Natural Resources ( PXD ) in a deal valued at $253 per share. Including net debt, the valuation comes in at $64.5 billion as the interesting part is that this is structured as an all-stock deal.

The deal will fortify domestic production in a huge way, with Pioneer's 850,000 net acres in the Midland basin to be combined with Exxon's 570,000 net acres in the same Midland and Delaware basin. Moreover, these resources are estimated to have 16 billion barrels of oil-equivalent in reserves and will create a growth platform in the US for the upcoming years.

Later that month, Exxon posted third quarter results as earnings ticked up (sequentially) to $2.27 per share. These earnings are furthermore aided by share buybacks which reduced the float to 4.02 billion shares, which now grant the company a $402 billion equity valuation at $100 per share, and $410 billion enterprise valuation if we factor in modest net debt of $8 billion here, despite lower earnings power.

This valuation has come down meaningfully from a $475 billion number this time last year, but comes amidst lower energy prices (and thus profits), higher capital expenditure budgets and lower depreciation expense. Moreover, this valuation comes ahead of the Pioneer deal (and the Denbury deal as well), with the Pioneer transaction set to increase the share count meaningfully of course.

And Now?

Given the direction of travel of energy prices this year, it is not a surprise to see shares lag versus markets at large, as the drop in oil prices has been substantial, certainly in the light of the unrest across the globe on the geopolitical front.

Despite the fact that oil prices have come down a bit, earnings power still trend at $8-$9 per annum with oil prices hovering in the $70s, which looks pretty decent. Then again, there are some wildcards including potential dilution from the deal with Pioneer, yet this is a strategic deal given the reserves, security of production and the cost thereof. Moreover, the deal addresses ESG practices, as well, as the Denbury deal was designed to improve Exxon's position here as well. In fact, Exxon Mobil is even targeting lithium mines right now.

On the other hand, are the issues in Guyana which could have serious repercussions on the company, with its operations being responsible for about ten percent of Exxon's production here.

Amidst all this, shares seem to trade pretty balanced here, as they have been lagging the market for good reasons, that of an outperformance last year and softer oil prices this year. Right now, I see value slowly emerging if shares fall to the $90s mark (in the absence of a major recession), as Exxon is still among the best of breed here.

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