Published on Friday, October 10, 2008
Down nearly 20 percent from its 52-week high as I write this, Exxon Mobil’s (XOM) stock has become controversial after reporting its second quarter 2008 results. I like controversy because it may yield investment opportunities.
Here are the key issues, both bull and bear, as I see them.
The bear case:
1. Exxon’s latest earnings disappointed investors. While the company turned in record earnings at $2.27 per share in this year’s second quarter, results were below Wall Street’s consensus estimate of $2.52 per share.
2. Production has been declining. On an oil-equivalent basis, production dropped 8 percent from the second quarter of 2007, and this was on top of a 5.6 percent year-over-year decline in the first quarter. Even excluding Venezuela’s expropriation, a Nigerian labor strike and lower entitlement volumes (higher oil prices result in lower production volumes under production sharing contracts), production still would have been down 3 percent in the second quarter. Exxon is a no-growth company with a depleting asset.
3. The pressures of nationalism in oil producing countries are weighing on the super-majors’ ability to find oil to replace reserves and manage existing operations, let alone grow. Venezuela’s expropriations and Russia’s hostile actions against Shell and BP highlight this trend. And the pressure is on in the United States to take more taxes from the oil industry.
4. High oil prices have been a double-edged sword as downstream earnings were crushed in the second quarter. Hurt by weak refining margins, downstream earnings dropped 54.1 percent. Chemical earnings fell 32.2 percent.
The bull case:
1. Oil is a necessity, and Exxon has the largest reserve base in the industry with proven reserves totaling 22 billion oil-equivalent barrels at the end of 2007. Exxon has replaced more than 100 percent of production for 14 years running. The reserve replacement ratio was 101 percent last year. Long-term, Exxon has 50 billion oil-equivalent barrels — 30 years worth of production at 2007 levels — it has yet to develop.
2. Exxon has immense financial resources. Cash has been flowing onto the balance sheet with cash and marketable securities growing to $39.7 billion at the end of the second quarter, up $5.2 billion from year-end 2007. Long-term debt was only 5.5 percent of total capital.
3. Exxon is a huge cash generator. Cash flow from operations was $52 billion last year and is $34.8 billion already in the first half of this year, up from $25.6 billion for the first half of 2007. Excluding capital expenditures, free cash flow was $36.6 billion last year and is $26 billion in the first half of this year, up from $18.7 billion for the first half of 2007.
4. Exxon is a highly profitable company. Return on equity in the latest trailing 12-months was 36.2 percent, well ahead of the industry’s 27 percent. Asset utilization, or sales divided by assets, is 1.9 times versus the industry average of 1.4 times. Return on assets, or net income divided by assets is 17.6 percent versus 12.4 percent for the industry. These return on equity components are driving Exxon’s performance.
5. The stock has plenty of room for ratings upgrades and institutional buying power. Eight of 16 analysts following the stock are recommending purchase. Exxon isn’t a favorite among institutional investors, as the company owns only 52 percent of outstanding shares.
6. Exxon shares are bargained priced at 8.2 times this year’s consensus earnings estimate, well below the stock’s five-year average of 13.3 times and the Standard & Poor’s 500 15.4 times.
What do I think? I put Exxon through my own comprehensive Company Stock Risk Profile research process spanning 50 categories of company fundamentals and stock valuation. The stock came out with a low risk rating, having failed 16 of the 50 categories (I define low risk as failing 17 or fewer categories.)
Exxon is the kind of stock I want anchoring my portfolio, particularly when times are tough. The company produces a product people need and use every day and it generates lots of cash. I also believe we are fast approaching the era of "peak oil" and Exxon’s large reserve base will continue to become ever more valuable.
Disclosure: I own Exxon.
Contact Stuart J. Shaw, creator of the Company Stock Risk Profile™, at stuartshaw@stuartshaw.com or (520) 877-9901. Shaw, a Chartered Financial Analyst and licensed in the state of Arizona as an Investment Advisor, created the Company Stock Risk Profile™ to simplify the process of analyzing securities for individual investors. Shaw’s column appears the second week of each month in Inside Tucson Business.
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