Exxon Mobil (XOM) is an oil supermajor. Due to its poor business performance, the company has pronouncedly underperformed its peers and the broad market in the last five years. During this period, Exxon has shed 27% whereas Chevron (CVX) has dipped only 6% and S&P has rallied 53%. However, Exxon is about to return to strong growth mode. In addition, it is offering an all-time high dividend yield of 4.8%. Therefore, investors should take advantage of the negative market sentiment for the oil major and purchase the stock before the market realizes its appeal.
Like the other oil majors, Exxon is an integrated company. In 2018, it generated 60% of its earnings from its upstream segment, 26% from its downstream (mostly refining) and the remaining 14% from its chemicals segment. The oil giant used to produce oil and natural gas at approximately equal amounts but it has shifted the ratio of oil to natural gas output to 60/40 lately.
On August 2nd, Exxon reported its results for the second quarter of the year. The company reported 7% production growth over last year’s quarter primarily thanks to impressive growth in Permian Basin, where output grew 20% sequentially and almost 90% over last year’s quarter. Moreover, despite lower oil prices in this year’s quarter, upstream earnings rose 7%, from $3.04 to $3.26 billion, mostly thanks to production growth and lower taxes.
Given the inability of Exxon to grow its production for a whole decade, the above growth rates could trigger enthusiasm in the market. However, it is critical to realize that last year’s quarter constituted a low comparison base. In fact, production volume fell 2% compared to the first quarter. In addition, the chemicals segment saw its earnings plunge almost 80%, from $890 to $188 million, due to lower margins and increased downtime. As a result, Exxon posted a 21% decrease in its earnings over last year’s quarter, from $3.95 to $3.13 billion.
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Exxon has failed to grow its production for a whole decade. Its output dipped from 4.2 million barrels per day in 2012 to 4.0 million barrels per day in 2014 and has been hovering around that level since then. This is the level of output that the company reported back in 2008.
This disappointing business performance is in sharp contrast to the performance of the other oil majors. All the oil majors failed to grow their output for several years until 2017 but they have returned to strong growth mode in the last two years. Chevron grew its output by 7% last year and expects to grow it by 4%-7% this year and by 3%-4% per year over the next four years. BP (BP) posted production growth of 10% last year and expects to grow its output by 5% per year over the next four years.
Despite the dramatic business underperformance of Exxon, investors should realize that the oil giant is about to return to growth mode thanks to a major shift in its strategy. Last year, the company announced that it will drastically increase its capital expenses in order to pursue production growth more aggressively. Thanks to its increased investment amounts, it expects to grow its production by 28%, from 3.9 million barrels per day now to 5.0 million barrels per day in 2025.
The shift in the strategy of Exxon is already prominent. In the first half of the year, the oil major boosted its capital expenses by 30%, from $11.5 billion last year to $15.0 billion this year. As growth projects in the energy sector take some years to begin bearing fruit, the results from the new strategy of Exxon will show up in the upcoming years. Nevertheless, there are already positive signs on the horizon. To be sure, Exxon expects to grow its production in the Permian Basin to 1.0 million barrels per day by 2024. Such a level represents 25% of the total current output of the company and thus it is evident that Permian will be a major growth driver for the company.
The growth prospects are even more exciting in the assets of Exxon in Guyana. While other companies have drilled approximately 40 dry holes in Guyana, Exxon has taken advantage of its unique expertise and has nearly doubled its estimated reserves in the area, from 3.2 billion barrels in early 2018 to more than 6.0 billion barrels as per its latest earnings report. Management now expects to produce about 750,000 barrels of oil per day in this area by 2025.
Even better, the reserves of Exxon in the above areas consist of lost-cost, high-margin barrels. As a result, they will render Exxon much more profitable at a given oil price than in the past. To provide a perspective, Exxon expects to grow its earnings per share by 135%, from $3.59 in 2017 to $8.44 in 2025, at an oil price of $60.
Source: Investor Presentation
In other words, the company expects to earn more in 2025 at an oil price of $60 than it earned in 2023-2014, when oil was hovering around $100. Moreover, as demand for oil products grows by more than 1.0 million barrels per day every year, we expect higher oil prices in 2025. This means that the growth potential of Exxon is even greater.
Due to the high cyclicality of the energy sector, which is caused by the dramatic swings of the price of oil, it is extremely hard for energy companies to maintain multi-year dividend growth streaks. Exxon and Chevron are the bright exceptions to this rule, as they are the only dividend aristocrats in this sector. Exxon has raised its dividend for 37 consecutive years.
Moreover, thanks to its poor stock price performance, Exxon is now offering an all-time high dividend yield of 4.8%. Due to suppressed oil prices this year, the payout ratio currently stands at 82% and thus it may lead some investors to think that the dividend is at risk. However, the payout ratio will improve in the upcoming years thanks to the growth prospects of Exxon. In addition, the oil major has one of the strongest balance sheets in the sector. Therefore, investors can purchase Exxon at an all-time high dividend yield and rest assured that the dividend will remain safe for the next several years. The safety of the dividend of Exxon was demonstrated in the fierce downturn of the energy sector between 2015 and 2017, when most of its peers froze their dividends but Exxon kept raising it by about 3% per year.
Resilience to downturns
The safety of the dividend of Exxon also results from its superior performance during downturns. Thanks to its more integrated structure, Exxon proved more resilient than most of its peers in the aforementioned downturn of the energy sector. During that downturn, Exxon saw its earnings per share fall 75% while Chevron and BP saw their earnings completely evaporate, as they posted losses in 2016. Moreover, Royal Dutch Shell (RDS.B) saw its earnings per share plunge 87% in that downturn.
Chevron and BP are the most vulnerable oil majors to downturns for different reasons. Chevron is the most leveraged oil major to the price of oil, as about 75% of its output is priced based on oil. BP is also highly vulnerable due to its high amount of debt, which has mostly resulted from its catastrophic accident in 2010. Overall, Exxon is more resilient than most of its peers during downturns and this defensive behavior should be viewed as paramount by income-oriented investors.
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Exxon has repeatedly disappointed investors for several years but the company is about to change course. As growth projects in the oil industry take some years before they begin generating cash flows, investors should be patient. Moreover, the negative market sentiment has resulted in an all-time high dividend yield of 4.8%. Investors should utilize the rare opportunity to purchase Exxon at such an attractive yield and rest assured that the dividend will keep rising for the foreseeable future.