There’s no denying the recent rebound in the price of crude oil has been beneficial for energy icons like Exxon Mobil Corporation (XOM). XOM stock is up 15% since its mid-January low, while crude is up more than 30% for the same timeframe.
On the other hand, there’s a difference between “better” and “good.” While Exxon and its peers are certainly in a better situation now than the downright dire situation they were in two months ago, it may still be too soon to celebrate a bright foreseeable future.
Nomura Securities gave investors a not-so-gentle reminder of this reality late last week. Should investors take this reminder with a grain of salt, or take it to heart? As usual, it depends.
Nomura Isn’t a Fan
Normally, when a research outfit initiates coverage on a stock it’s a bullish event. That’s because the demand from investors tends to slant toward stocks to buy rather than stocks to sell.
That’s not always the case, though, as Nomura verified on Friday. Nomura analyst Theepan Jothilingam has initiated coverage of Exxon Mobil, starting out with a “reduce” rating and a price target of only $70. That’s about 16% less than the current value of XOM stock.
Jothilingam acknowledges that Exxon’s downstream/refining operation remain solid. Problem is, the company’s downstream business can’t carry the company’s weight indefinitely, offsetting its struggling exploration and production efforts.
The report from Nomura stated:
“Exxon’s downstream integration and resilience is a powerful tool against low oil prices, while the current AAA rating highlights a best-in-class financial position. What surprised us was a more balanced outlook on growth with a stronger reserve position, which suggests that the often discussed M&A risk is present but perhaps not necessarily as pressing as some argue. Our cautious outlook mainly reflects valuation. The business model is best-in-class but arguably the flight to quality leaves Exxon’s deserved premium multiple too wide to the peer group….Where could we be wrong? A further deterioration in oil prices is likely to see the flight to quality continue. Exxon could also deliver further material reductions to opex (in addition to the USD 8.5bn in 2015), despite no explicit forward-looking disclosure provided at the analyst update in New York.”
While the premise of falling oil prices driving XOM stock higher makes superficial sense in his so-called ongoing ‘flight to quality’ scenario, there’s no historical or empirical evidence to suggest investors would choose to make lemonade out of those lemons.
In other words, falling oil prices may be apt to do more damage to energy names than good no matter how you slice them. Conversely, higher oil prices should ultimately lift oil-related stocks, even if only for perception reasons. Investors aren’t doing a lot of the “which company does what?” analysis right now.
A Lose-Lose?
The Nomura report also explained that Exxon Mobil doesn’t have much more potential to cut capital expenditures in 2016 relative to cuts of 2015. That poses a threat to free cash flow this year (and free cash flow wasn’t looking particularly healthy as of last year).
Again though, the picture Nomura paints tends to be a worst-case scenario all around. That is, it assumes Exxon won’t ramp-up its E&P capital expenditures should the price of oil rise, yet that same increase in the price of crude wouldn’t translate into a higher valuation for XOM based on its downstream business.
At the other end of the spectrum, while cutting capex in a low-oil-price environment is the smart move to make as a means of conserving funds [i.e. not wasting money on fruitless projects], Jothilingam says the refining business that’s mostly unaffected by oil prices wouldn’t get any additional credit for the reliable value it presents to shareholders.
The whole thing begs one question: Is there any way for Exxon shares to win from here? Nomura doesn’t seem to think so.
Bottom Line for Exxon Mobil
Jothilingam isn’t completely off-base. XOM stock has, to a degree, a valuation problem no matter how you slice it. Except, perhaps, for one — a massive rebound in the crude oil price that makes both downstream and upstream profitable and reliable again.
While that’s going to happen eventually, it’s not apt to happen in a meaningful way this year. That recovery is at least on the radar, however, and an upgrade halfway through that rebound doesn’t do anybody any good.
Where the Nomura report may be less-than-helpful is in its assumption that investors should be valuing and evaluating energy stocks in a normal light right now. They shouldn’t.
Arguably, no oil-related stocks are investment-worthy right now. Yet, from a speculative point of view, there are some relatively healthy companies that investors do want to own for that unknown point in time when crude oil finally does begin that long journey higher. It’s all about relativity and perception. From that perspective — for the true long-term owners — best-in-class Exxon Mobil remains a buy despite Nomura’s pessimism, with shares still closer to multi-year lows than multi-year highs.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
