Investors in the oil patch haven’t been too happy the past 18 months, as oil prices cratered. Things, however, have been looking up as oil prices have rebounded somewhat.
Exxon Mobil Corporation (XOM) has been struggling right along with everyone else, but as the stock bumps up against 52-week highs, are its troubles behind it?
I think they may be.
The Bright Side of XOM Stock
The first thing to recognize about XOM stock is that it has one of the most important things for any stock to have: a solid balance sheet.
With plenty of cash, a reasonable debt load and manageable interest payments, XOM has been able to navigate this volatile period successfully. That’s the reason why I often quote cash, debt and debt service payments in most articles. When times turn bad — and they will for any company — you want to know the balance sheet will support it.
Whereas XOM stock generally has about $11 billion to $13 billion in free cash flow, most of which it pays out as dividends, in FY15, FCF was only $4 billion.
The oil crisis appears to have passed, as oil is now over $46, and is close to breaking through resistance and moving higher. Still, XOM managed to generate $16.55 billion in net income last year, so it’s not like the business was destroyed. So with prices moving higher again, any further profit erosion seems unlikely.
Investors seem to think so, too. On April 26, S&P downgraded XOM stock from AAA to AA+. Most of the time, that would precipitate a big selloff. Instead, nobody cared. These days, an AA+ rating is gold. Ask the shale producers.
The rating issue does raise one minor point that is worth discussing. Yes, the balance sheet is fine. However, XOM did lever up significantly over the past few years, to the point where long-term debt is over $29 billion. It made several acquisitions and has been spending a lot on production (as well as buybacks).
While debt service is barely paid at 1% interest, should revenues continue to be impacted negatively if oil prices fall and stay down, then it’s the dividend that gets put at risk.
A Few More Considerations for Exxon Mobil
There’s also a lingering issue of reserves. When an oil producer sells off the oil it extracts, it needs to replenish those reserves. It’s a balancing act because they don’t want to over-produce or under-produce.
Because natural gas extraction declined last year, XOM only replenished 67% of its reserves. It needs to get back to 100%, and that means spending more on production or buying up smaller producers.
There’s also an interesting political wrinkle going forward. Right now, the U.S. has sanctions on Russia, which prevents XOM from exploiting the huge area of land in Russia it was permitted to develop. If Donald Trump becomes president, that project could move forward. Trump is a businessman, and he wants business to flow. That could mean tremendous upside for XOM stock.
Overall, I don’t think XOM is in any kind of crisis. I think it’s in solid shape, and remains the premier name in the energy sector that probably makes it a must-have core holding. It is now only 15% off its all-time high, and still yields 3.4%.
I would give it a hard look.
As of this writing, Lawrence Meyers does not own shares in XOM.
