Is the Oracle Right About XOM?

by Aaron Levitt | November 19, 2013 11:19 am

Given Warren Buffett’s status as “America’s Favorite Value Investor”, people go absolutely crazy when the Oracle’s 13F filings are made public. That’s because SEC document can provide a window into Buffett’s thinking on which stocks are the biggest bargains in the market. And given Berkshire Hathaway’s (BRK.B[1]) favorite holding period of “forever,” regular retail investors truly have a chance to piggyback on of the greatest investors of our time.

warren buffett 630 headshot[2]With that said, the Oracle of Omaha’s latest major is buy is certainly a doozy in both the size and potential value. That huge purchase was major integrated oil stock Exxon Mobil (XOM[3]).

For investors, Buffett buying XOM serves as comment on just how cheap the energy giant has become relative to its peers and rivals. That means the time to “put a tiger in your tank” maybe finally here.

$3.45 Billion

With production problems and refining issues plaguing Exxon over the last few quarters, the stock has significantly underperformed many of the other stocks in the energy sector. That has resulted in many value hounds looking at XOM shares in a whole new light. Respected value investor Don Yacktman recently said that “Exxon is like a reasonably-priced high-quality bond.”

Buffett did Yacktman one step better and sunk a ton of money — $3.45 billion to be exact — into the integrated energy firm. That makes Berkshire’s buy of XOM the largest new holding since adding International Business Machines (IBM[4]) back in 2011. Overall, the Oracle is now the proud owner of 40.1 million shares of Exxon.

While the filing doesn’t actually say whether or not Buffett made the decision to purchase shares — he has been farming out smaller purchases to managers at GEICO and Berkshire’s other insurance subsidiaries — it can be seen as major conformation on just how cheap Exxon has gotten over the past year. Shares are only up about 7.7% this year — with much of that gain coming over the last few weeks after XOM reported earnings. That performance pales in comparison to the S&P 500’s return of about 26%.

$3.45 billion isn’t a small chunk of change, so someone at Berkshire must truly believe that XOM shares are a real value. The other interesting tell from the filing is that Berkshire Hathaway also decreased its stake in ConocoPhillips (COP[5]) by roughly 44%. Buffett and company now only own 13.5 million shares of COP — down from 24 million. Buffet hung onto ownership of COP’s spun-off refining arm Phillips 66 (PSX[6]).

So given Buffett’s newfound stance on XOM and the energy sector, the question is whether he’s right about buying Exxon.

Signs Point to Yes

It’s true that XOM has suffered over the last few years, but things are finally starting to turn in the right direction for the integrated giant. Last quarter, the oil stock managed to see a 1.5% increase in its output of oil and natural gas, thanks to a slate of new projects that pushed output back over the 4 million barrels per day mark.

That increase follows a two-year stretch of production declines.

Perhaps more importantly, Exxon is now finding that oil more cheaply than its rivals. According to data provided by Bloomberg[7], XOM spends about $19.27 to find a barrel of crude oil. That’s less than the $21.48 per-barrel at rival Chevron (CVX[8]) and $22.66 for beleaguered BP (BP[9]). With a plethora of new projects set to begin pumping out crude in 2015 and beyond, Exxon looks to continue minting plenty of cash.

And as we know, cash is music to Buffett’s ears.

XOM is a cash flow machine, and, despite its earnings drop, the energy firm still managed to make a staggering $7.87 billion[10] or $1.79 per share in profits for the last quarter. Those hefty cash flows have continuously made their way back to shareholders via dividends and share buybacks. Exxon managed to hand out roughly $5.8 billion of that cash back to shareholders in the third quarter alone. And with a low payout ratio and a long history of dividend increases[11] on its book, Buffett is setting himself up for long term at XOM.

Meanwhile, he’s buying that cash on the cheap.

Exxon shares are tantalizing value based on various metrics. XOM currently trade at a forward P/E just north of 12 — roughly a 23% discount to the broad market’s forward multiple. The valuation is cheaper than many of its large integrated rivals and even cheaper when compared to U.S. shale-focused independent E&P firms like Southwestern Energy (SWN[12]). Meanwhile, other metrics like price-to-book value and price-to-sales also tilt towards XOM’s favor.

Snagging Up XOM Shares

Exxon is truly is like a cheaply priced bond and is priced for success. So no surprise that Buffett took the plunge in a big way — XOM has all the hallmarks of a Berkshire holding. Ultimately, Buffett’s buy of XOM shows just how cheap shares have gotten over the last few quarters

For individual investors, that cheapness could mean it is time to add Exxon to a portfolio.

Following Buffett’s lead into Exxon makes a whole lot of sense. Over the long term, XOM’s history of dividends makes it a powerful portfolio ally. While it might not “explode” upwards like some smaller shale-focused firms, the firm will continue to pump out oil, dividends and cash flows years to come. That makes XOM an ideal buy & hold for any portfolio.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. BRK.B:
  2. [Image]:
  3. XOM:
  4. IBM:
  5. COP:
  6. PSX:
  7. Bloomberg:
  8. CVX:
  9. BP:
  10. staggering $7.87 billion:
  11. dividend increases:
  12. SWN:

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