The good times are back for oil and gas stocks, which are having their best year as a group since 2007; Exxon Mobil Corporation (NYSE:XOM) is no exception up 16% through Dec. 22. With momentum on its side, it’s time to buy XOM stock. Right? Wrong!
Despite a yield of 3.3% for Exxon stock, one of the highest levels it’s seen in the past decade, Exxon Mobil is a classic case of irrational investor exuberance that could be proven wrong in 2017.
Here are three reasons why.
Three Reasons Exxon Stock Is Overvalued
Oil Prices
OPEC recently agreed to cut oil production by 1.2 million barrels a day starting in January and running for at least six months, if not longer. That got oil prices over $50, halfway to the promised land, where Big Oil makes a whole lot of money.
InvestorPlace contributor Ryan Fuhrmann reasons that rising oil prices combined with lower capital and exploration expenditures in 2017 will result in higher cash flow and earnings for the world’s biggest oil company.
In 2016, analysts expect XOM to earn $2.26 per share; 25% below its annual dividend payout of $3. In 2017, analysts expect earnings-per-share to jump to $4.11, 37% higher than its dividend payout, a 62 percentage-point swing in the span of a year.
No wonder its stock price is on the verge of 20%.
However, for that to play out, OPEC’s cuts have to mean something to the price of oil for the entire 12 months of 2017.
Libya just reopened pipelines that have been blockaded for two years adding 270,000 barrels of oil each day for the next three months. That will bring the country’s output to 870,000 barrels of oil per day or about half its total potential. If Libya were to max out its production, the OPEC cuts would be rendered meaningless.
The bigger question is whether OPEC and the non-OPEC countries agreeing to cut production actually do so. If they don’t, you’re not likely to see prices move beyond current prices in the low $50s. If so, $4.11 per share in earnings becomes a pipe dream.
Exxon Mobil’s Best Year
Exxon Mobil’s best year for operating income over the past decade was 2006 when it generated $99.5 billion on $377.6 billion in revenue for an operating margin of 26.3%. Oil prices, adjusted for inflation, averaged $69.64 per barrel that year. In 2014, it generated operating profits of $51.9 billion on revenues of $411.9 billion — I’m using 2014 and not 2015 or the trailing 12 months to show how XOM stock was already overvalued two years ago before things hit the skids — for an operating margin of 12.6% with an average price per barrel of $87.05.
In 2006, XOM spent $19.9 billion on capital and exploration expenditures or 5.3% of revenues. In 2014, it spent $38.5 billion on capital or exploration expenditures or 9.4% of revenues.
Exxon Mobil spent twice as much in 2014 as it did in 2006 to generate a little more than half the operating profits … despite an average oil price more than $17 higher.
Yet XOM stock was valued almost identically in 2006 to its valuation in 2014.
Exxon Mobil Valuation Metrics 2006 vs. 2014
| Year | P/E | P/S | P/CF |
| 2006 | 11.7 | 1.2 | 9.2 |
| 2014 | 11.6 | 0.9 | 8.3 |
One can only come to two possible conclusions: Either Exxon stock was overvalued in 2014 or undervalued in 2006.
Personally, I believe it’s a little bit of both, but let’s move on to the third reason XOM stock is seriously overvalued.
A Debt Problem
Exxon Mobil had $6.6 billion in long-term debt in 2006 which was 3% of its total assets. In the first nine months of 2016, its long-term debt was $28.9 billion or 8.5% of total assets. A 550 basis point increase might not seem like a big deal when looked at in the context of total assets, but when you increase long-term debt by 337.9% over a decade but only increase total assets by 55%, I believe it becomes a bigger problem than investors care to admit.
In October, Raymond James analysts Pavel Molchanov and Luana Siegfried shared some less than flattering remarks about Exxon Mobil with Barron’s readers. Essentially, they suggested any XOM stock received by InterOil Corporation (USA) (NYSE:IOC) shareholders should be immediately sold and the proceeds reinvested in oil-levered stocks such as Halliburton Company (NYSE:HAL).
Why?
“Given our Underperform rating on Exxon since November 2015, our readers will surely not be surprised by our stance, but we’ll go ahead and recap it … In a broad thematic sense, Exxon screens uniquely poorly in the context of our forecast for sustained oil price recovery into the $60s by year-end 2016 and even higher in 2017. This is not an issue of market cap but rather Exxon’s structural overweight to refining, chemicals, and (within upstream) non-LNG gas — none of them directly benefiting from rising oil prices.”
So, Exxon stock ratcheted up its debt almost four-fold over the past decade to acquire assets that don’t benefit from rising oil prices. Meanwhile, it hasn’t spent nearly enough securing more oil reserves and should oil hit $100 in the future, it won’t benefit nearly as much as these other companies.
Ouch.
Bottom Line on XOM Stock
Regardless of what happens to oil prices, I personally don’t see markets having a good year in 2017; that more than anything will keep Exxon stock down in the next 12-months, which is a good thing because at $90 and change — it’s too expensive.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
