Exxon Mobil Corporation (NYSE:XOM) stock holders are probably still shaking their heads in disbelief. Exxon Mobil stock barely moved despite what looked like a very strong first-quarter earnings report earlier this month. Chevron Corporation (NYSE:CVX) and BP plc (ADR) (NYSE:BP) completed the trifecta, with only ConocoPhillips (NYSE:COP) disappointing.
And yet, instead of celebrating Big Oil’s ability to grow profits amid lower oil prices, investors shrugged. XOM stock continues to skid along support around $80 per share, and continues to trade near a 52-week low.
But the relative weakness in Exxon Mobil stock shouldn’t be that much of a surprise. One quarter simply isn’t a long-time in the oil and gas space — particularly for a supermajor like XOM. Meanwhile, longer-term concerns remain. Oil prices are coming down, although natural gas has rebounded. Exxon Mobil still is struggling to drive production growth.
And the core problem with the bull case for XOM stock remains. No matter where you stand on oil, there are better plays. Where exactly does that leave Exxon Mobil stock?
The XOM Stock Conundrum
This quote from Raymond James analysts summed up the long-term issue for XOM stock:
“Exxon’s ultra-defensive characteristics (including a significant overweight in downstream and chemicals) inherently limit leverage to oil prices. Since we expect further oil recovery to cyclical highs in 2017, Exxon stands out as one of the least appealing ways to play that, irrespective of the (Q1) beat.”
In other words, Exxon Mobil stock is not the best way to play an oil recovery, and a few million dollars in incremental earnings in the first quarter doesn’t change that problem.
That’s a fair point. Exxon Mobil survived the oil crash better than most because of the downstream and chemicals businesses. Refining spreads widened, increasing profits downstream. Input costs into the chemicals business plunged, boosting margins in that segment. While many wildcatters went bankrupt, XOM stock declined just 35% from its 2014 peak to its 2016 low. While income investors fretted about dividend cuts at BP and Chevron, XOM continued its 34-year streak of raising its dividend every year.
The shoe is on the other foot now, however. Presumably, investors in Exxon Mobil stock are at the least expecting oil and gas prices to rise somewhat going forward. But if they do, XOM won’t benefit as much as peers. And Q1 earnings highlighted that point.
Upstream Up and Downstream … Up?
That thesis would seem to be contradicted by the Q1 numbers. Exxon Mobil earnings more than doubled year-over-year in Q1. The driver was the upstream business — whose profit gains came almost solely from higher pricing. Segment profits were $2.25 billion, with pricing providing a $2.3 billion benefit.
Meanwhile, Downstream profits did increase, due to higher volume. Chemical profits fell, unsurprisingly, as margins compressed due to the same higher oil prices that boosted the upstream segment. But a $70 million margin loss in the Chemical business pales in comparison to the $2.3 billion increase in upstream.
The problem for XOM stock is that Q1 isn’t really representative of the company’s profile going forward. Oil prices already have come down since quarter-end, reversing the benefits for the Upstream business somewhat. A 4% production decline leaves that business reliant on pricing. More notably, all of Exxon Mobil’s Q1 E&P profits came from overseas. The U.S. upstream business actually posted a loss.
Meanwhile, crack spreads actually increased toward the end of the quarter, providing a boost to the refining businesses. Those spreads are reversing as well, however. All told, Exxon’s Q1 was a little bit of a “Goldilocks” quarter – everything just right. But the news for Q2, at least from market prices, isn’t nearly as good.
Why Buy XOM Stock?
So the conundrum remains. The benefits seen in the Downstream business can be better captured through independent refiners like HollyFrontier Corp (NYSE:HFC) or Delek US Holdings, Inc. (NYSE:DK).
Investors betting on a rebound in U.S. shale can target Sanchez Energy Corp (NYSE:SN) or, in a riskier move, Chesapeake Energy Corporation (NYSE:CHK). Both of those companies are set to grow production, and at least in CHK’s case, have breakeven levels mostly below $40 a barrel. Should oil rise sharply, both stocks almost certainly will perform Exxon Mobil stock.
It’s not necessarily that XOM stock is a bad play. There’s a case to buy a stock with a 3.75% yield, the ability to weather most kind of oil and gas markets, and a solid balance sheet. To be sure, there are some longer-term risks relative to oil production and usage. If Tesla Inc (NASDAQ:TSLA) indeed starts an energy revolution, Exxon Mobil could be a casualty. But there are many, many worse stocks in the market to own than XOM.
But there seem to be better ones, too, at least for any specific thesis relative to XOM stock. And at the least, expecting big earnings moves or even big gains in Exxon Mobil stock is far too optimistic.
The inherent hedge between upstream and downstream means that Exxon Mobil simply isn’t built for those types of moves anymore. Investors — even bullish ones — should keep that in mind.
As of this writing, Vince Martin does not have a position in any securities mentioned.
