From a capital appreciation standpoint, Exxon Mobil (NYSE:XOM) stock has been a disappointment. Over the last decade, the XOM stock price has gained 12.5%. During that period, Exxon Mobil stock has badly lagged the S&P 500, which has returned a sizzling 223%.
But for investors focused on income, XOM actually hasn’t been a terrible play. Exxon Mobil’s dividends have more than doubled from a total of $1.66 per share in 2009 to what should be $3.48 in 2019. Investors’ total return from Exxon Mobil stock has averaged 4.3% per year.
That’s still disappointing, since the S&P 500 has returned almost 15% annually, including dividends. But it’s not terrible in an environment in which U.S. Treasuries have yielded less than 3% most of the time.
We’re still in that environment, with the 10-year Treasury yielding just 2.1%.
It’s true that buying a stock just for its yield can be very dangerous, as previous income darlings like General Electric (NYSE:GE), Kraft Heinz (NASDAQ:KHC), and Anheuser-Busch InBev (NYSE:BUD) all have cut their dividends recently.
But Exxon Mobil doesn’t have the debt problem those companies did (and still do) have. And while XOM stock has exposure to crude oil prices, it also uses a hedge to protect its profits. As a result, XOM stock price probably won’t fall below $70 for long. And that makes XOM stock, currently at $75.50, an interesting play for income-focused investors in general and value-oriented, income-focused investors in particular.
Why $70 Is a Key Level for XOM Stock Price
XOM hiked its quarterly dividend to $0.87 in May. That, in turn, suggests that investors are receiving $3.48 per share of XOM stock annually. And so, if the XOM stock price reaches $69.60, the stock would offer a yield of exactly 5%.
It’s difficult to see Exxon Mobil stock consistently yielding more than 5% for a few reasons. First, that type of yield is noticeable and usually not offered by relatively safe stocks. Of the Dow Jones Industrial Average stocks, only Dow (NYSE:DOW) and IBM (NYSE:IBM) offer higher yields. Both companies have real challenges (Dow is facing cyclical pressure and IBM has long-running growth problems).
In the S&P 500, there are 35 components with higher yields. All have warts, among them AT&T (NYSE:T) and its debt load and Altria (NYSE:MO) which is facing concerns about long-term demand for its products.
The second reason is that, historically, XOM stock has hardly ever yielded 5%. Its yield peaked at 5.5% during the 1987 market crash and touched 5% a few times through the early 1990s.
But that was a very dark time in the crude oil markets, which had crashed after their early 1980s boom. Meanwhile, interest rates were much, much higher; investors could get 7% to 9% yields from10-year Treasuries.
Without that alternative, a 5% yield from XOM stock is going to look very attractive. Indeed, in late May, as XOM and other oil stocks sold off, XOM stock bottomed just above $70. A bounce in crude prices helped, but it’s likely that at least some investors saw the yield nearing 5% and pounced.
Exxon Mobil Stock Is Safer Than It Appears
Of course, the question is whether Exxon Mobil stock really is safe. A 5% yield – or even a 4% yield – is attractive in this market. But what happens when crude prices plunge?
The answer is that XOM’s earnings will decline, but in a mostly manageable fashion. As I’ve written before, Exxon Mobil’s “downstream'” operations – notably in refining – and its chemicals business provide an internal hedge. That’s why XOM stock actually is a poor play on oil prices. But it’s also why XOM stock didn’t fall that far when the shale bust hit in 2016 – and why the company was relatively unscathed during the fourth quarter of 2018, which was disastrous for many oil and gas companies.
If oil prices rise, XOM’s upstream business will thrive and its downstream business will take a hit. When oil prices fall, the reverse is (usually) true. Despite this hedge, the XOM stock price is boosted by higher crude prices, as seen in 2014 when XOM stock hit an all-time high. But even amid a plunge in prices two years later, Exxon Mobil’s dividend continued to rise,.
XOM stock isn’t risk-free. But Exxon’s earnings easily cover the current dividend of XOM stock. The odds of XOM executing a GE-style dividend cut are slim, even with crude and natural gas prices relatively low. And this is an environment where, as I noted just last week, investors usually have to stretch for yield. If XOM is yielding 5% and 10-year Treasuries have a 2.1% yield, many investors are going to buy XOM stock.
The Trade
For income investors, then, XOM looks reasonably attractive at $75.50. Its valuation is reasonable, at 14.4 times analysts’ average forward earnings estimate. And XOM still looks poised to deliver further growth, as its CEO, Darren Wood, last year set a target of doubling the company’s earnings by 2025.
For traders, there’s an intriguing option trade to be made as well. A bull put spread at $70 (selling the $70 put and buying a lower-priced put for protection) can offer double-digit returns or better, depending on the expiration date. That’s essentially a bet that the XOM stock price won’t be under $70 at expiration, which seems a nice bet to make at the moment.
But there are some risks facing XOM stock at the moment. The U.S. presidential election could pressure XOM stock if a “green” Democrat was to win or even starts to gain momentum. A plunge in oil prices is another risk: Exxon Mobil does have hedges, but XOM stock still fell when crude collapsed in 2016.
But there’s risk everywhere when the market is at all-time highs, particularly for income investors. Getting a 4%+ yield from Exxon Mobil stock is one of the better risk-reward options out there at the moment. And that’s precisely the point: investors aren’t going to let a yield above 4% last for long. XOM stock isn’t going to be the biggest gainer in the market over the next six months or the next three years. But, at the right price, it’s an attractive dividend play.
As of this writing, Vince Martin has no positions in any securities mentioned.
