Energy stocks are out of favor these days and are a victim to the ongoing trade disputes between the U.S. and China. Yet the oil market has a demand and supply imbalance that is hurting oil prices. If crude prices alone dictate where oil stocks head next, why should investors bother with this sector? Exxon Mobil (NYSE: XOM) is a good exception because Exxon sock can take the big swings over the long term.
On Aug. 7, EIA Petroleum Inventories rose 2.4 million barrels compared to the expected 2.8 million barrels drop. This data point helped push oil prices to the low $50 range. But the real catalyst to oil prices falling is the U.S. threatening to put another 10% tariff on the remaining $300 billion of goods and products coming from China.
Markets are expecting the world economy to slow, weakening the demand for oil. The falling energy prices should not scare investors away because eventually, the U.S. and China must come to a trading agreement. Even if they fail to do so and a recession hits, energy firms are adjusting for the slowing demand.
Exxon stock is the most attractive energy play to position for the inevitable rebound in the sector. In the first half of 2019, the company had nine major project FIDs.
It had four deepwater discoveries in Guyana and Cyprus, and it achieved key milestones for PNG and Mozambique LNG. Downstream and Chemical start-ups are offsetting the downward pressure on margins. To top it off, Exxon raised its quarterly dividend by 6%, marking the 37th consecutive year of dividend growth.
Opportunity with Exxon Stock
Exxon reported strong earnings of $3.1 billion. It is not slowing capex, which increased to $8.1 billion in 2Q19, up from $6.9 billion reported in the first quarter. In Upstream, liquid realizations improved, but in Downstream, refining industry margins are still at five-year lows.
Still, Exxon’s cumulative free cash flow and dividends grew since 2010. Recent chemical and refining start-ups will add meaningfully to its earnings and cash flow. Should the energy sector continue to weaken, Exxon will maintain its counter-cyclical investments to capture incremental value.
For the third quarter, Exxon forecast lower downstream and chemical scheduled maintenance, which will weigh less on earnings.
Asset disposal is another opportunity that may help XOM stock. Management highlighted $15 billion in asset sales. But because Exxon is three months into the three-year program, the benefit of the asset sale will play out slowly. In the meantime, the company has no plans to change its investment plans in value-accretive projects.
A commitment to maintain its growing dividend without hurting its financials will please dividend-income investors.
The Chemicals unit offers investors an opportunity outside of oil markets. Polyethylene demand grows at around 1.5 times GDP. With robust demand around the world, due to the need for plastics, expect the markets working down the excess capacity very quickly.
In the next year, there will be increments of capacity in ethylene and polyethylene coming online, so fundamentals will remain strong. Expect markets working through the excess supply, which are due to new capacity increments, over the next 12 months. After that, a quick rebound in the chemical business is possible. While the market remains soft for at least six months, investors have time to accumulate Exxon stock.
Exxon forecast Permian and Bakken production growth. In the second quarter, Permian production increased by 20%. But the high concentration of lateral feet per square mile may lead to spacing issues. Exxon is working on plans whereby it will drill multiple horizontal benches at one time. The simultaneous drilling will lower risks.
The global softness in gas prices is another potential headwind. Exxon’s gas volumes are diversified between U.S. and European markets. So although LNG spot prices in the last six months, its demand growth in Asia is constant.
Valuation and Your Takeaway
Nine analysts covering Exxon stock have an average price target of $82.28. In an EBITDA Multiples Valuation model, investors may assume an LTM EBITDA multiple of around 9 times. In that scenario, Exxon stock is worth ~$80 (per finbox.io). Exxon’s strong portfolio allows the company to absorb weak energy pricing and slowing demand for plastics.
Yet the portfolio is positioned to accelerate growth as the markets improve. Investors will not know when energy prices recover but they can be sure that Exxon will recover quickly when that happens.