Unless energy prices improve and the Middle East cuts the output of crude, oil stocks will underperform the markets for a while longer. Exxon Mobil (NYSE:XOM), whose shares yield a dividend of ~4.9%, is a mega-cap that investors might look at for investing in energy. The company is shedding assets to shore up its balance sheet. It is also aligning its business model to fit a world that wants lower carbon emissions.
On Sept. 5, Exxon agreed to sell its Norwegian oil and gas assets for up to $4 billion. This will mark its exit from the region. The sale makes sense because Exxon is turning its focus to onshore U.S. shale production. It is also developing oil discoveries in Guyana.
Exxon is aware of the growing future energy demand. As the quality of life improves in China and India, energy demand will increase. The correlation between energy demand and societal progress is undeniable. Exxon said:
“China’s demand tripled and India’s nearly doubled. The relationship between societal progress and energy consumption is indisputable. Access to reliable and affordable energy is essential to modern life. As billions of people strive for better living conditions, the world’s need for energy will continue to grow.”
And although having fewer carbon emissions is desirable, the world needs reliable and affordable energy.
Trends Justify Investments
The IEA estimated that the industry needs around $21 trillion in investments by 2040. This trend would justify Exxon’s investment plans. It aims to create value by having a unique set of competitive advantages. Its large-scale business is supported by its low-cost supply and high-performance products.
Exxon touts its five advantages: technology, scale, integration, functional excellence and world-class people. Investors may be sure that Exxon will continue investing in itself and growing during the downturns. When markets rebound, it will generate out-sized revenue and profits.
Exxon’s Permian, InterOil, and Mozambique acquisitions during the last downturn strengthened the diversity of its portfolio. Its existing projects are large, too, and account for $15 billion worth of spend.
Upside for XOM Stock
Analysts are still conservative in their view on XOM stock, with 10 out of the 11 analysts covering the shares rating the stock as a hold. Per TipRanks, the average price target is $80.60, which is more than 13% above its recent share price of $71. The hold rating on Exxon stock is understandable: commodity prices and margins are at historic lows and below Exxon’s 10-year median. Why buy Exxon stock if the company is currently facing extreme downstream and chemicals sector weakness?
Exxon continues to fund its businesses despite the current price environment. And the company continues to maintain its dividend at a yield of almost 4.9%. Investors buying Exxon stock when it weakens are betting that the cycle will turn higher. Such bottom-of-cycle conditions tend to end, sooner or later.
Opportunity Over Energy ETF
Exxon has a disciplined approach with all projects. It will only move forward with projects that deliver strong returns even at low oil prices. That is, at below $35 a barrel. In the near-term, weak oil prices will weigh on XOM stock but as demand-supply dynamics improve, the energy market is bound to bounce back. Its investments in upstream and the short and long cycle, plus the chemical and refining sector, offer shareholders a healthy level of diversity within the energy sector. Instead of holding an energy ETF, investors are better off buying a well-managed company like Exxon.
Target Price and Your Takeaway
Investors may turn to a 10-year DCF EBITDA Exit model (on finbox.io) to arrive at their own fair value for Exxon Mobil stock. At an 8-9% discount rate and a 21% average EBITDA margin, the stock could offer double-digit upside. SimplyWall.St, which calculates Exxon’s intrinsic value based on future cash flows, thinks XOM stock is worth around $99. Exxon’s debt levels rose slightly but 77.8% of it is well covered by operating cash flow.
On the chart, it looks as though Exxon could fall to new lows. But the bearish sentiment against oil stocks creates an entry point for value investors. At current levels, Exxon is a good buy-and-hold opportunity.
Disclosure: As of this writing, the author did not hold a position in any of the aforementioned securities.
