In the past two months, there’s been a rotation in the market from growth stocks to value stocks. For dividend value stock investors, Exxon Mobil (NYSE: XOM) stock offers investors a great dividend yield, an excellent source of cash flow and a potential long-term earnings multiple expansion opportunity. XOM stock, so far flat for the month of November, is only 6% above its 52-week low.
The oil industry has major stigma attached to it these days. In fact, XOM stock may be the poster child for an oil industry that investors assume will be left in the dust as the world transforms to alternative energy. But before investors write off Exxon stock as an investment in an industry in secular decline, take a closer look at the numbers.
It’s All About the Cash Flow
Exxon Mobil reported total cash flow of $9.54 billion in the third quarter. The company is executing a plan to double its cash flow through 2025.
Since 2013, Exxon has invested in more than 30 major projects. Almost all of these projects have better margin outlooks than its legacy business. Bank of America is projecting Exxon’s cash flow will grow from $3.77 billion in 2019 to $6.44 billion in 2020 and $11.5 billion in 2021.
Exxon pays a mouth-watering 5% dividend. At first glance, the 98.5% payout ratio may seem troubling until you look at how much cash flow is projected to grow in the next two years.
The oil market hasn’t recovered from its 2014 crash nearly as quickly as many XOM stock investors would have hoped. But Exxon Mobil stock is modestly valued at a forward earnings multiple of 17.9x. The dividend is paying investors well for their patience. And Exxon has both near-term and long-term catalysts ahead.
Big Oil Versus Big Energy
I realize saying Exxon has long-term growth catalysts ahead is where I may lose some people, but hear me out. One of the reasons why XOM stock has lagged the market in recent years is because few long-term investors want to put their money into “big oil.” As the world transitions to alternative energy over time, “big oil” will be left in the dust.
The reality is that the world is likely a decade away from peak global oil demand. In the meantime, a company the size of Exxon Mobil will certainly not sit on its hands and wait for its business to disappear.
Exxon is already investing up to $100 million over 10 years to partner with the U.S. Department of Energy’s National Renewable Energy Laboratory and National Energy Technology Laboratory. This partnership will involve developing greener energy solutions. Naysayers can dismiss these types of investments as PR stunts. But why wouldn’t Exxon pivot its model as global demand shifts from oil to alternative?
BofA analyst Christopher Kuplent calls this massive shift “Supermajor 2.0.” “Our Supermajor 2.0 re-rating thesis is underpinned by the transition from ‘Big Oil’ to ‘Big Energy,’” Kuplent recently wrote to clients. He said this transition could help oil stocks decouple from crude oil prices over time. “Oils who make most progress on this transition to ‘Big Energy’ [will] be rewarded by equity markets with relative re-ratings,” Kuplent said.
How To Play XOM Stock
Big oil bears often mention government regulations, consumer demand and falling alternative energy costs as serious long-term threats to investments like XOM stock. But that thesis assumes that the big oil business model is static.
A decade ago, e-commerce posed a huge threat to brick-and-mortar retailers like Walmart (NYSE: WMT). Today, WMT stock is trading at all-time highs because, shockingly, it started investing heavily in online sales several years ago.
Remember, Netflix (NASDAQ: NFLX) was once a DVD mailing service. Good companies adapt with the times.
I see the same future ahead for big oil companies. Steadily over the next decade as the world approaches peak oil and the economics of alternative energy become better and better, companies like Exxon will invest more and more into alternative energy. In the meantime, the legacy oil business will continue to be a cash cow as global demand grows. That cash flow will help fund massive dividends and buybacks. Eventually, it will help fund alternative energy investments.
To be sure, 10 years is a long way to look down the line. But thinking XOM stock is dead in the water because the oil business is in secular decline is one-dimensional thinking.
Exxon stock is cheap, it has a solid balance sheet, near-term cash flow growth opportunities and a world-class 5% dividend yield. It may not be a top performer in your portfolio. But XOM stock is a solid, low-risk source of dividend income with near-term risk to the upside.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.
