It seems like everyone is giving up on Exxon Mobil (NYSE:XOM) stock. Shares hit their lowest level in a decade after the oil giant reported a fourth-quarter earnings miss.
It’s easy to dismiss Exxon if you rely simply on one-dimensional thinking. Petroleum is the past. Renewable energy is the future. That seems to be the extent of the analysis of most recent Tesla (NASDAQ: TSLA) buyers I’ve talked to.
But looking below the surface at Exxon reveals a company that has an impressive growth outlook in an industry that still has several years of growth ahead. In the meantime, Exxon has billions of dollars in earnings it can return to shareholders, use to scoop up its own cheap shares or invest to position itself for the renewable future.
Cash Flow Is King
Exxon just reported a staggering $5.7 billion in net income in the fourth quarter. The company is currently executing a plan to double its cash flow by 2025.
Exxon has been a cash cow for years, and it has been busy putting that cash to work. Since 2013, it has invested in more than 30 major projects. Analysts say almost all these projects, once up and running, will operate at higher margins than Exxon’s core business. Bank of America recently estimated that Exxon’s free cash flow will rise from $3.6 billion in 2019 to $8.5 billion by 2021.
At the same time, Exxon is investing strategically in high-margin projects, it is also paying a generous 5.6% dividend. Exxon also bought back $4 billion of its own stock in 2019, taking advantage of the stock weakness. The company has already raised its dividend by 8% so far in 2020. Exxon’s payout ratio of around 80% may seem a bit worrisome at first glance until you appreciate the 48.9% EPS growth Bank of America is projecting for Exxon this year.
Sure, the global oil market has still not fully recovered from its 2014 collapse. But Exxon shares now trade at just 17.8 times Bank of America’s 2020 EPS estimate. The dividend will pay investors for their patience, and the buybacks will help support organic earnings growth.
Is Exxon a Value Trap?
I happen to believe Exxon is a value, but others see the oil giant as a value trap. Former Kase Capital Management hedge fund manager Whitney Tilson recently said XOM stock is showing signs of a classic value trap. Tilson pointed to declining revenues, income and operating cash flows over the past 10 years. He also pointed out that Exxon isn’t generating enough cash flow to cover its capital expenditures and dividend and is relying heavily on debt to do so.
“In light of ExxonMobil’s declining business and unfunded dividend, you have to wonder what investors are thinking in valuing the stock at 18.5 times 2019 earnings of $3.36 per share,” Tilson wrote.
I’ll put aside the fact that the declines Tilson is talking about are comparing today’s numbers to the oil market boom a decade ago. Of course revenue is down from the peak of a boom. It has also been trending higher over the past three years.
For the record, I’m typically 100% on the same page as Tilson. I just happen to disagree with him on Exxon. As Bank of America analyst Doug Leggate recently said, Exxon is investing in upgrading its business and is setting itself up for a brighter future by dumping non-core assets in favor of high-quality ones.
“Should a long list of non-core assets find buyers, we see XOM’s strategy as recycling cash towards higher return projects while high grading portfolio profitability through a project backlog not available to any of its global peers. This is a very different interpretation from those that prefer to describe the use of low cost debt to fund discretionary spending as ‘borrowing to pay the dividend,’” Leggate says.
XOM Stock as a Long-Term Investment
In general, I believe the market is being far too harsh on energy stocks. In particular, in the current low-rate environment, high-yielding energy stocks like XOM stock offer a unique investment opportunity.
One of the reasons why XOM stock has performed so poorly in recent years is simply because investors no longer want to back “big oil.” However, there is still plenty of money to be made in oil. There’s also plenty of time for oil companies like Exxon to adapt their models.
The world is still likely at least five years away from peak oil demand. In the meantime, Exxon is already investing in green energy solutions. By the time 2030 rolls around, Exxon may look as much like a pure oil company as Amazon (NASDAQ: AMZN) looks like an online bookstore today.
As global markets change and shift, so do the companies that target them. Energy demand is going nowhere. The idea that Tesla is going to somehow replace the entire energy and auto industries is laughable. Over time, Exxon will likely change its business from “big oil” to “big energy.” In the meantime, I believe it will use its oil profits to pay its sizable dividend and invest in modernizing its business.
As of this writing, Wayne Duggan did not hold a position in any of the aforementioned securities.
