Exxon Mobil (NYSE:XOM) is marching along the road to recovery. But even though Exxon Mobil stock is up 10% over the last month, the world’s foremost energy producer is receiving a lot of criticism for implementing strategies that seem strange in the current environment.
The novel coronavirus pandemic and geopolitical tensions have led to an unprecedented decline in crude oil prices. These factors also led to share prices of oil stocks dropping precipitously, and XOM is no exception.
However, as oil demand inches upward, stocks are erasing these losses.
Exxon is also in the spotlight as it has veered from the steps energy producers have taken in response to Covid-19. After a very long time, the company posted a loss in its latest quarterly earnings. However, in spite of that, it maintained its dividend payout. More importantly, it is still devoting a healthy amount to capital expenditures this year.
This comes as several companies in the sector have gutted their capital expenditure budgets. Exxon is betting their spending will return handsomely when things begin to normalize.
Leaving the operational issues to one side, I believe the best thing going for XOM at the moment is its valuation. Compared to its peers, the stock is very cheap, considering its history and upside potential. There are long-term headwinds that the company will have to navigate, but the stock seems in a good position to rally as Covid-19 loosens its grip.
Exxon Is Betting Big on Capital Expenses
In the current environment, every company is making extensive cuts to its capital expenses. However, Exxon has chosen to go down a different route. Although the company announced capital expenditure cuts of 30%, it will still spend $23 billion this year.
Looking ahead, the company will spend between $30 billion and $35 billion on capital expenses, which is a very high amount considering we don’t know how long oil prices will take to recover.
I believe the company is betting on a quicker than expected recovery. In such a case, companies that have sound investment strategies today will have a lot to gain when economies start to shake off the effects of the virus.
However, the timeline of the recovery is not crystal clear at the moment. Exxon’s free cash flows don’t paint a rosy picture and if revenues take time to recover, the company may have to take out expensive debt to finance its operations and pay dividends.
Financial Health Is Stable
Exxon is doing quite well when you pit its financial metrics against that of its peers. Return on equity of 6.01% stands head and shoulders above anyone else in the sector. Although free cash flows are under stress because of capital commitments and high dividend payouts, its operating cash flow remains stable.
Exxon’s operating margin is also stable, last taking a hit in 2016 due to an increase in shale production and a supply glut caused by OPEC+. Oversupply is also a key theme the industry is grappling with at the moment. We have to wait and see if the dip in demand is similar to 2016 or will it take a substantial time to rebound.
XOM Stock Valuation
Exxon Mobil stock is trading at a price-earnings ratio of 20 on a trailing 12 months. That’s not too bad, considering peers Chevron and Valero (NYSE:VLO) are trading at P/E ratios of 49 and 69. This compares very unfavorably with the sector median of 11.04 times.
Long-term Headwinds Pose a Significant Threat
According to forecasts, the share of renewables in the U.S. energy mix will rise from 17% to 21% in 2020 and 23% in 2021. And the U.S. is not alone in this regard, as more and more countries are looking to change their energy mix to one that is more environmentally friendly.
It’s also unclear what long-term effects Covid-19 will have on oil demand. Climate change was already a hot button topic before Covid-19 but the pandemic has just added fuel to the fire. However, until renewables can become cost-effective enough to overtake traditional sources of energy, companies like Exxon are relatively safe.
Last Word on Exxon Mobil Stock
Exxon Mobil is a very strong player in the oil and gas space, a position it has held for quite some time. The company has an extensive history of delivering value to shareholders, excellent dividend payouts, and trades at a record-low valuation.
Having said that, Exxon’s management has made some unusual moves in response to Covid-19. If oil prices rebound then these initiatives could pay dividends, if not they could prove to be costly mistakes. Still, the high yield and attractive entry point offer enough incentives to invest in this stock.
XOM stock is a buy for me.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. Faizan does not directly own the securities mentioned above.