After an awful start to 2020, oil is finally showing some spark, which is just what they need over at ExxonMobil (NYSE:XOM). Now sure, Exxon Mobil stock is till down 32% year-to-date, but crude oil prices have recovered from their bizarre run below $0, and hit $40 per barrel recently.
Natural gas has firmed up as well. And the Fed’s extraordinary liquidity measures have pumped some crucial funds into the credit market, helping struggling energy producers.
XOM stock was off more than 50% at one point, but the money is flowing back into the sector now.
I’m a long-term bull on Exxon and it’s a sizable position in my portfolio. That said, the recent rally has been rather swift — don’t be surprised if Exxon consolidates here around the $50 range for a while. Here’s why.
No V-Shaped Recovery for Exxon Mobil Stock
While the stock market as a whole has recovered most of its March losses already, this hasn’t and won’t happen for integrated oil companies. So for traders playing short-term momentum in the energy stocks, be aware that the January 2020 levels are not realistic price targets for oil companies such as Exxon.
Why is that? Simply put, there’s a huge downturn across all parts of the energy supply chain. An integrated oil company has many ways to make money. There’s exploration and production, where they extract the oil and gas. There’s midstream, where they deliver raw products to refineries. And there’s the refineries and chemicals division. In the case of Exxon, they have branded gas stations as well.
In general, as one part of this network makes less money, it comes back somewhere else. Historically, low oil prices, for example, would be offset by high chemical prices. A polyethylene chemical plant, for example, should make a lot more money when oil prices are low, as oil is its main input cost, after all.
With this economic crisis, however, that’s not happening. Both chemical and refined products (gasoline, jet fuel, asphalt, etc.) have plummeted to a multi-decade low.
Thus, Exxon Mobil stock is suffering from both low oil prices and low demand for finished products from its chemical and refining plants. This is putting an historic squeeze on their profit margins. Exxon is reacting to this with cutbacks – they just pushed back an expansion to their pivotal Beaumont refinery out to 2023.
The most pressing issue around Exxon Mobil stock is the dividend. The company is a Dividend Aristocrat, as it has raised its dividend every year dating back to the early 1980s. It’s a mark of pride for the company, and its consistency has made it a core holding for a whole generation of growth and income investors.
And, historically, Exxon hasn’t had trouble covering that dividend. For decades, the company had a triple-AAA rated balance sheet and earned far in excess of its dividend.
But trouble struck in 2015 when oil price crashed and Exxon started having to borrow to afford its dividend. Over the past five years or so, Exxon has gradually taken on more debt to concurrently support its dividend and growth plans. Now, however, with profits plummeting, many investors bailed on Exxon afraid that the dividend will be on the chopping block.
If the economic recovery continues at a decent pace, Exxon will probably be able to maintain its dividend. That said, they spent tens of billions of dollars on growth initiatives at a difficult moment.
Investors aren’t going to give them the credit for massive projects such as Guyana that are coming online now until oil prices are sharply higher. Given Exxon’s weak cash flow generation at the moment, expect investors to doubt the stability of Exxon’s dividend well into 2021.
Exxon Stock Verdict
Given the high market volatility, it’s not that appealing to buy Exxon Mobil stock outright today. To be clear, I own a lot of Exxon myself, but I’m not looking to add more yet given the concerns above.
That said, if you trade options, you might want to look into harnessing that volatility to your advantage by selling cash-covered puts. As of this writing, with Exxon at $46, January 2021 $45 puts are going for $5.25. Thus, if Exxon stays above $45 through next January, you’d earn a more than 10% yield on your capital in seven months. That beats the dividend yield on the stock nicely. And if Exxon drops again and the stock is put to you, you’d have a cost basis in the $39s as opposed to $48.
If Exxon soars, it’d be preferable to buy more shares outright. But given the challenges to both the macroeconomic outlook in general and the oil market in particular, it’s hard to see Exxon shares blasting off from here. Thus, it’s a good time to consider strategic ways to hold Exxon until the economic picture gets clearer.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned XOM stock.