Exxon Mobil (NYSE:XOM) got some much-needed relief this week in the form of vaccine news. XOM stock spiked from $30 to $36 on the news of Pfizer’s (NYSE:PFE) encouraging results of its novel coronavirus vaccine.
But of course, the shares are still well off their highs for the year (in January, XOM stock was trading at $70). The fact is that this oil major still faces considerable challenges, reflected most recently in its removal from the prestigious Dow Jones Industrial Average. XOM stock had been in the gauge since 1928.
Of course, the Covid-19 pandemic has been the main factor for the problems with XOM stock. With global economies suffering from recession, the demand for oil has been depressed. And given that there appears be another wave for the virus, the problems could continue to worsen — at least through the winter.
Virus is Not All That Ails XOM Stock
There are other factors at work keeping XOM stock depressed. For example, with the relaxing of regulations in the U.S. and the emergence of innovations like fracking, there has been significant growth in oil supply. This meant pressure on crude prices. In the meantime, OPEC has been aggressive with production. This group has also had much infighting, especially between Russia and Saudi Arabia.
Then there have been the longer-term impacts on the oil industry. Alternative sources like wind and solar have become more cost effective. The huge success of Tesla (NASDAQ:TSLA) is perhaps the main example of this.
So, in light of all these trends, what should investors do with XOM stock? Is it even worth considering now?
I think there is an opportunity here. To be sure, investors will need some patience. But there could ultimately be some nice returns.
Here are my three reasons for this optimism:
Economies of Scale Help
Perhaps the biggest advantage for XOM stock is its massive scale. This is critical since oil is an undifferentiated commodity. Thus, with economies of scale, a company can compete better.
But XOM also has a diversified platform. This helps to provide more stability in the business. Note that Exxon has substantial businesses in upstream, downstream, LNG (liquified natural gas) and chemicals.
It’s true that none of these are doing particularly well, but things will improve as global growth comes back. What’s more, there will be favorable dynamics in the oil industry as smaller players continue to liquidate or sell out to larger players. With this consolidation, there will be further declines in supply — which will ultimately boost the bottom line for XOM.
Restructuring to Meet Market Realities
Even though XOM is a large organization, it is highly disciplined and agile. Keep in mind that the company is on pace with its cost-cutting targets for this year and next year. The plan is to cut up to 15% of the global employee base. This would come to roughly 14,000 jobs.
But XOM is also taking steps to drastically reduce its capital spending to adjust to the market realities. To this end, the target for this year has been set for $23 billion, which is $10 billion below the original plan. As for next year, the company expects to spend between $16 billion to $19 billion.
And finally, XOM will unload some of its assets in North America. It’s not clear how much cash this will generate but it could easily be in the tens of billions.
About That Juicy Dividend
Other mega oil companies like BP (NYSE:BP) and Royal Dutch Shell (NYSE:RDS.A, NYSE:RDS.B) have recently cut their dividends. But XOM has not done the same. The company’s management has made it clear that the dividend is a high priority. Oh, and the current yield is currently at a juicy 9.54%.
Now with the low profits, the company will need to continue to borrow money to cover the payout. But this should not be a problem. The debt markets are highly favorable and XOM has a pristine credit rating of double A-.
Besides, when the economy comes back, there will be a high degree of operating leverage for XOM and the cash flows could easily spike. In other words, the borrowing is likely to be temporary. So when the energy markets get back to normal activity, XOM stock could see some major gains.
On the date of publication, Tom Taulli did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Tom Taulli (@ttaulli) is an advisor/board member for startups and author of various books and online courses about technology, including Artificial Intelligence Basics, The Robotic Process Automation Handbook and Learn Python Super Fast. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s.