Naysayers. In the beginning of the year, they are out in full force. They are the people telling you...
After second quarter earnings, you have to ask if ExxonMobil (XOM) deserves its premium to other super-major oil stocks
07/30/2012 2:30 pm EST
If you’re a long-term investor or if you own ExxonMobil because it pays more than a 10-year U.S. Treasury bond (2.6% yield on ExxonMobil versus 1.54% on 10-year Treasuries)—and you suspect ExxonMobil is less risky than the U.S. government, you’re likely to simply shake off some of these downgrades. So what if an analyst thinks the current low price of oil is the reason to take the stock from buy to hold? So what if an analyst thinks the current valuation is stretched?
You know in your heart that the cash flow at ExxonMobil is very safe and very dependable.
But what if your heart is wrong? What if a few of the downgrades raise questions about the quality of ExxonMobil earnings?
Here’s the problem in the company’s second quarter earnings. Net income rose by 49% to $15.9 billion from the second quarter of 2011—if you include $7.5 billion in asset sales. If you don’t, the quarter’s results show ExxonMobil producing less oil and natural gas and selling them at lower prices and weak sales from the company’s chemical unit in Asia and Europe. Absent the asset sales ExxonMobil’s operating profit was just $8.4 billion, the lowest since the third quarter of 2010, and down from $8.5 billion in the second quarter of 2011.
If you’re a long-term investor who owns ExxonMobil for its cash flow and dividend, what you now have to decide is whether the negative trends in the second quarter are signs of long-term problems or will be relatively quickly reversed.
Standard & Poor’s is in the quickly reversed camp. S&P projects that ExxonMobil earnings will fall to $8.00 a share in 2012 from $8.42 in 2011, but then rebound to $9.10 in 2013.
The Wall Street consensus isn’t so sure. The consensus sees earnings dropping to $7.64 in 2012 and then rebounding to only $8.25 in 2013. That would still be below the 2011 figure.
What worries me is the company’s production projections for the next few years. Total production of oil and nature gas fell by 5.6% from the second quarter of 2011—that was much worse than the 3% decline for the entire 2012 year that the company projected in March. The company recently told Wall Street that it expects production to be down for 2012 as a whole but to increase in 2013 as the company’s Kearl Canadian oil sands project comes on line. The company’s capital budget is pegged at $37 billion a year for the next few years, but the company is still projecting just 1% to 2% production growth annually from 2011 through 2016.
In my book companies that trade at big premiums to their peers shouldn’t show big uncertainties, but that’s exactly what I see with ExxonMobil. S&P calculates a 12-month target price for the shares of $103—up 18% from today’s price of $87.29—but they get to that price target by assuming that ExxonMobil should trade at 6x projected 2012 EBITDA (earnings before interest, taxes, depreciation, and amortization) instead of the 4.5x ratio for other super major oil companies. Credit Suisse, in contrast, has a 12-month target price of $85.
If you don’t see the basis from that kind of premium—and I don’t—then you don’t get to that target price. When I picked ExxonMobil for my Jubak Picks 50 long-term portfolio http://jubakpicks.com// in December 2008, I wrote that ExxonMobil was the one oil major that had found a way out of the box of higher spending and falling production. I’m not so sure now and I’ll be taking a hard look at the stock—especially versus competitors such as Chevron (CVX) and Statoil (STO)—when I review that portfolio in December.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of ExxonMobil as of the end of March but it did own shares of Statoil. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/ .
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