Is Exxon Becoming Too Risky?

07/30/2012 2:39 pm EST


Jim Jubak

Founder and Editor,

Blue chips are supposed to be less volatile, so the uncertainty surrounding the world's biggest energy company is very troubling, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

Wall Street analysts have been busy cutting their ratings on shares of ExxonMobil (XOM) after the company’s second-quarter earnings were announced on July 26.

If you’re a long-term investor, or if you own ExxonMobil because it pays more than a ten-year US Treasury bond (2.6% yield on ExxonMobil versus 1.54% on ten-year Treasuries)—and you suspect ExxonMobil is less risky than the US 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 online. 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 6 times projected 2012 EBITDA (earnings before interest, taxes, depreciation, and amortization) instead of the 4.5 times ratio for other supermajor 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 to that target price. When I picked ExxonMobil for my Jubak Picks 50 long-term portfolio 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, may or may not now own positions in any stock mentioned in this post. The fund owned shares of Statoil in March. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.
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