Ben Reynolds' Top Dividend Aristocrats: Part 3

12/20/2019 5:00 am EST

Focus: DIVIDEND

Ben Reynolds

CEO, Sure Dividends

The oil and gas industry is notoriously cyclical. Companies that operate in commodities are at the mercy of swings in pricing, which can be volatile and unpredictable, notes Sure Dividend editor Ben Reynolds, in his ongoing series highlighting his current favorite Dividend Aristocrats.

The cyclical nature of oil and gas makes it hard for commodity producers to generate steady profits from year to year. In turn, this prevents many companies from maintaining long histories of consistent dividend growth.

There are only two energy stocks on the list of Dividend Aristocrats, an exclusive group of 57 stocks in the S&P 500 Index with at least 25 consecutive years of annual dividend increases. One of the two is Exxon Mobil (XOM), the largest oil company based in the United States.

Click here to download an Excel Spreadsheet with all 57 Dividend Aristocrats now. Inside you will find metrics that matter like price-to-earnings ratios, market capitalizations, and dividend yields for each stock. 

Exxon Mobil has increased its dividend for 37 consecutive years. Its remarkable consistency over so many years, despite operating in a cyclical industry, makes Exxon Mobil a top energy stock pick for dividend growth investors.

A Time-Tested Industry Giant

Exxon Mobil has a long and impressive history of growth. Its roots trace back to Standard Oil, the first oil company to dominate the industry. Standard Oil was eventually broken up and divided into several different smaller companies. Interestingly, both of the current oil companies on the list of Dividend Aristocrats — Exxon Mobil and Chevron (CVX) — are among the successor companies of Standard Oil.

Today, Exxon Mobil has a market capitalization of $296 billion. It is a giant across the full spectrum of the oil and gas industry. Exxon Mobil has a large upstream business engaged in discovery, exploration, and production of oil and gas. But it also has a large downstream segment that includes refining, a midstream segment that includes oil and gas transportation, and a chemicals business.

As mentioned in the introduction, oil and gas is highly cyclical. Exxon Mobil is not immune from this, and its own earnings per share have exhibited volatility from time to time, depending on the direction of commodity prices.

or example, the energy sector was hit with a significant downturn from 2014-2016 due to sinking oil prices. As a result, Exxon Mobil’s earnings-per-share fell from $7.60 in 2014, to $1.88 per share in 2016. Exxon Mobil was similarly affected by the Great Recession of 2007-2009.

And yet, Exxon Mobil has raised its dividend each year, even throughout these various downturns. One reason is because of the company’s immense financial scale, which provides flexibility to drastically cut costs to preserve profitability.

This sets it apart from many smaller oil and gas producers that cannot stay profitable during industry downturns, and thus cannot maintain consistent dividend growth every year. The recent industry downturn of 2014-2016 caused many energy companies to reduce or even eliminate their dividends to stay afloat.

Exxon Mobil has struggled so far in 2019, due primarily to the weak commodity pricing environment. WTI crude oil currently sits under $61 per barrel, while Brent crude — the international benchmark — trades at $66 per barrel.

While oil prices have more than doubled off the 2016 lows, they remain well below the 2014 highs above $100 per barrel. This has kept a lid on Exxon Mobil’s earnings.

Last quarter, net income of $3.17 billion declined by nearly half from $6.24 billion in the same quarter last year. That said, we expect positive earnings growth for Exxon Mobil over the long-term, even if commodity prices remain near current levels.

Drivers of Long-Term Growth

Exxon Mobil cannot control underlying commodity prices, but it does execute on the things within its control, specifically its production. Last quarter, its upstream liquids production increased 5%, thanks in large part to the Permian Basin, one of the highest-quality oilfields in the United States.

Continued production growth will allow Exxon Mobil to grow its cash flow, even if oil and gas prices do not increase from present levels. Exxon Mobil generated $21.4 billion in operating cash flow (excluding working capital changes) through the first three quarters of 2019.

Fundamentally, the conditions of the oil and gas industry remain supportive of growth. According to a recent company presentation, Exxon Mobil states that new supply of 550 billion barrels of oil and 2,100 trillion cubic feet of natural gas are required through 2040 to meet projected global demand.

And, according to the International Energy Agency, approximately $21 trillion of oil and natural gas investment is needed by 2040. Demand continues to grow across the world, particularly in the emerging markets.

Exxon Mobil is positioned to capitalize on the global growth opportunities. One reason is the continued high-grading of Exxon Mobil’s asset base and project lineup. The company divests non-core assets so that it can invest in more attractive opportunities. To this end, Exxon Mobil anticipates $15 billion of asset sales by 2021.

Exxon Mobil has a number of large projects set to ramp up in the near future, including the Permian Basin in the U.S., as well as international projects in Guyana, Brazil, Papua New Guinea, and Mozambique. As these major projects come online, they will no longer require such significant capital expenditures.

At the same time, completed projects will generate cash flow. This is why Exxon Mobil expects earnings to grow by more than $4 billion from 2019 to 2020, even with flat commodity pricing. In fact, even if oil prices average just $40 per barrel, Exxon Mobil still anticipates ~40% earnings growth by 2025, compared with 2017 levels.

Valuation and Expected Returns

We expect high total returns above 12% per year for Exxon Mobil over the next five years, consisting of 17% to 18% annual earnings growth and the 5% dividend yield, partially offset by a reduction in the price-to-earnings ratio. Exxon Mobil stock currently trades for a price-to-earnings ratio of 26, as 2019 is expected to be a down year for earnings per share.

Our fair value estimate for Exxon Mobil is a price-to-earnings ratio of 13, which is more in line with its historical average. A declining valuation multiple is expected to reduce total shareholder returns by 13% per year, over the next five years.

Still, we expect total annual returns of 9%-10% per year for Exxon Mobil stock over the next five years. This is a satisfactory rate of return, particularly as the stock holds high appeal for income investors with its 5% current yield. Exxon Mobil offers a combination of dividend yield and total return potential, making it one of our top-ranked Dividend Aristocrats today.

Click here to download an Excel Spreadsheet with all 57 Dividend Aristocrats now. Inside you will find metrics that matter like price-to-earnings ratios, market capitalizations, and dividend yields for each stock. 

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