Exxon Earnings Show Big Oil's Big Value

07/29/2010 10:25 am EST


Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue, editor of The Energy Strategist, says giant Exxon Mobil offers high profitability and financial strength at one of its lowest prices in a long time.

Big integrated oil companies are traditionally considered the most defensive plays in the energy sector. Companies like ExxonMobil (NYSE: XOM) are less volatile than the Standard & Poor’s 500 index, offer above-average dividend yields, and have a history of performing well even amid weak commodity prices.

Consider that Exxon Mobil’s beta (a measure of a stock’s volatility relative to the S&P 500) is 0.78, [which means] the stock is less volatile than the index as a whole. Exxon has generated a total return of just under 700%—11% annualized—over the past two decades, [nearly double the] 340% for the S&P 500.

Although ExxonMobil and its ilk deserve their long-term reputation for safety and consistent profitability, even omitting BP (NYSE: BP), the Energy Strategist Integrated Oils index has still lagged the S&P 500 Energy Index this year. ExxonMobil, the quintessential energy blue chip, is off 12.6% so far this year.

This unusual situation presents a compelling opportunity. Institutional investors have pared exposure to the energy sector in response to the BP oil spill, throwing away the proverbial babies with the bathwater. Most of the big integrated oils I cover trade at their cheapest valuations since the panic-induced lows in late 2008, but their underlying fundamentals remain intact.

Most of the integrated oil companies amount to a combination of up stream and down stream operations. Upstream activities include the exploration for and production of crude oil and natural gas; downstream operations focus on refining and marketing.

Broadly speaking, integrated oils generate roughly three-quarters of their profits from upstream operations and the remaining 25% from downstream business lines, [so] the commodity price environment is favorable right now.

Ultimately, the group may benefit from new regulations on drilling in the deepwater Gulf of Mexico; only the largest integrated oils will have the scope to handle such developments and meet stringent requirements.

ExxonMobil is the largest of the integrated oils based on market capitalization, enterprise value, and daily production. The company has no net debt, as well as a coveted, and increasingly rare, AAA credit rating from Standard & Poor’s. Its 2009 return on assets was 8.4%, and its return on equity was 17.3%—tied for the lead among the Super Oils.

In light of its attractive asset base and operating excellence, the main reason [Exxon has underperformed its peers in recent months is] the oil giant’s acquisition of US-focused natural gas producer XTO Energy.

Investors appear concerned that ExxonMobil might have paid too much for XTO, while some have expressed concerns that the new assets increase the profile of natural gas in Super Oil’s production mix.

The market has vastly overreacted to both concerns, furnishing savvy investors with an excellent opportunity to buy ExxonMobil’s shares. Yielding 3%, ExxonMobil is a Buy up to $65. (It traded above $61 early Thursday after the company reported earnings of $1.60 a share, 14 cents above analysts’ estimates—Editor.) Big Oils are a classic value investment proposition at current prices; now is the time to go shopping.

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