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Still the King of Energy Stocks
09/16/2011 7:30 am EST
You don’t have to look to hard to find some great companies at great prices, and this oil major still has lots going for it, writes Allen Good of Morningstar StockInvestor.
I think the secular trend of increasing tightness in oil supply will vastly outweigh any potential near-term weakness from economic conditions. Trading at a single-digit multiple of earnings, this stock remains one of my favorites.
ExxonMobil (XOM) sets itself apart among the other supermajors as a superior capital allocator and operator. Through a relentless pursuit of efficiency, technology, development, and operational improvement, it consistently delivers higher returns on capital relative to peers.
With a majority of the world’s remaining resources in government hands, opportunities for the company to grow its large production base are limited. However, we believe ExxonMobil’s experience and expertise, particularly with large projects, should allow it to successfully compete for resources.
Resource nationalism is becoming an increasingly greater challenge to international oil companies’ (IOCs) ability to grow production. Countries rich in oil and gas reserves are becoming less willing to allow outside energy companies free rein to exploit resources within their borders.
Instead, they chose to look for dependable partners to work with their national oil companies (NOCs) to explore for, produce, and transport their oil and gas reserves.
In our opinion, governments cannot find a better partner than ExxonMobil. With its deep pockets, expertise, and integrated operations, it can tackle nearly any megaproject, regardless of scale, location, or operational difficulty.
While we believe ExxonMobil is better suited than the other supermajors for the current environment, that does not necessarily mean production and reserve gains will come easily. ExxonMobil needs projects of a certain size in order to contribute meaningfully to its production profile. However, today fewer projects of that caliber exist than in years past.
In addition, investing exclusively in large projects exposes the company to a variety of risks. Given their long lead times, megaprojects have the potential for overinvestment risk if commodity prices crash during development. Failure to meet deadlines or material and labor inflation could create cost overruns that damage project returns.
Given that the few untapped large resource pools left in the world are under government control, megaprojects generally are done in partnership with NOCs. Competition for these projects is intense.
In order to gain access, ExxonMobil must not only demonstrate its value, but may also have to agree to production-sharing agreements that are not as advantageous as in the past. Meanwhile, competitors eager for access may be more willing to agree to the NOCs’ less favorable terms.
More often, management is faced with a tough decision: take less favorable terms on more projects, focus on projects where its expertise is highly valued by the NOC, or pursue frontier locations.
Embedded within ExxonMobil’s culture is a relentless pursuit of cost savings and operational improvement. As a result, the company can ensure operational continuity throughout its global operations.
This allows ExxonMobil to capitalize on worldwide integration of its upstream and downstream segments to drive costs out of the system. Integration, particularly with chemical production, also adds value to its refining operations, which we generally consider as not having a moat. Meanwhile, by leveraging its size, the company can achieve economies of scale to contain costs.
Additionally, ExxonMobil centralizes its capital allocation activities. Consequently, the company evaluates projects from around the world against one another, and only those with the most attractive returns receive funding. With a disciplined approach, the company avoids overinvesting at the height of commodity cycles.
By the nature of its larger projects, the company must take a long-term approach that prevents it from counting on elevated commodity prices to drive project economics. Instead the focus is on delivering projects on time and under budget, ensuring original economics remain in place.
Part of the company’s moat is attributable to its financial strength. Strong cash flow, large cash balances, and low debt levels enable the company to maintain a low cost of capital and to continue investing without reliance on capital markets.
While ExxonMobil’s current production mix is evenly split between liquids and natural gas, we anticipate that by 2015 natural gas will be a slight majority of ExxonMobil’s production. However, a significant portion of those volumes will be LNG. As a result, we expect ExxonMobil’s price realizations to improve, which also help offset the lower assumed prices.
Our fair value is approximately 4.9 times our 2012 EBITDA estimate of $94.5 billion. In our discounted cash-flow model, our benchmark oil and gas prices are based on Nymex futures contracts for 2011 to 2013.
For natural gas, we use $4.57 per thousand cubic feet in 2011, $5.05 in 2012, and $5.29 in 2013. Our long-term natural gas price assumptions for 2014 and 2015 are $6.50 and $6.70, respectively.
For oil, we use $101 per barrel in 2011, $104 in 2012, and $103 in 2013. Our long-term oil price assumptions for 2014 and 2015 are $95 and $98, respectively. We assume a cost of equity of 10.5%.
We forecast production growth of a little over 3% during our period. Our forecast is slightly below management’s forecast to compensate for the potential negative effects of higher oil prices related to production sharing contracts as well as the risk associated with larger projects.
Full realization of management’s guidance could offer upside to our valuation, while extensive delays or reduced US natural gas production due to lower prices could result in downside risk. Refining margins have staged a recovery in the past year, and we model further improvement over our forecast period.
ExxonMobil should benefit from highly complex facilities and access to growth markets. Meanwhile, we anticipate chemical earnings to remain strong with economic recovery. Both segments should benefit from integration, which can ensure profitability despite a downturn in market conditions.
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