When the market closed on Tuesday the 18th February, shares of Exxon Mobil (XOM) had once again reached a new 52 week low during intraday trading. This has become quite a frequent occurrence with their share price currently sitting just under $60 being a far cry from its heights during the last few years of around $90. One interesting observation is that this sustained selloff has now pushed their dividend yield to the highest level in a generation, with it now even slightly exceeding the heights during the late 1980’s. Several months ago I published an article that provided a valuation in a theoretical scenario were peak oil demand is reached soon, with the purpose being to assess the downside potential in a very bearish future. Whereas this article provides countering valuations for more realistic bullish scenarios to assess the upside potential.
There has been quite a number of investors question their current high spending strategy and the resulting toll it has been taking on their financial position. Thankfully they currently still have a strong financial position, which I discussed in greater detail in a previous article. Given this situation the primary assumption was that they will continue maintaining an adequately strong financial position and thus can avoid either raising equity or reducing their dividend. Naturally it was also assumed that although the world continues to move away from hydrocarbons, the transition stays at the current steady pace and thus does not threaten their business model for many decades.
The primary scenario foresees their quarterly dividend remaining unchanged perpetually into the future at $0.87 per share or $3.48 per share on an annual basis. This scenario was selected to provide a conservative base line valuation that incorporates a material margin of safety, in case their high spending strategy falls flat, possibly due to weak commodity prices. I personally believe an attractive investment is one that can be justified without assuming any future growth.
Meanwhile the secondary scenario was the most bullish situation I could realistically envision unfolding, which foresees their quarterly dividend increasing steadily throughout this decade as their high spending strategy is broadly successful, with the dividends summarized in the table included below.
Image Source: Author.
These dividend estimates were derived from the guidance included in their 2019 investor information presentation, see the two graphs included below. It can be seen that they are expecting their operating cash flow to grow to approximately $60b in 2025, providing that oil prices average $60 per barrel. Whilst they have also included guidance for oil prices of $40 and $80 per barrel, I personally believe these are too bearish and bullish respectively.
When this guidance is combined with the midpoint for their 2025 capital expenditure guidance of $32.5b, this produces guidance for free cash flow of approximately $27.5b. Since this technically includes their asset sales and that they would likely wish to deleverage, it was assumed that approximately 75% of this free cash flow would be available to be returned to shareholders through dividend payments. Given their current outstanding share count, their future dividend in 2025 would be $4.85 per share, with their dividends during the years between increasing at equal intervals. Following this point in time, it was assumed that their dividends will only increase broadly in line with inflation for the remainder of the decade before remaining unchanged perpetually into the future, as the world moves away from hydrocarbons. Whether they ever begin investing significantly in clean renewable energy remains too uncertain and thus is absent from this valuation scenario.
Image Source: Exxon Mobil 2019 Investor Information Presentation.
The primary valuations used a standard discounted dividend model, with their cost of equity being estimated with the Capital Asset Pricing Model. Whilst this model is not perfect, it still provides enough accuracy for the purpose of this analysis. This model produced a cost of equity of 6.91% with the following inputs, a risk free rate of 1.56% (10 Year U.S. Treasury), a 60 month Beta of 0.90 (SA) and an expected market return of 7.50%. Meanwhile, the additional valuation consideration compares the spread between two of their key metrics to those of their largest United States based competitor, Chevron (CVX).
The primary valuation returned a result of $50.39, which is 15.85% lower than their current share price of $59.88 as of the time of writing. This indicates that unless their dividend growth continues further into the future, their shares are worth moderately less than their current share price.
Meanwhile the secondary valuation returned a result of $72.42, which is 20.94% higher than their current share price as of the time of writing. Whilst this upside potential may sound attractive, considering it results from what I believe to be the most realistically bullish scenario, I would still prefer to see greater upside before investing to provide an adequate margin of safety.
The additional valuation consideration provides further food for thought by simply comparing the spread between two of their key metrics to those of Chevron. A lower spread relative to its history indicating that Exxon Mobil is relatively undervalued and vice-a-versa. Thankfully these graphs largely speak for themselves and indicate that at no other point in decades has Exxon Mobil’s dividend yield exceeded that of Chevron to such a significant extent, despite coming close in the early 1990’s. Meanwhile their price to book ratio has seldom been more attractive either, which further supports the notion that their shares are becoming attractive. Unfortunately there was insufficient data available to include other metrics such as price to earnings ratio across a suitable length of time.
Even though their shares currently offer the highest dividend yield in a generation, I would prefer to see a moderately lower share price before investing. Whilst their current share price could still produce positive returns for their shareholders, I personally find the margin of safety slightly too thin, especially at this time of heightened geopolitical and economic risks. If their share price falls to my zero growth valuation of approximately $50, I would switch from neutral to bullish, barring any fundamental change.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.