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INITIATING COVERAGE REPORT
William C. Dunkelberg Owl Fund February, 6
th 2016
John Matthews: Lead Analyst [email protected] Michael Butkerait: Associate Analyst [email protected] Kevin Marble: Associate Analyst [email protected]
Sector Outperform Recommendation: BUY
Key Statistics: Price $80.08 52 Week Low $66.55
Return 9.93% 52 Week High $93.45
Shares O/S (mm) 4,163 Yield 3.67%
Market Cap (mm) $333,368 Enterprise Value $369,500
1 Year Price Graph
Earnings History: Quarters EPS Δ Rev. YoY Δ Price
1Q15 $1.17 -36.7% -19.1% 2Q15 $1.00 -33.6% -14.4% 3Q15 $1.01 -37.3% -19.8% 4Q15 $0.67 -31.5% -13.8%
Earnings Projections: Year Q1 Q2 Q3 Q4 Total
2014 $2.10 $2.05 $1.89 $1.56 $7.60
2015 $1.17 $1.00 $1.01 $0.67 $3.85
2016e $0.42 $0.56 $0.89 $0.64 $2.65
2017e $1.03 $1.09 $1.23 $1.10 $4.45
All prices current at end of previous trading sessions from date of report. Data is sourced from local exchanges via FactSet, Bloomberg and other vendors. The William C. Dunkelberg Owl fund does and seeks to do business with companies covered in its research reports.
COMPANY OVERVIEW
Exxon Mobil Corp. is an Integrated Oil & Gas company that explores for, develops and distributes crude oil and natural gas and refined products. It also manufactures and markets petrochemicals. Exxon operates business under three segments: Upstream (39.3% of FY 2015 Net Income), Downstream (36.3%) and Chemical (24.4%). The Upstream segment is organized and operates to explore for and produce crude oil and natural gas. The Downstream segment manufactures and sells petroleum products. The refining and supply operations provide fuels, lubricants, and other high-value products and feedstocks to customers. The Chemical segment operates to manufacture and sell petrochemicals. The company operates and markets products in the U.S. and most other countries of the world, and categorizes its geographic revenue streams as Non-US (70.3% of Q3 2015 Revenue) and United States (39.4%).
INVESTMENT THESIS
Exxon is currently trading at a 10.9% discount to its 1-year
historical EV/EBITDA spread to Chevron Corporation, as well
as 15.0%, 22.0% and 22.4% discounts to its 3, 5, and 10 year
historical EV/EBITDA spreads to Chevron as well. Exxon
became undervalued as a result of (1) the crude oil and oil
market sell-off and (2) not exceeding Q3 2015 earnings results
by as great a margin as its most relevant competitor, Chevron.
After reaching an all-time high closing price of $104.38 on June
23, 2014, Exxon’s stock has since fallen by 23.3% to its current
level. Throughout this time period, the price of crude oil has
fallen by 70.9%. Investors have reacted irrationally. Looking
forward, our sector believes that Exxon will see bottom line
growth through its ideal positioning in the downstream segment
of its business operations. With no end in sight of the bearish
trend in the oil market, Exxon has invested in projects that will
help insulate the company from falling commodity prices, while
also exposing the company to growing markets for its products
in emerging economies. This will be achieved through Exxon’s
Rotterdam Hydrocracker expansion, and its synthetic oil product
positioning in Asia Pacific. These catalysts, alongside the
company’s economic moat created by its economies of scale, will
drive Exxon to an 11.15x EV/EBITDA multiple, pushing the
company’s stock to our target price of $88.07, yielding a 13.6%
return including the company’s 3.67% dividend yield.
EN
ER
GY
: IN
TE
GR
AT
ED
OIL
& G
AS
Exxon Mobil Corp. Exchange: NYSE Ticker: XOM Target Price: $88.07
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INDUSTRY OVERVIEW
Supply and Demand
The current crisis in the energy industry is unlike any that has ever occurred before. The shale revolution has ushered in
an era of abundant supply albeit at higher costs to E&P’s than foreign producers, namely in the Middle East. This excess
supply from shale has lead commodity prices to plummet in recent times. Estimates show production of petroleum and
other liquid fuels in countries outside of the Organization of Petroleum Exporting Countries (OPEC) grew by 1.3 million
b/d in 2015. The 2015 growth occurred mainly in North America. Non-OPEC production is projected to decline by 0.6
million b/d in 2016, which would be the first decline since 2008. Most of the forecast decline in 2016 is expected to be in
the United States as the slowdown in upstream spending starts to materialize. This drop in commodity prices will also
have an impact on proven reserves as their price is determined on a 12 month moving average. This will likely weigh on
overall proved reserves and potentially on upstream valuations. US Utilization of Refinery Capacity is at 87.40%,
noticeably lower than the long term average of 89.91%. This means that demand for refined products has been declining,
evidenced by the recent and large increases in refined product reserves. This can be further seen in the amount of excess
inventories. At 494.9 million barrels, U.S. crude oil inventories remain near levels not seen for this time of year in at least
the last 80 years. There were also raises in stocks of refined product that include motor gasoline which is up 4% from last
year and distillate fuel oil which is up 21%. What all of this means is that while the supply will start to slowly decline, it is
still well above demand leading to prolonged low commodity prices.
Oil as a Commodity
The decline of commodity prices has had a distinct effect on all three sectors of the Oil & Gas industry. Upstream
companies have been slowly cutting back spending in future projects as the falling prices have made more projects
economically unviable. The US Energy Information Administration estimates that E&P spending will have declined as
much as 12% in 2015, with similar estimates for 2016. Low commodity prices will also have an impact on potential
earnings for companies in upstream while also causing a large increase in impairment charges as drilling on certain
properties become unprofitable. Midstream companies are also facing risks as customer decrease production of oil and
will affect demand for transportation. This decline means that less volume will go through pipelines, causing a decline in
sales. This trend is extremely dangerous considering that most midstream companies are highly leveraged and generally
pay high dividends. The most positively affected by these changes are the refiners, as their input costs have drastically
fallen. One challenge they will face is that their refineries are not equipped to process the sudden abundance of light and
sweet crude that is now being produced. This type of crude is more valuable because it is easier to process compared to
heavy and sour crude that most refineries in the US were designed to process.
Crack Spreads
As crude prices plummeted in the second half of FY 2015, the energy
industry saw a widening in crack spreads due to the temporary
stickiness of gas prices. While there are many different relevant
spreads for different feedstocks and products, the crack spread is
generally defined as the difference between the price of oil and the
price of petroleum products extracted by oil. Exxon’s 30 refineries in
17 different countries hedge its risk to fluctuations in one particular
spread. While it does have a diversified presence in the downstream
area, 30.3% of TTM revenue and 11.4% of FY 2015 net income
came from U.S. refineries, mostly located in the Gulf Coast.
Therefore, Exxon’s earnings are exposed most to movements in the
Gulf Coast 3:2:1 LLS crack spread. This spread is seasonal and currently tightening as gasoline demand is weaker in the
winter as compared to the summer due to less travel during winter months. So while Exxon’s downstream operations
benefitted in 2H2015, posting segment profits of $3.38b (up 122% YoY), we can expect margins to tighten mildly in the
near term as spreads tighten in throughout FH 2016.
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Geopolitical Factors
Valuations of firms operating in the
energy sector have increasingly been
driven by geopolitical factors and
speculation about influences on global
crude oil prices. An early February
report by the EIA shows domestic
crude stockpiles rose above 500 million
barrels for the first time in 80 years, as
Saudi Arabia continues to maintain
production levels despite pleas from
the other OPEC countries which are
being hurt by the cheap price of crude.
Russia and Venezuela in particular are
being hurt by ~$30/bbl crude prices as
the second and twelfth largest crude
oil-producing countries, respectively.
Both countries have made attempts to
lobby SA into making a deal to cut production, but so far nothing has been successful in deterring the oversupply from
persisting; the move to maintain production levels is largely seen as an attempt to drive out competition from shale plays
in the U.S. In addition to global political noise, stocks of highly levered energy companies are being affected by the
Federal Reserve’s prospective interest rate hikes. For example, on January 14th St. Louis Federal Reserve President James
Bullard remarked that the instability in oil markets has caused a "worrisome" drop in U.S. inflation; Exxon stock rose 5.1%
on the day as traders speculated a delay in rate increases due to poor industry outlook. Fundamentally, large domestic oil
companies have been able to maintain financial performance by cutting costs and reevaluating prospective projects, but as
the outlook in global energy becomes more uncertain, valuations have suffered. Nonetheless, the price of crude has been
unduly volatile as speculation over political news continues and consequently technical pressures have driven valuations
of U.S. energy firms downwards throughout FY 2015 and into FY 2016. Our sector expects to see even further increased
political influence on the market as tensions are heightened within OPEC before its June summit and as the U.S. heads
into its presidential election.
U.S. Export Ban Lifted
In 1973, OPEC placed an embargo on oil sales to the United States, due to the U.S.’s support of Israel in the Yom
Kippur War. This ultimately led to a huge lack of oil supply in the American economy. To make up for the shortfall, in
1975, the United States placed a restriction on crude oil exports. Exceptions were made under the ban: deliveries to
Mexico and Canada were permitted, as were shipments of condensate (ultra-light oil). However, forty years later, the ban
has been lifted in its entirety. Congress’ decision to lift the ban is meant to provide a long-term boost for the U.S. energy
industry, and to provide stability for allies in Europe and Asia who would otherwise import oil from the politically volatile
Middle East. On New Year’s Eve, 2015, ConocoPhillips and NuStar both announced that they had completed the first
shipments of American oil since the lifting of the ban. To protect independent oil refiners from lost sales and
international pricing pressure, a tax-break provision was enacted upon the ban being lifted. Independent refiners may now
exclude 75% of oil-transportation costs from their pre-tax net income when calculating an existing domestic
manufacturing deduction. However, the worldwide oil industry will not see a large influx of American oil any time soon.
In fact, for the week ended January 22, 2016, American oil exports fell 25% from the same period in 2015. For several
years, up until the recent drop in crude oil prices, WTI, the American benchmark, traded at a noticeable discount to Brent,
the international benchmark. With WTI currently trading essentially in line with Brent, American oil is no longer cost
efficient for international customers. Also, America’s Gulf Coast currently does not have the necessary equipment in
place to send oil tankers to sea. Thus, the lifting of the ban will have no impact on our thesis through the course of the
investment horizon.
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SEGMENT OVERVIEW
As an Integrated Oil & Gas firm, Exxon’s business operations consist of three segments: Upstream (39.3% of FY 2015
Earnings), Downstream (36.3%), and Chemical (24.4%). It is more relevant to analyze each segment’s percentage of total
net income relative to one another, as opposed to their respective percentages of total revenue, due to large amounts of
revenue generated by the typically low-margin Downstream segment.
Upstream - (39.3% of FY 2015 Earnings)
Exxon’s Upstream segment explorers for, develops, and produces
crude oil and natural gas products. Under this segment, Exxon uses
mining technologies to drill exploratory and development wells.
Exploratory wells are drilled to discover oil reserves, and development
wells are drilled to ultimately extract proven oil reserves. Exxon uses its
vast network of consolidated subsidiaries and equity companies to
produce crude oil, natural gas, natural gas liquids, bitumen and
synthetic oil through these drilled wells. Exxon produces the aforementioned products in six identified geographic
segments: the United States (24.4% of FY 2015 Net BOE Production), Canada/South America (10.9%), Europe (14.3%),
Africa (12.9%), Asia (33.5%), and Australia/Oceania (4.0%). In times of high oil prices, the upstream business is
incredibly profitable, and comprises the bulk of Exxon’s net income. However, with the fall in oil prices that began in July
of 2014, the upstream business has lost substantial profitability for all oil and gas explorer and producer companies. From
FY 2014 to FY 2015, Exxon’s upstream earnings decreased 74.2%, from $27.5 billion to $7.1 billion, mainly due to a $1
billion loss in its U.S. operations that was partially offset by $8.2 billion in non-US earnings. This has caused Exxon to
drastically slash CapEx in its upstream segment by 22.3%, from $32.7 billion in FY 2014 to $25.4 billion in FY 2015.
Remarkably though, Exxon has managed to increase upstream production, from 4.0 million BOE/D to 4.1 million
BOE/D. And, realizations remained above benchmark spot prices throughout 2015, most recently averaging at $34.36 in
Q4 2015. Furthermore, production increases have helped partially make up for Exxon’s top line Upstream losses.
Downstream - (36.3% of FY 2015 Earnings)
Exxon’s downstream segment is composed of refining, logistics and marketing complexes across the world. As of the end
of FY 2014, Exxon possessed ownership interest in 30 refineries located in 17 countries. These refineries hold 5.2 million
barrels a day in distillation capacity and 131 thousand barrels per day in lubricant basestock manufacturing capacity.
Exxon currently and historically generates the large majority of the company’s revenue. However, the refining industry is
typically low-margin, and as a result did not contribute the majority of Exxon’s net income. Since the prices in Brent
crude and WTI crude oil have both plunged since July 2014, Exxon’s refining margins have drastically expanded, which is
discussed in greater detail in the Financials section of this report. As the cost of the crude oil input continues to drop, the
crack spread of crude oil to refined oil product widens. Exxon has recently looked to take advantage of this trend. In an
effort to maximize cost efficiency, Exxon increased maintenance activities on its refineries YoY. Sales fell for all refined
products except the heating oils, kerosene and diesel segment, and sales also fell in all major geographic locations as well,
except Asia Pacific. Though decreased volumes lowered downstream earnings by $200 million, widened margins
increased earnings by $4.1 billion. Exxon is now in the process of enacting multiple expansion projects in this segment of
its business in order to capitalize on the higher downstream margins, discussed in greater detail in the Catalysts section of
this report.
Chemical - (24.4% of FY 2015 Earnings)
Exxon’s Chemical business segment manufactures and sells petrochemicals, namely olefins, polyolefins and aromatics. In
North America, Europe, the Middle East and Asia Pacific, Exxon produces ethylene, polyethylene, polypropylene and
paraxylene products. The chemical segment, much like the downstream segment, uses crude oil and natural gas as an
input. As the costs of these feedstocks have continually decreased, earnings have grown and margins have expanded. As
of the end of FY 2014, Exxon held ownership interest in 15 chemical plants worldwide. Chemical prime product sales
have remained flat from FY 2014 to FY 2015, increasing slightly from 24.2 to 24.7 million tons of product sales.
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CATALYSTS
Rotterdam Hydrocracker Expansion
In 4Q 2015, Exxon Mobil announced that it
would allocate $1b of its $23.2b 2016 CapEx
for expansion of its Rotterdam refinery in
order to gain position in the European
market for EHC Group II base stocks, which
are a high margin product used in lubricant
and process oil applications, namely motor
oil formulations. The industry conversion
from group I to group II base stocks has
accelerated over the past 18 months due to
regulation pushing auto manufacturers to
employ higher viscosity stocks to meet fuel
economy requirements on new models. As a
result of these regulations, other lubricant
manufacturers have begun to switch over to
base II as well because of its superior performance and recent increase in availability. Historically, base I stocks have been
significantly cheaper than Base II & III stocks because refining or “cracking” Base I stocks is cheaper; however, as
regulations increased demand for Base II & III stocks, companies were able to switch production and offer cost
reductions due to economies of scale. Thus, the industry is coming to a tipping point in favor of Base II as customers
both directly and indirectly affected by regulation are experiencing a very cheap upgrade from suppliers.
The European base oil market is currently valued at $8.2b and is projected to grow steadily to $8.7b in 2020, however this
growth estimate is conservative as it refers in part to historical market data affected by the Eurozone crisis, when
spending and consumer confidence had bottomed out. Through the first 3 quarters of 2015, new car registrations in
Europe totaled 12.57 million, up 3.1% YoY, with double-digit growth in Spain and Italy, where Cash for Clunkers-esque
programs were implemented in order to aid the shift to more fuel-efficient vehicles. Going forward, more regulation on
auto emissions can be expected from progressive European governments, which will drive demand for newer models and
thus demand for cleaner Group II base oils. With approval for the hydrocracker expansion expected early in 2016 and full
capacity to be realized by 2018, Exxon is well-positioned to exploit the market trend towards Group II stocks because of
its well-established European network and CapEx ability. Key competitor RDS was recently forced out of the European
base oils market and is completing termination of its base oils operation in its Pernis refinery in The Netherlands. An
NLGI report states “[Shell] said that the unit — which produces lubricant feedstock and waxes — is no longer efficient
enough to compete… The announcement marks another closure in what is expected to be a string of refinery
rationalizations in Europe as its older base oil units struggle to compete with newer high quality production in the
Mideast Gulf, Asia and the US.” Exxon has consistently been ahead of the curve, completing major projects in 2015 to
ramp up base oil production capacity in its Baytown, Texas and Singapore. Its proprietary hydrocracking technology has
proven to offer cost efficiencies in the more time and chemical intensive cracking of Group II base stocks as compared to
Group I base stocks. The Rotterdam project is projected to increase hydrocracking capacity by 40% to 70,000 bpd in
order to meet the growing European demand. Our sector sees this strategic move as a catalyst that will help sustain the
long-term diversified income growth in downstream operations which has proven to be a fundamental driver of the
company in a volatile energy environment. Management has been successful in growing downstream net income from
$3.05b in FY 2014 to $6.55b in FY 2015 by taking on profitable projects both domestically and overseas. The expansion
of the hydrocracking capacity in Exxon’s Rotterdam refinery will further broaden the firm’s production portfolio and
offer a third strategic foothold in the growing, high margin base oils market.
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Growing Synthetic Oil Demand in Developing Economies
Exxon’s downstream segment produces, among many other products,
premium synthetic motor oil. Synthetic motor oils get their name from
the synthetic crude, as opposed to conventional crude, that is used to
produce them. Synthetic crude is created through refining and distillation
processes of conventional crude, ultimately making synthetic crude more
pure and of much higher quality than conventional crude. This results in
synthetic crude by-products, such as premium synthetic motor oils,
working much better with modern-day car engines. Synthetic motor oil
flows easily through car engines no matter the temperature; synthetic
motor oil leaves car engines cleaner than conventional motor oil would;
and, synthetic motor oil has a longer usage cycle than conventional motor
oil. As a result of these benefits, synthetic motor oil costs consumers
anywhere between 2-4 times the cost of conventional motor oil. Exxon produces a variety of synthetic motor oils under the Mobil 1
brand, which management defines as the company’s “flagship synthetic
engine oil.” Roughly 35 car brands are manufactured to use Mobil 1 oil
products. To grow the Mobil 1 brand, Exxon plans to expand its reach in
Asia. Exxon will do this by adding productive capacity for Mobil 1 at its
Singapore refinery through a multi-billion dollar expansion project. When
the project is completed in 2017, the Singapore facility will be the only
refinery in the Asia Pacific that produces Mobil 1, and one of six
refineries in the world that creates and distributes the product.
Introducing this product to the Asian market, Exxon will absorb a great
deal of market share in the region’s emerging markets.
Demand for premium synthetic motor oil is projected to increase
throughout the world over the next several years, predicated mainly on
the predicted consumption of emerging markets. This increased
consumption will be a result of increased motor vehicle usage and rising
industrialization in the Asia Pacific region. From 2014-2024, Asia Pacific
demand for synthetic motor oil in passenger cars is expected to rise by
eight percent. And, the worldwide synthetic lubricants market is expected
to increase in value at a 2.5% CAGR from 2016-2020, rising from $32.6
billion in value to $36 billion. This market will be driven mainly by Asia
Pacific, due to the expected high demand for automobiles in the region
for the foreseeable future. In our sector’s opinion, these aspects of
Exxon’s future cash flows have not been adequately priced in. Analysts
seem to believe that oil will rebound near the end of the year, while
fundamental indicators (i.e. supply and demand) suggest otherwise. As a
result, analysts are giving more credence to the historically higher margin
upstream segment of the Oil & Gas industry. However, our sector
disagrees with this assumption. Crude oil prices will remain compressed
throughout 2016 due to a constantly increasing glut of oil. Downstream
business models will increase in value as the year goes on, and Exxon will
benefit from this shift in sentiment due to the fact that it is committed to
growing its downstream segment through expanding its refinery business
in the world’s fastest growing economies.
ECONOMIC MOAT
Economies of Scale:
Exxon is the largest IOC in the world.
Exxon's integration model allows it to
capture economic rents along the oil and
gas value chain. Its integration of refining
and chemicals allows it to have margins
that its competitors cannot feasibly
possess. These facts, alongside Exxon’s
low cost position in the upstream
segment, give the company a distinct
competitive advantage over potential
emerging competitors.
RISKS
Commodity Prices:
All of Exxon’s products are closely
related to the price of a few commodities.
Exxon’s operations, margins, and
earnings can drastically change based on
changes to commodity prices. Factors
affecting these prices are economic
conditions, technology, weather patterns,
increase in competition from alternative
resources and a change in consumer
preferences for alternative fueled vehicles.
Government and Political Factors:
Exxon faces uncertainty in a number of
regions where a change in policy can
place resources off-limits or can limit
outside investment these restrictions tend
to increase in times of high commodity
prices. Countries with underdeveloped
legal systems increase the risk of
unpredictable action from elected officials
and can make it more difficult to enforce
contracts.
Regulatory and Litigation Risks: Exxon faces uncertainty in changes in
regulations that could increase
environmental regulations and increase
the cost of operations or mandate the use
of more alternative fuels. The adoption
of government payment transparency
could cause Exxon to violate non-
disclosure laws of other countries that
could lead to cancellations of contracts.
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POSITIVE
Well Positioned for Accretive M&A
As oil prices have plummeted, many companies in the Oil & Gas Industry have
found it difficult to remain profitable. Explorers & Producers (E&P’s) are most
directly affected, as these companies have seen the value of their end product fall
dramatically. Now that WTI and Brent crude oil trade at ~$30 a barrel, the
operations of E&P’s have become unprofitable. Assuming that oil prices remain
compressed, many E&P’s will risk defaulting on loans, and some may cut dividend
payments to stay afloat. The midstream industry has been negatively affected by the
downturn as well. Midstream companies are paid for the volume of oil and gas
products they deliver over a set period of time. When E&P’s go bankrupt, overall
production volumes will drop, leading to a huge top-line hit for midstream
companies. Thus, midstream companies are also exposed to the risk of being forced
to cut dividends. With diminished financial security and lowered dividend payouts, upstream and midstream companies
are set to lose a substantial portion of their equity market values. Meanwhile, Exxon still possesses a standout balance
sheet, with $26 billion in Cash and Short-term Receivables, and the company has consistently generated positive free cash
flow during the oil market downturn. Exxon is well-positioned for accretive acquisitions of distressed E&P’s and
midstream companies, which both fit into the company’s short-term and long-term growth strategies.
TARGET PRICE
Exxon is currently trading at an EV/EBITDA multiple of
10.16x, representing a discount of 10.91% to Exxon’s one
year historical multiple spread to its only relevant competitor,
Chevron. Using a blend of the DCF Perpetuity and Exit
Multiple approaches and the intrinsic LTM and NTM
EV/EBITDA and P/E multiples, our sector reaches a median
base case target price of $88.04. Including Exonn’s 3.66%
dividend yield, our sector predicts a target return of 13.6%.
TARGET PRICE = $88.04
Dividend Yield = 3.67%
Historical Mean Spread: 1.25
Current Mean Spread: 1.14
PEER GROUP IDENTIFICATION
Chevron Corporation (CVX): Chevron is an Integrated Oil
& Gas company with operations that span the globe. The
company derives the great majority of its revenue and net
income from its upstream and downstream segments.
Chevron explores for and produces crude oil and natural gas,
and refines oil and natural gas into a variety of products for
shipment and wholesale. Chevron is the only Integrated Oil &
Gas firm that is even remotely close to Exxon’s market
capitalization and enterprise value, and as a result, is the only
firm comparable to Exxon.
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FINANCIALS
Revenue
In FY 2015 Exxon reported sales of $268.8 billion,
representing a 34% YoY decline. Looking forward total
revenue is expected to be $218.4 billion in FY16 and
$272.2 in FY17. Revenue is expected to fall as Exxon’s
gas realization declines due to the continued weakening
of oil prices. Upstream reported revenue of $5.9 billion
in 3Q15, down 36%YoY. Revenue was down due to
lower realizations of both oil and natural gas. The
average price Exxon sold crude was for $43.43 in 3Q15
compared to $93.18 in 3Q14. On an oil-equivalent basis,
production increased 2.3% from the third quarter of
2014. Liquids production totaled 2.3 million barrels per
day, up 266,000 barrels per day. The average worldwide price for natural gas in 3Q2015 was $5.12 mmbtu compared to
$6.68 mmbtu during 3Q14. Natural gas production was 9.5 billion cubic feet per day, down 1.1 billion cubic feet per day
from 2014 due to regulatory restrictions in the Netherlands and field decline, partly offset by project volumes.
Downstream reported revenue of $47 billion in 3Q15, down 39% YoY. This decline was due to depreciation in price
despite an increase in volume of Petroleum products that include gasolines, heating oils, and aviation fuels. The chemical
segment also saw a decline of 30% due to decreasing sale prices despite increased volume.
Net Income
During FY15 Exxon reported a net income of $16.4 billion, down 50% from FY14’s $32.2 billion. This is due to the
decline price of commodities that affected the upstream segment and was partially offset by an increase in margins from
the downstream and chemical segments. While this may seem alarming, it still has managed to do better than it’s
competitor Chevron, whose net income declined 66% during the same time. This is due to Exxon having less exposure
to upstream as it drills, refines and creates chemicals whereas Chevron just drills and refines. This gives Exxon a natural
hedge against lower commodity prices due to the increases margins for their downstream and chemical segments. Since
the decline of oil prices, the upstream segment now makes up a much smaller percentage of net income than it had in
prior years.
Upstream earnings were $7.1 billion, down $20.4 billion from 2014. Lower realizations decreased earnings by $18.8
billion. Favorable volume and mix effects increased earnings by $810 million, including contributions from new
developments. The decrease in oil has caused upstream to only represent 39% of net income compared to its peak of 81%
during FY09. These decreases will likely continue if oil prices continue to decline as they cannot change their fixed cost
as quickly as oil is declining. The decline of oil has shown that Exxon is much more efficient at drilling for oil as
Chevron has posted a net loss of $2 billion in their upstream segment. This is due to Exxon’s management being
effective at managing their assets in order to protect profits
Downstream earnings of $6.6 billion increased by $3.5 billion from FY14.Stronger margins increased earnings by $4.1
billion, while volume and mix effects decreased earnings by $200 million. Other impacts on earnings were higher
maintenance expenses as well as unfavorable inventory that also affected earnings by $420 million. Going forward our
sector sees Exxon continuing to increase the segments impact on earnings as it invests in its infrastructure in both
Europe and Asia taking advantage of strong macro trends. Both the Rotterdam and Pacific Asia downstream expansions
are expected to expand margins as Exxon broadens its exposure in the base and synthetic oils markets, respectively.
Chemical earnings of $4.4 billion increased $103 million from 2014. Stronger margins increased earnings by $590 million.
Favorable volume and mix effects increased earnings by $220 million. All other items decreased earnings by $710 million,
reflecting unfavorable foreign exchange, tax and inventory effects.
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Margins
Through the first three quarters of 2015, EBITDA margin was 13.8% representing a slight compression from 14.1% for
FY2014. Favorable spreads expanded margins in Exxon’s downstream segment while sluggish crude prices compressed
upstream margins. In the chemical space, net margin expanded from 11.3% to 16.1% due to strong refining margins and
a favorable product mix. Going forward, management expects upstream margins to stay compressed due to low oil
prices throughout 2016 while downstream and chemical margins remain relatively in line with 2015 on a full year basis.
Specifically, favorable crack spreads going into the summer months will benefit Exxon’s downstream profitability.
Earnings
Exxon has beaten earnings 10 out of the last 12 quarters with an average beat of 7.2%. During this time the largest
positive surprise was in Q1 2015 with a surprise of 41% and the largest miss was during Q2 2013 missing by 18%. Most
recently the company beat Q4 revenue by $8.4b, reporting $59.8b (-31.5% YoY), and also beat EPS by $.03, reporting
$.67 (-57% YoY). These declines were caused by falling commodity prices affecting Upstream but were partially offset
by higher margins and an increase in volume in the refining segment. Oil-equivalent production increased 4.8% from the
fourth quarter of 2014, with liquids up 14% and natural gas down 5.6%. Despite the beat, they were trading down 2%
premarket as WTI crude oil prices below $31/bbl posed headwinds for the broader energy sector. Looking forward,
analyst estimates are projecting earnings to decline another 37% Q/Q then finally start to increase as many expect oil
prices to finally rise in the second half of the year. Our sector views these estimates as too bearish; Exxon has been able
to prove that it is effective at managing its assets in order to yield superior gains to its competitors throughout FY 2015.
Cash Flow
Because of falling profitability in upstream operations, Exxon’s operating cash flow fell 32.8% to $30.3b in FY2015. Free
cash flow, however, rose 8% to $12.1b over the same period as CapEx was reigned in and adapted to the low crude price
environment in the second half of the year. Exxon will c
ontinue to strengthen its FCF by postponing lower margin projects and focusing spending increasingly on the more
profitable refining enhancements. Management’s goal of $7b in additional CapEx reduction for 2016 and suspension of
its stock buyback program communicate that the firm will be selective in pursuing projects while focusing more on
paying off the $14.5b in debt principal due between 2016 and 2020. FY2015 FCF of $12.1b stands at 66.4% of principal
outstanding and analysts estimate $18.5b in additional aggregate FCF through 2017, compared to CVX estimates of only
$1.5b in the same period. While Exxon’s OCF has taken a significant hit in 2015, our sector sees long term growth as the
oil market moves back towards equilibrium as well as short-term upside as a result of effective cash management.
Capital Expenditures
Decreased CapEx is an industry-wide trend being broadly adopted, as projects are being reevaluated with lower crude oil
prices worked into calculations. FY 2015 CapEx totaled $31b which represented a 19% decrease YoY and $3b under
guidance. Management guided $23.2b in CapEx for FY 2016, another YoY cut of 25.4%, remarking that it is committed
to maintaining flexibility in a “soft business climate”. Upstream CapEx was the heaviest spending area at $25.4b in
FY2015 due to the capital intensive nature of upstream operations. Downstream expenditures totaled $2.6b and
chemical CapEx totaled $2.8b in the same period, representing 8.4% and 9% of FY2015 CapEx, respectively. While
Exxon continues to invest the vast majority of capital into upstream assets in order to make the most of the dismal
situation in that segment, the firm has begun a notable shift in CapEx towards downstream and chemical operations.
Upstream CapEx represented 92.4% of total expenditures in 2013, 85.1% in 2014, and has since fallen to 82.4%. Our
sector views this strategic shift as a positive moving forward, as crude prices will likely stay in the $30-$40 range
throughout the rest of the year and into 2017. Exxon’s increased investment in higher margin refining capacity will
continue to drive profitability in 2016.
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Shareholder Returns
Exxon has consistently rewarded its shareholders by raising its dividends for over 25 years. The company currently has a
dividend of $.73 and plans to raise that to $.76 in 1Q 2016. The dividend currently yields 3.66% which compares to
Chevron at 5.05%. It is important to note that Exxon as of the last filing has a higher dividend than EPS. Despite this,
our sector does not believe that a dividend cut is likely, as the company has a strong balance sheet and superior credit
rating that will allow them to maintain it past or investment horizon. Exxon has recently announced that they will only
buy back shares to offset dilution as opposed to in the past when they were known for large repurchase programs. This
announcement is in reaction to recent financial performance caused by declining commodity prices.
Debt
Exxon currently has a total debt of $18.2 billion, with an annual interest expense of $319m. Exxon has a debt to equity
ratio of 19.4%, which compares to Chevron’s 23%. They also have a current ratio of 1.5, quick ratio of 1.02, and cash
ratio of .08. In March of 2015, Exxon made a major debt offering, issuing $8b in bonds to use the proceeds for general
corporate purposes, including acquisitions, capital expenditures and refinancing. Exxon has a credit rating of AAA from
Standards & Poor’s allowing it to borrow for less than any of its competitors.
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VALUATION
Undervaluation
Exxon is currently trading at a 10.91% discount to its one year historical average EV/EBITDA spread to Chevron, the
company’s only relevant competitor. Exxon began to consistently trade at a noticeable discount to its one year average
historical spread after both companies reported Q3 2015 earnings results. While Exxon beat analysts’ earnings estimates
by a sizable 14.0%, Chevron exceeded earnings estimates by posting a sizable beat of 43.8%. As the broader oil market
continued to sell off during this time period, analysts assumed that Chevron was well prepared for a downturn in the oil
market. This was because of Chevron’s large investments in expanding its upstream segment, leading analysts to believe
that the company would recover handsomely once oil prices readjusted and picked back up in 2016. However, in its Q4
2015 results, Chevron disclosed a $588 million loss in Q4 2015, missing analysts’ estimates by a hefty 42.25%.
Meanwhile, Exxon once beat Q4 2015 earnings estimates by 5.02%. Furthermore, there are no fundamental reasons to
believe that the price of oil will rise in 2016, and it is likely that the commodity has yet to reach a bottom in price.
Nonetheless, analysts have not recognized Exxon’s superior future earnings and margins prospects relative to those of
Chevron, and they believe an oil price recovery to be imminent. Recognizing these oversights, our sector observes
Exxon to be fundamentally undervalued. And lastly, quantitatively speaking, Exxon possess far more attractive figures,
metrics and ratios than Chevron, as is displayed in the comp table below.
DCF Assumptions - John
To reflect the volatility currently surrounding the oil markets, our sector predicts Exxon’s revenue to fall by 5.5% in
2016, only to increase by 5%-10% each year thereafter. All growth rate and margin assumptions have been kept
consistent for 2016e-2020e, using either the most recent value or an average of the most recent values as the underlying
assumption. Balance sheet assumptions are meant to represent recent trends in asset and liability allocation over the past
two years. From 2016e-2018e, capital expenditures as a percent of revenue represent management’s 2016 CapEx
guidance. In 2019e and 2020e, capital expenditures increase in what our sector believes will be a more profitable oil
market. Due to the oil market’s recent volatility, our sector believes Exxon will have to draw down debt to fund its
business operations, to which it will pay a slightly higher than usual interest rate (3%) because of the general financial
instability of the current business climate. Lastly, our sector predicts that Exxon will continue to pay out dividends to its
shareholders at a consistent rate, as the company has suspended its share buyback program.
WACC Calculation - John
The WACC of 8.39% was calculated using the weights of Exxon’s current market value of equity and the company’s net
debt, 95.5% and 4.5%, respectively. The cost of equity was calculated with the CAPM formula to be 8.7%, using 1.9% as
the risk-free rate, 6.62% as the market risk premium, and 1.03 as the company’s beta relative to the SPX. Cost of debt
was calculated as 1.9% by multiplying Exxon’s weighted average interest rate from 2015-2020e, 2.9%, to the company’s
effective tax rate, 33.9%.
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APPENDIX
Exhibit I: XOM, CVX, & CL1 Price Chart
Exhibit II: XOM to CVX 1-year Price Regression
Exhibit III: XOM to CL1 1-year Price Regression
Exhibit IV: XOM to CL1 10-year Price Regression
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DISCLAIMER
This report is prepared strictly for educational purposes and should not be used as an actual investment guide.
The forward looking statements contained within are simply the author’s opinions. The writer does not own any
Exxon Mobil Corp. stock.
TUIA STATEMENT
Established in honor of Professor William C. Dunkelberg, former Dean of the Fox School of Business, for his
tireless dedication to educating students in “real-world” principles of economics and business, the William C.
Dunkelberg (WCD) Owl Fund will ensure that future generations of students have exposure to a challenging,
practical learning experience. Managed by Fox School of Business graduate and undergraduate students with
oversight from its Board of Directors, the WCD Owl Fund’s goals are threefold:
Provide students with hands-on investment management experience
Enable students to work in a team-based setting in consultation with investment professionals.
Connect student participants with nationally recognized money managers and financial institutions
Earnings from the fund will be reinvested net of fund expenses, which are primarily trading and auditing costs
and partial scholarships for student participants.
