Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Last week we discussed why we considered the energy sector one of our top three sector picks for 2021. We also added America’s largest oil company, Exxon Mobil (XOM), to our ‘Granny Shots‘ portfolio. We wanted to focus on a single-stock idea this week from the sector we recommended last week. We believe energy will significantly outperform consensus expectations. Thus, it should be no surprise that we think a massive oil major with the unique advantages and assets that Exxon has, in addition to a high dividend, should do very well if our thesis about the energy sector is correct. Look what happened when the VIX had its biggest three-day collapse ever; energy led the way. That should give you an idea of how it will perform when the market feels the all-clear is given to get ‘risk-on’ when the virus is vanquished.

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Exxon beat on earnings earlier this week and narrowly missed revenue. Nobody likes to see a $19 billion write-down but items like these often mark the bottom of a bad period. In Exxon’s case, the impairment reflects a change in strategy that we believe significantly benefits shareholders, a new hyper-focus on low-cost, high margin capital expenditure projects that should generate a lot of free-cashflow within years, not a decade or more.

 We think that several powerful cyclical forces are moving in Exxon’s and the price of oil’s favor. We also believe there is a possibility that a commodities super-cycle is starting. If it is, one thing is clear from the ground-up changes XOM made during the depths of this pandemic-induced crisis; if oil prices are at their current levels or higher in the coming quarters, Exxon shareholders will be substantially rewarded. We see ample evidence that oil and natural gas demand and thus prices will move upward. Our data team compared recent gains in energy with past bull markets and this is what they found.

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Source: Bloomberg, FAMA, and Fundstrat

Why We Think Exxon Is a Granny Shot

We have added Exxon Mobile to our ‘Granny Shots’ portfolio because its periods of outperformance are correlated with the type of PMI-recovery activity that we are currently seeing, and we believe the company’s valuation is historically low and will revert to the mean, meaning it comports with our Style Tilt toward Value/Cyclical stocks.  The fact that the company has a reasonable path to defending its very attractive 7% plus dividend should support the stock’s price from a demand perspective. However, the core feature of our thesis is increasing demand for the company’s products. Sometimes a stock goes up not because it has a flashy new management team or is involved in shiny new industries featured in SPACs. Sometimes a company does well simply because of what it has, what it can do, and how much people need it.  We elaborated on how the institutional Fear of Missing Out (FOMO) could further bolster our thesis last week.

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Source: Company Reports, Q4

Exxon Mobil’s post-COVID-19 market-cap of around $200 bn is deceivingly low, particularly in a world where Game Stop briefly became a Fortune 500 company. The sheer scale of the amount of assets, the number of places they are in, and the number of people involved directly and indirectly with this company’s value chain is incomprehensible. A simple fact of the cyclical energy business is that revenues increase when prices do. So does the value of this behemoth’s tremendous assets, including the largest proven oil and natural gas reserves in the world. Exxon has an edge over competitors in the more environmentally friendly natural gas business as well.

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings
Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Source: SeekingAlpha

As you can see, current valuation levels are low and imply that the stock is a bargain. We will show you how powerful an upside surprise could be below. We think a fairer valuation for XOM would be the levels of around five to seven years ago. We think it will revert to those levels in coming quarters.  We’ve also confirmed that XOM is in a technical uptrend.

Exxon’s Coronavirus Remodel

 Most folks who are not acquainted with the oil and gas industry don’t realize that the Upstream segment is a tiny portion of revenues for the oil majors, despite being the more externally visible and politically charged side of the business.  Exxon Mobil has the upper hand over all its competitors in the quality and profitability of its upstream projects.

While Capex has been slashed dramatically at the firm, the per capita levels do not match rivals. Exxon has used this crisis to focus its Capex on the lowest cost and highest margin projects. The drop-off in CAPEX across the industry could very well result in diminishing supply that is felt across the market. In this future price environment, Exxon will thrive in all business segments and will likely be able to grow its market-share, and maybe margins, within downstream and chemicals. The firm estimates that by 2025 nearly half of its free-cash-flow will be derived from these newer projects.

 By far, the downstream segment is the most significant portion of Exxon’s revenues and where the opportunity for future margin expansion and growth lay. Exxon has made significant improvements in this area that were accelerated by the crisis. We think things will improve from here. The action taken to steer the ship during this unprecedented down cycle will likely result in significantly higher than consensus profitability. Exxon has invested heavily in its already superior refining capacity; which should boost long-term margins. This will be supported by an anomalously robust post-pandemic boom likely accompanied by a significant price appreciation in commodities. Look at the effect even seemingly insignificant increases in downstream margins have on the implied share price.

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Source: Trefis

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Source: Trefis

For a company whose primary business, at the operational level, uses highly complex machinery and processes to undertake some of the most logistically impressive tasks achieved by human beings on Earth, our bull case is surprisingly simple. We think the reflationary forces and pent-up demand means that risks to Exxon, which are very clearly laid in terms of the underlying price of commodities is clearly to the upside. We focused on some evidence of accelerating growth of GDP to support this in our article on energy last week.

The energy business is increasingly cyclical, established larger players like Exxon have a significant advantage in an uptrend, and most importantly, Exxon has taken some very hardline cuts both in labor and capital expenditures that will not only increase EPS potential but will also boost margins since the firm has scrapped all upstream projects that are not highly profitable and insulated against low prices.

While the free cash flow has suffered in past quarters because of this, enough so that the dividend was not able to be covered out of it, the cyclical upswing, reflationary forces, and the cuts and innovation necessary to survive the worst downturn in memory should make this ‘dinosaur’ more Jurassic Park and less museum fossil (think of a cyclically empowered T-Rex chasing the bears away). We understand the secular challenges facing energy, and we also know that it is a late-stage industry. We also cannot find any plausible scenario in which peak oil is not in the future; fossil fuels will still be the lifeblood of important economic activity for decades.

Why Exxon Mobil (XOM) Is Still a Buy Despite Mixed Earnings

Source: Energy Information Administration

Risks and Where We Could Be Wrong

The primary risk to the positive future we see for Exxon Mobil’s share price is any interruption of the timeline on vaccinations and the path toward a full-recovery from COVID-19. The recent announcement by the Biden Administration that new strains are virulent and might potentially evade the immune response and current vaccines highlights how stark and serious this risk could be. Our positive forecast for Exxon Mobil is contingent upon a significant demand recovery occurring with economic normalization. Any unforeseen variable that delays this reality will result in lower periods of demand for oil and should undermine the price of the commodity.

Political risk is deemed by us to be relatively low. However, if the pro-environmental forces are able to drive a more aggressive regulatory approach, then that would also mitigate the stock’s upside.

Prior “Signals”

    
DateTopicSubject / TickerThe Signal
01/28/21SectorEnergy GICS-1 (XLE)If You Like TSLA’s 2020 Performance, Try The Energy Sector
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11/05/20StockIngalls & SnyderDespite Gyrating Markets,  This Manager Returned 40% in ‘19
10/21/20Stock10-K Filings Part 3Other Voices: Why Reading 10-K Filings Is Crucial; Part 3
8/19/20Stock10-K Filings Part 2Other Voices: Why Reading 10-K Filings Is Crucial; Part 2
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7/29/20StockWeight Watchers (WW)Weight Watchers Can Continue to Outperform Post COVID-19
7/22/20StockXilinx (XLNX)If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs
7/15/20StockMarket ConcentrationNarrow Mkt Rally Fuels Worry; We Expect Cyclicals To Join
7/8/20StockSEC FilingsOther Voices: Why Reading 10-K Filings Is Crucial; Part 1
7/1/20StockSimply Good Foods (SMPL)Post-COVID-19, Simply Good Foods Stock Looks Appetizing
6/24/20StockLam Research, Applied MaterialsLam Research, Applied Materials Set to Reap IoT Harvest
6/17/20StockNordic Semiconductor (Nod.NO)Continued IoT Growth Good News for Nordic Semiconductor
6/10/20StockHelmerich & Payne (HP)Helmerich & Payne Stock Could Energize Your Portfolio

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