Dividend Aristocrats In Focus Part 27: Energy Titan ExxonMobil

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Oct 24, 2014
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In part 27 of the 54-part Dividend Aristocrats In Focus series, I take a look at the competitive advantage and future growth prospects of ExxonMobil (XOM, Financial). ExxonMobil is the largest publicly traded oil and gas company in the world with a market capitalization of $397 billion. It is the second largest publicly traded company overall, behind only Apple (AAPL, Financial). ExxonMobil is the successor to Rockefeller’s Standard Oil, one of the most successful businesses in history before it was split apart. The company has a long history of success, and has increased its dividend payments for 32 consecutive years. ExxonMobil’s business is analyzed below to show how it generates its revenue and profits.

Business Overview

ExxonMobil divides its operations into three operating segments: upstream, downstream, and chemical. The upstream segment is involved in exploration and production of oil and natural gas. The downstream segment is involved in refining, purifying, and distributing oil and natural gas. Finally, the chemical segment manufactures and markets various chemicals for the company. ExxonMobil’s percentage of earnings by segment for the first half of 2014 is broken down below:

  • Upstream: 82% of income
  • Downstream: 8% of income
  • Chemical: 10% of income

The vast majority of ExxonMobil’s earnings and value as a business come from its highly lucrative upstream oil operations. The company has long maintained high margins and a strong competitive advantage in its upstream segment.

Competitive Advantage

ExxonMobil’s competitive advantage comes from its massive size and ability to be involved with the largest oil and gas projects. The company can also better diversify its oil and gas plays due to the size of the company. If one play does not work out as expected, overall company risk is minimized through diversification. ExxonMobil's scale cannot be overstated. The company is the leader in the oil and gas industry.

The oil and gas industry has long held close ties to the U.S. government. ExxonMobil spent over $13 million last year lobbying the government. Thirty-three out of the company’s 50 lobbyists are ex-government employees; ExxonMobil uses its strong earnings to reward ex-government employees with jobs. It makes a great deal of sense for ExxonMobil to focus on government policy. The company is significantly affected by both U.S. foreign policy and environmental laws. Overall, ExxonMobil hopes to gain better legislation through its lobbying efforts.

Growth Prospects

ExxonMobil has done an excellent job of replacing proven reserves. The company has a 10-year reserve replacement rate of 120%; it is replacing reserves at a faster rate than production. ExxonMobil’s long-term growth is tied to both the price for and demand of oil and natural gas. The company will benefit from rising GDP growth in the developing world as more middle class consumers demand cars and other oil burning devices. Long-term energy demand is slowing in the developed world as consumers continue to switch to more fuel efficient vehicles and ways of life in general. All told, ExxonMobil projects total worldwide demand for oil will grow just 0.7% per year, and natural gas will grow 1.7% per year up to 2040.

Bringing the analysis back down to the company level, ExxonMobil has several new start-up projects that will drive growth for the next decade. The picture below shows the company’s new start-up projects.

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Source: ExxonMobil 2014 Annual Meeting

ExxonMobil has managed solid growth over the last decade, with revenue per share growing at over 6% per year. The company boosts its growth through share repurchases. The company has reduced its share count by about 4% per year on average over the last decade. ExxonMobil generates massive cash flows which it uses to repurchase shares and pay dividends. Aside from share repurchases, revenues have grown at only about 2% per year over the last decade. The company has room to grow quicker this decade thanks to the multitude of new projects it has coming up.

Dividend Analysis

ExxonMobil has a current dividend yield of about 3%. The company has grown its dividend payments at 9.8% per year over the last decade, while EPS have grown at about 7.5% over the same time period. The company currently has a payout ratio of about 35%, and shows no signs of increasing it in the future. As it stands, shareholders can expect dividend growth in line with overall company growth. A safe bet is to expect dividend growth of about 6% per year, which is the company’s long-term revenue per share growth rate. If ExxonMobil grows its dividend payments at 6% per year, it will have the yield on cost shown below over the following various time frames:

  • Current yield: 3%
  • Yield on cost in 3 years: 3.6%
  • Yield on cost in 5 years: 4.0%
  • Yield on cost in 10 years: 5.4%

Valuation

ExxonMobil is near the lower bound of its historical PE 10 (also known as Shiller PE) ratio. The PE 10 ratio is appropriate to use for ExxonMobil because its earnings are relatively volatile due to their dependence on the price of oil. Taking average earnings over 10 years smooths this volatility and gives a clearer picture of valuation. ExxonMobil’s PE 10 ratio is near levels not seen since the market bottom in March 2009. The company appears significantly undervalued based on this metric.

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Source: YCharts

ExxonMobil has historically traded at a significant discount to the overall market. Over the last decade, ExxonMobil has traded at about 0.65x of the S&P 500’s PE ratio. This large discount implies the company should have a current PE ratio of about 11.7. The company currently has a PE ratio of 11.9, in line with its long-term averages relative to the overall market. Despite this, I believe ExxonMobil to be undervalued due to its PE ratio. At the least, the company is fairly valued.

Recession Performance

ExxonMobil is reliant on the price of oil. When oil prices fall, so do ExxonMobil’s earnings. The company saw earnings fall through the Great Recession of 2007 to 2009 as oil prices dropped substantially. The company’s EPS from 2007 to 2010 are shown below to document the effects of the Great Recession of 2007 to 2009 on the company.

  • 2007 EPS of $7.28
  • 2008 EPS of $8.69
  • 2009 EPS of $3.98
  • 2010 EPS of $6.22

ExxonMobil did not experience negative earnings, but earnings per share did fall by over 50% during the worst of the most recent recession. A prolonged recession would affect the profitability of the company in the short run, but not its long-term growth prospects.

Final Thoughts

ExxonMobil is the industry leader in oil and gas. The company offers shareholders a CAGR of 9-11% from dividends (3%), share repurchase (4%), and organic business growth (2% to 4%). ExxonMobil ranks as a Top 10 stock based on the 8 Rules of Dividend Investing due to its high yield of 3%, low payout ratio of about 35%, better than average revenue per share growth rate over 6%, and relatively low price standard deviation of 25%. Further, the company appears undervalued. ExxonMobil is a good buy for dividend growth-oriented investors looking for market-leading exposure to the oil and gas industry.