Exxon Mobil: The Powerhouse Poised to Dominate

Recommendation: Buy

Implied Return: 12 - 20 %

Market Cap- 375.74B

Current Price- 89.92

Summary

Exxon has weathered the effects of the business cycle to surprise the street with its

dominance in revenue generation and its ability to diversify its core operations.

The balance portfolio in Upstream, Downstream and Chemical operations has shown

its promising result Q1 of 2014. Chemical operation was the star, growing

substantially and offsetting declines in Upstream and Downstream volumes.

Exxon has allocated capital intelligently, with projects with high NPV lined up and

paving the path for a promising future.

Asia remains a market with potential that needs to be served.

Price stabilization to occur soon in the crude oil market. Exxon business model allows

it to remain profitable, even in a low oil price environment.

Company Profile

ExxonMobil is one of the world’s largest publicly-traded oil and gas companies. Its global

functional business consists of Upstream, Downstream and Chemical operations. As of

September 30th, 2014, the corporation had a resource base of nearly 91 billion oil-equivalent

barrels, world’s largest integrated refiner and lube base stock manufacturer and the highest

return chemical company amongst peers. Exxon has held the title of being the world’s largest

refiner and one of the world’s largest manufacturers of commodity and specialty chemicals.

Its chemical business consists of manufacturing and marketing of commodity petrochemicals,

(including olefins, aromatics, polyethylene, polypropylene plastics, and specialty products)

and transports and sells crude oil, natural gas, and petroleum products. In addition, the

company has interests in electric power generation facilities. It operates in the United States,

Canada, South America, Europe, Africa, Asia, and Australia/Oceania. Exxon Mobil Corporation

was founded in 1870 and is headquartered in Irving, Texas.

Industry Rating Neutral, Stock Rating – Outperform

Sector Forecast- Oil prices have dropped by more than 50% since June, 2015 with the high at

$115 and low of $45, as seen in January. Volatility remains an underlying component for the

energy sector with debate over whether the prices have hit a floor. Historically oil prices have

known to move in cyclical highs and lows, but it is my personal opinion that we have hit a new

cycle with eminent new highs and lows, making it important to reconsider this component

before I move to the valuation part. The falling of oil prices reflects the increase in supply,

while demand remains relatively low. In addition to price, inventory levels are also to be

considered. Hence, in our evaluation, we will consider a base case of $58/bbl. for 2015 and

$80/bbl. in 2016.

With an industry revenue of 1.28 trillion in the exploration and production sector, US

producers will continue to drill with oil prices being on the low side. On the flip side, OPEC

members may cut production in order to keep prices at its intrinsic original. Pipelines that are

slowly coming into scrutiny may leave the challenge of getting fuel to the market to Oil Giants.

Oil exporting nations like Russia are facing the heat with the falling prices and the US sanctions

don’t help its case. But amidst this volatility, or rather turmoil, the visibility for earnings makes

the energy sector a neutral sector. The correction in supply matches with real world demand

(which we predict to increase), along with either OPEC cutting supplies or companies reducing

on capex in production. Another factor that may lead to higher prices is the depletion of low

cost reserves. The challenge lies for oil giants to make new discoveries of oil. Evident short

term volatility is overshadowed by the future struggle to create higher supply. Currently,

reviewing IEA data (https://www.iea.org/oilmarketreport/omrpublic/), we see that global

supplies have fallen by 235 kb/d in January for both Optec and Non Open productions.

1) Crude Oil Production– Production will increase to 9.52 million barrels a day in 2016 and

currently it will trend at about 9.30 barrels in 2015. Similar trends for Dry Natural Gas

Production and Coal production are predicted.

2) Energy Consumption- Taking into account the different mediums of energy including but

not limited to renewables, coal, electricity etc. demand for 2015 in Quadrillion units is

97.90 and 98.76 in 2016.

3) Crude Oil Prices – 1) West Texas Intermediate Spot Average which is commonly referred

to as oil in the western world. This commodity is the underlying commodity of oil futures

contract. Prices will start from 55.02 in 2015 and will hit 72 in 2016. 2) Imported Average

– ranges from 51.57 to 67.53 in 2016.

4) Liquid Fuels (Refiner Prices for Resale, Refiner prices to End Users, Retail Prices), Natural

Gas and Electricity will be priced lower than it was in 2014 but there is solid economic

reason to believe that towards q4 of 2015 and q1 2016, these numbers will hover at a

higher range.

Interesting to observe is the supply distribution with OECD and Non OECD countries.

World Supply is expected to increase in 2015 and then decrease in 2016. The change

in US supply will be higher than the rest of world, where it is evident that supply will

see an upward trend in the states. The dominance of OPEC countries in the supply is

significant, making events and changes there vital in oil prices.

As for consumption, the importance of emerging markets is substantial, considering

it shows the highest rate of increase in the consumption forecasts for 2015, 2016.

Key countries that are driving this are China and India.

Supply 2014 2015 2016

OECD % World Supply 27.4 27.94 26.71

US % OECD Supply 50.79 53.07 57.47

Canada % OECD Supply 15.99 15.89 17.41

Non- OECD % World Supply

72.55 72.06 72.02

OPEC % of Non OECD Supply

50.36 54.12 53.58

Total World Production

92.94 93.76 94.24

Consumption 2014 2015 2016

U.S. (50 States) 19.02 19.31 19.41

OECD 49.66 49.35 48.72

Canada 2.40 2.38 2.38

Non-OECD 50.34 50.67 51.28

China 10.67 11.00 11.34

Other Asia 11.67 11.88 12.20

Total World Consumption

92.13 93.14 94.15

Exxon Mobil Current Status and Fourth Quarter Recap

Fourth Quarter 2014 Recap

Exxon Mobil surprised the market with its 4th quarter earnings report. It reported full year

earnings of $32.5 billion with fourth quarter earnings of $6.6 billion. Promising numbers were

the increase in free cash flow of $18 billion, an increase of $7.3 billion from 2013. It completed

eight major upstream projects in 2014, which is remarkable considering the down cycle of the

industry. Jeff Woodbury stated that these results are attributable to Exxon’s integrated

business model. The effects of global economic growth despite deceleration in China, Europe

and Japan proved beneficial even in the commodity price cycle. Chemical speciality product

margins improvement show the upside of lower crude oil prices with rising spreads and lower

feed.

‘Upstream earnings fell

because of lower crude oil

prices but notably, favourable

sales mix effects increased

earnings $400 million, driven

by a higher margin production

growth from the U.S. and major

projects in Canada, Angola and

Papua New Guinea.’

Promising future. Demand is

growing at a decreasing pace. This is

expected because of growth in

emerging markets, US consumer

spending to increase and general

population demands. Infrastructure

projects will be a contributor to this

demand.

Volumes were largely affected by the Abu Dhabi concession, but liquid productions were up

owing to new projects. Key takeaway from upstream operations is that earning decreased

compared to 2013Q4 and volume and mix effects improved earnings by $140 Million,

reflecting higher margin on volume growth. The volume increased for liquid productions

especially because of seasonal demands from Europe.

Downstream Earnings were down 419 million from a year ago, but over the quarter earning

increased by $40 million owing to effective marketing and non-US refining margins. Higher

maintenance activities and unfavourable tax effects were partially offset by forex.

‘The star for Exxon was the chemical earnings, which were higher by 320 million owing to

higher non-U.S. product margins on lower feed costs. Volume and mix effects decreased

earnings by $60 million and all other items primarily unfavourable foreign exchange effects

reduced earnings by $110 million.

Sequentially chemical earnings were essentially flat as stronger specialty product margins

were offset by volume and mix effects and increased maintenance activities’

The increase in FCF shows ExxonMobil’s resiliency and ability to deliver to shareholders. The

flexible capital allocation program of buybacks pace is narrowly determined by market cycle

but broadly factored by capex requirements, dividend requirements and long term business

cycles. Even though share buybacks have been cut, it is much less than expected and less

than peers. Exxon’s primary source of financing is operating cash flows and this being in a

healthy state shows that steering into the future is a possibility.

Pricing- Under Priced, Buy Recommendation

Throughout the valuation process, it is vital to realize how the value of a company such as

Exxon Mobil depends on the state of the economy and the price of oil. These two components

have known to move in a cycle, making recent earnings an unstable basis for future

predictions. The quality of a business, therefore, may be judged by how well it does when

conditions out of its control are at their worst. Investors haven’t realized the full potential of

Exxon’s drilling activity in Romania and Argentina. We will discuss Exxon’s growth potential

further along in this article. The street hasn’t taken into account a lot of opportunities that

Exxon currently has outside exploration and production. Exxon has a lot of potential in its

chemical business, with the use of cheaper oil to make other products. The company’s global

downstream chemical segment plays a huge part for Exxon in adding to revenues and helping

to hedge energy pricing to some degree. Refining and production costs are likely to fall as

drilling operations see a slowdown. This is seen in our macro-analysis: rig operator and other

companies that work with Exxon will start charging less. There is a possible overreaction to

the oil prices, where a lot of analysts believe that the bottom has not been hit. It is worthy to

note that Exxon has one strong balance sheet and low per-barrel breakeven price level. Lower

prices could potentially mean more business exiting or consolidation, which Exxon can

definitely leverage on, owing to their funding capabilities and low cost of borrowing.

ExxonMobil’s long-term growth outlook is favourable due to the expected demand increases

in energy over the next several decades. The company will likely grow earnings per share

faster than overall energy demand for three primary reasons. First, as demand increases

globally, it is likely that the long term average price of oil will rise. This will cause Exxon’s

operations to become even more profitable than they are today. Secondly, ExxonMobil can

grow faster than overall energy demand by gaining market share in the highly competitive

oil and gas industry. ExxonMobil is currently the largest publicly traded oil and gas company

in the world, and has a history of outperforming its peers due to its incredibly efficient and

disciplined upstream operation. Finally, ExxonMobil will likely see more efficiency gains

resulting in higher long-term average profit margins as technology continues to improve.

Why Exxon?

Performance

The highlights from 2014Q1 show that Exxon has delivered its full year production,

maintained capital allocation, improved production mix and profitability, increased vital free

cash flow and maintained robust shareholder distributions. It has performed better than the

Index and its competitors over the last 5 years and is poised to continue to do so. Investors

should expect the stock price to hang around the high 80’s because the market stabilizes.

2014Q1 showed solid financial performance.

Long View for LNG Projects

Gas demand is subject to an increase in the coming years, with LNG being a core component

of Exxon’s portfolio. In order to make sure that they meet the demand, Exxon has already

established projects around the world, even though these projects are capital intensive. The

flexibility Exxon has gained with its mostly long term contracts when it comes to LNG means

that they have the potential to divert cargos. This boost in LNG projects could lead to

increases in margin generation. The $19 billion development in Papua New Guinea will

produce 6.9 million tons per annum of LNG for shipment to international markets as well as

domestic sales. The key here is that the design of such facilities is world class, such that it

helps Exxon maintain good relationships with the host governments, communities and

partners and ultimately help them continue growth more smoothly. The use of Exxon’s

market capabilities and project execution should excite its shareholders, thus showing the

dominance of Exxon when it comes to expansion and success.

Dividend, Pay-outs and Growth Rates

It is remarkable that for 25 years and more, Exxon dividends have steadily grown giving a

value and long term growth potential which it has had for more than 30 years. It has stalled

recently because of its lower valuation but the trend has always been upwards. The dividend

yield analyzed over the years is a good indicator of how the company is doing, and the

resistance it has to the cyclical effects of the commodity markets. Also, statiscally stocks with

higher dividend yields have consistently lower dividend yield stocks for more than 75 years.

Further, Exxon’s payout ratio is 24.6% of its earnings, showing that there is room for company

growth in the next few years. High Yielding low payout stocks have the statistical advantage

of doing better, which further solidifies any position in Exxon. Out of all its peers, it has the

lowest standard deviation for fluctuations, especially considering it is in the commodity

business. The resilience and low susceptibility to oil prices is something investors have

ignored.

Opportunities

The success of the Exxon exploration program is a result of capital allocation in projects with high

net present value. Recently, the offshores of Romania have begun to be targeted and

Argentina also has seen two successfully horizontal wells. In 2015 Exxon is using these wells

in Vaca Muerta for testing. There is also the addition of high acreage to their exploration

and their 17 years of success with Hibernia, an oil field in the North Atlantic Ocean. The

blocks acquired offshore Newfoundland are proven oil equivalency hydrocarbon basins with

recent industry discoveries, as stated by Jeff Woodbury, VP.

The well-developed disciplined capital allocation has not only increased the areas of

exploration but has increased unit profitability from over $18 a barrel in 2013 to about

$19.50 in 2014. Also, this is the season for lower asset prices for other companies, and

Exxon has known to be quick to pounce on such attractive M&A opportunities. Exxon is thus

at a great position to expand and reduce costs structure, leveraging on their flush financial

flexibility.

Exxon has almost US$5 billion in cash and equivalents, which is proof of its financial

strength. The US shale market, which Exxon had missed, may now become a realistic

venture because of the struggling oil majors here. They can get into fracking for cheap,

especially since there are a lot of small companies that have struggled with debt and with

low oil prices and rising debt levels, making it likely that they will exit. With its ability to

borrow cheaply—Exxon has a higher credit rating than the U.S. government—analysts say

the company is capable of swallowing any rival, regulatory obstacles aside. And the

company has amassed a hoard of its own shares that boost its takeover power.

I would like to end by stating that it is important to remember that there is a finite supply of

natural resources which investors frequently forget. This implies that findings, producing

existing and new oil, requires taking up projects that may be expensive or difficult. Exxon

has the advanatage of being able to take such risks considering the renaissance feel

surrounding the US oil industry.

Management

Nothing has to be said about the effectiveness and dominance of the management team in

supply chain management, keeping investors and all the other stakeholders happy. There is

assurance that in the oil and gas industry Exxon is one of the best operators. Cash operating

costs at ExxonMobil refineries have been well below industry average, driven largely by

efficiency. With energy being almost 60% of refinery costs every incremental increase in

efficiency has a great impact. There is a lot of potential for Exxon to improve this with

scale...

Competitors Over the last quarter, comparing earnings and revenues of companies such as Chevron,

Conoco Philips, BP shows that they are having trouble generating revenues largely to the

fact that their business isn’t as diversified as Exxon’s. In comparison, Chevron (CVX)

revenues decreased by 19%, Royal Dutch Shell (RDS.B) revenues fell by 15.4%, and Hess

Corporation’s (HES) revenues dropped 50.7% in 4Q14 compared to the same quarter a year

ago. Out performance over peers such as BP restores confidence in Exxon. In terms of debt,

Exxon has the lowest debt to EBITDA multiples but its P/E ratio trends below the market,

showing there is lack of expectations for higher earnings. This is understandable, but it is

important to remember that the key reason to hold Exxon is for a long term dividend return

and potential upside, especially in a volatile market. A good stock with a high P/E like BP

may be considered if an investor is looking for a riskier option but with a higher upside.

Holding these two stocks together in any energy portfolio could thus be beneficial for an

investor.

Valuation

Exxon Mobil Corp

USD $ in millions, except per share data

Year Value FCFE(t) or TV(t) Present value at 10.54%

0 FCFE(0) 22,849

1 FCFE(1) 26,399 23,882

2 FCFE(2) 29,757 24,353

3 FCFE(3) 32,706 24,214

4 FCFE(4) 35,027 23,460

5 FCFE(5) 36,527 22,132

5 TV(5) 608,705 368,813

Intrinsic value of ExxonMobil's common stock

486,853

Intrinsic value of ExxonMobil's common stock (per share)

$114.97

Current share price

$89.92

Upside Potential 26%

rXOM = RF + βXOM [E(RM) – RF]

= 2.56% + 0.69 [14.16% – 2.56%]

= 10.54%

Market Based Forecasts

I used a normalized price of oil basis evaluation to remove the impact of commodity prices

from the valuation. The intrinsic value found using this method was 105.25.

Conclusion

Current Price –89.92

Target Price – 108.72

Best Case – 115

Entry Price – 86-88

Exit Price – 105<x<114

Exxon has outperformed its peers. A concern with investors is that the stock hasn’t risen

much in the last year. But the upside, because of the relative low price, means that a good

entry price is around 86. With energy demand looking to increase faster than supply is

increasing, price stabilization is likely in the next three quarters. Exxon has a large reserve

and has enough to last 16 years, which is much larger than its peers. In Upstream, Exxon has

made plans to capitalize in the growing emerging markets where demand for LNG is set to

increase 165 percent between 2010 and 2025, to 370 million tonnes per year. ExxonMobil’s

LNG marketing experience and successful track record of developing large LNG projects

were instrumental in securing sales with customers in China, Japan, and Taiwan. Bakken

production growth after the acquisition of XTO.

Few assumptions we are going to make in our analysis is as follows: Short Term (American

Markets) http://www.eia.gov/forecasts/steo/tables/?tableNumber=8#

http://www.economist.com/news/finance-and-economics/21644198-oil-price-has-been-

rising-againbut-will-it-last-saudi-project-part-two

Read more: With Oil Cut in Half, Will Any of the Majors Cut Dividends? - Chevron Corp

(NYSE:CVX) - 24/7 Wall St. http://247wallst.com/energy-business/2015/02/18/with-oil-cut-

in-half-will-any-of-the-majors-cut-dividends/#ixzz3SKSDP3HU

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Read more: With Oil Cut in Half, Will Any of the Majors Cut Dividends? - Chevron Corp

(NYSE:CVX) - 24/7 Wall St. http://247wallst.com/energy-business/2015/02/18/with-oil-cut-

in-half-will-any-of-the-majors-cut-dividends/#ixzz3SKS4FJsL

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