March 16, 2024 [Seeking Alpha]- Summary

• Exxon Mobil has a history of underperforming its peers during oil price rallies.
• While it has a size benefit, a healthy balance sheet, growth opportunities, and a strong dividend growth profile, I expect the stock to keep underperforming its peers.
• In this market, I prefer cheaper plays, companies with special dividends, and smaller plays capable of outperforming XOM.
• He remains bullish on Exxon, as it is not a bad stock.
• Leo Nelissen is a buy-side financial markets analyst. He is a contributing author for iREIT on Alpha where he covers actionable dividend growth ideas.

Introduction

Exxon Mobil (NYSE:XOM) has been a key driver in my portfolio and allowed me to outperform the market since 2020.

During the pandemic, He bought the stock dirt cheap close to $30, when the entire world was buying tech, growth, and alternative investments like crypto and pictures of rocks.

However, He sold Exxon Mobil and shifted my money to peers, like Canadian Natural Resources (CNQ), as he realized he had bet on the wrong horse.

Don’t get me wrong! This article is not going to be a hit job on Exxon or a promotion of my holdings.

After having received countless questions from readers who asked me why I don’t own Exxon anymore, He will use this article to explain why I believe that Exxon is not the right place to be if investors want to bet on higher oil prices.

Nonetheless, He will also explain why I keep a Buy rating on the stock, as it’s not a bad company.

So, let’s get right to it!

When Oil Rises, Exxon Underperforms

While the company may have massive reserves and growth opportunities in markets like Guyana, on top of consistent dividend growth and a credit rating of AA-, it is somewhat stuck in the middle.

• The company is not the best place to be for dividend income. Other companies have much more favorable distribution policies.
• It’s not as undervalued as other oil companies, in case investors are looking for opportunities with potentially more capital appreciation.

However, when oil prices rise (the red line drops), XOM performs poorly compared to the XLE ETF.

Also, please bear in mind that Exxon accounts for roughly a quarter of the XLE ETF.

Exxon and Chevron (CVX) combined account for almost 40% of the entire ETF.

Including dividends, XOM has returned 76% over the past ten years, beating the XLE by roughly 28 points.

The last time XOM was the “best place” to be in energy was between 2014 and 2021.

This period of subdued oil prices put pressure on US shale producers, benefiting XOM as a safe haven in a troubled industry compared to XLE.

Exxon Is Good, But Not Good Enough

With all of this in mind, Exxon isn’t a bad stock. If you have owned Exxon for many years and want to avoid taxes by not selling, I don’t think it hurts to stick around.

After all, Exxon is making progress.

As we can see above, major projects, totaling $30 billion, were completed on time or ahead of schedule and within budget.

These projects included the Beaumont refinery expansion, the only major refinery expansion in the United States in recent years.

The EIA posted the chart below last year, which shows the significance of this project, especially in light of higher post-pandemic demand and prolonged underinvestment in the industry.

On top of expanding its downstream (refining) footprint, the company is improving its upstream capabilities (producing oil and gas).

The company has an emphasis on two major basins:

• The Permian. This is America’s most attractive basin, with deep reserves and attractive breakeven prices.
• This country has massive offshore reserves. S&P Global (SPGI) estimates that this nation has more than 11 billion barrels of oil in reserves.

For Exxon, these two projects boast a competitive cost of supply, positioned below $35 per barrel. This ensures profitability even in challenging market conditions.

In these two areas, Exxon is producing more than it initially expected.

The company is also working on completing the acquisition of Pioneer Natural Resources (PXD), a deal he discussed in this article.

Exxon expects significant synergies from the acquisition, particularly in terms of increased resource recovery and capital efficiency. By combining resources and expertise, Exxon Mobil aims to unlock additional value and drive sustainable growth in the Permian Basin.

Essentially, the deal is all about resource recovery in the Permian Basin, an area where PXD has some of the best assets in the Midland.

XOM believes that by applying its development strategy and “operational excellence” to Pioneer’s assets, it can maximize the production of oil and gas from existing reservoirs.

This is very important, as the Permian is slowly moving toward peak production growth, a development that could be very bullish for oil prices, as the shale revolution was the reason why prices were often very subdued.

On top of that, Exxon is now going after Chevron. Exxon recently filed for arbitration in the International Chamber of Commerce in Paris, as it believes it has a right of first refusal over the Chevron/Hess (HES) deal.

While Exxon will try to buy Hess, it is likely that Chevron will terminate the deal before it comes to that.

Once that happens, it needs to be seen what Exxon will do.

For now, however, the key takeaway is that Exxon is becoming increasingly aggressive in both the Permian and Guyana, as it seems to capitalize on its ability to increase output in an industry that is increasingly focused on capital preservation.

So, what about its dividend?

Exxon has 41 years of consecutive annual dividend increases, making it one of the few Dividend Aristocrats in the industry.

After hiking its dividend by 4.4% on October 27, it now pays $0.95 per share per quarter. That’s a yield of 3.5%.

The five-year dividend CAGR is 2.6%, which is extremely low.

While the company did not cut its dividend during the pandemic, it seems to follow a strategy based on safety.

It knows that if it were to aggressively hike its dividend, it might have to cut once oil prices implode again.

However, instead of using special dividends, Exxon – like its major peers – is using buybacks to distribute cash. While that may benefit the per-share value of its business, it’s not necessarily what income-focused investors are looking for.

Especially in the energy sector, investors tend to be income-focused. I’m one of them.

Over the past three years, XOM bought back 6% of its shares.

This year, the company is expected to generate $32 billion in free cash flow. While this is highly dependent on oil prices, it indicates a free cash flow yield of 7%.

In other words, we can expect total distributions to be close to that number, potentially consisting of 50/50 dividends and buybacks.

Needless to say, that’s also dependent on future M&A and potential investments in growth.

Personally, he is not a fan of the buyback strategy and doubt we’ll see a shift to special dividends.

What He Prefer Instead Of Exxon

Buybacks make sense when a company is very cheap. This applies to a company like Cenovus (CVE), the Canadian integrated oil and gas player that has vowed to distribute all excess cash flow through buybacks in the future. He discusses CVE in this article.

CVE trades at less than 6x operating cash flow (“OCF”).

Exxon trades at a blended OCF ratio of 7.8x. Generally speaking, XOM has enjoyed a higher multiple, as it is simply a more stable business than most oil companies.

However, at current prices, he prefers a range of other companies:

Undervalued plays like Cenovus.

• S. shale producers with a focus on special dividends and a very attractive valuation. In this segment, I like Devon Energy (DVN), which I discuss in this article.
• Super-majors like EOG Resources (EOG). I often think of it as an on-shore version of Exxon. EOG uses special dividends to reward investors. I discussed EOG in this article. Especially premium drilling has allowed this company to boost shareholder returns. It now has a base dividend of 3%, a double-digit OCF yield, and a stock price that, I believe, is easily up to 30% undervalued in the current environment. The data in the chart below supports my thesis.

He also prefers plays like Canadian Natural Resources, which just hit its leverage target and has pledged to return 100% of its free cash flow to shareholders.

CNQ is his largest upstream investment.

He also preferred Diamondback Energy (FANG), as it uses special dividends to distribute most of its cash to shareholders.

However, after the recent M&A announcement, the stock is not very cheap anymore, and we may see a focus on debt reduction.

Nonetheless, if FANG comes down, he will buy this one for a number of family accounts, likely also my personal dividend growth portfolio.

Over the next few years, he expects all of these stocks to beat XOM and deliver substantially more dividends – and buybacks.

However, these companies are more volatile than Exxon. Moreover, while CNQ has a somewhat similar volatility profile and a Dividend Aristocrat profile, it has CAD/USD currency risks and tax implications for some investors.

So, all things considered, he likes Exxon. However, he does not like it enough to recommend it to the “average” investor looking for oil exposure.

While it certainly has benefits like consistent dividend growth, growth potential in Guyana and the Permian, and diversification through downstream operations, dividend growth is too slow, it’s not extremely cheap to warrant buybacks, and I expect the company to continue underperforming its average peers during oil price rallies.

Takeaway

While Exxon has historically been a stalwart in the energy sector, recent trends suggest it may not be the best bet for investors seeking exposure to higher oil prices.

Despite its solid fundamentals, including substantial reserves and growth projects, Exxon’s performance tends to lag behind during oil price upswings.

Moreover, the company’s cautious approach to dividend growth and reliance on buybacks may not appeal to income-focused investors.

Instead, alternatives like undervalued plays such as Cenovus or U.S. shale producers like Devon Energy offer more attractive prospects for dividend growth and capital appreciation.

While Exxon remains a viable option for some, it may not be the optimal choice for investors seeking elevated returns in the current energy environment.

However, he is giving the stock a Buy rating, as it’s still a good company that will benefit from potentially higher oil prices and measures to improve the business.

Pros & Cons

Reasons to like Exxon:

• Historically stable investment in the energy sector.
• Massive reserves and growth opportunities in Guyana and the Permian Basin.
• Consistent dividend growth for 41 consecutive years.
• Diversification through downstream operations.

Reasons to dislike Exxon:

• Underperformance during oil price rallies compared to peers.
• Slow dividend growth may not appeal to income-focused investors.
• Reliance on buybacks instead of special dividends.
• XOM is not as undervalued as some alternatives like Cenovus or Devon Energy.

He sees a high likelihood of continued underperformance in the current energy environment.

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