April 12, 2023 [The Motley Fool] – According to a Wall Street Journal report last week, ExxonMobil (XOM 0.71%) has its sights set on making a megadeal.

It has reportedly held informal talks with U.S. oil producer Pioneer Natural Resources (PXD 0.08%) and at least one other company. Such a deal with Pioneer or a similarily sized producer could reshape the U.S. oil patch by giving Exxon a much larger footprint in the resource-rich Permian Basin.

Here’s a closer look at why Exxon is on the prowl, what’s the draw of Pioneer, and whether a deal would make ExxonMobil stock a better investment.

Swimming in cash

Last year, ExxonMobil recorded $56 billion of profit, fueled partly by higher oil and gas prices. That was a record for the company and a historic high for the Western oil industry.

Exxon generated an even bigger cash flow gusher. It produced an industry-leading nearly $77 billion in cash flow from operating activities. That gave it the money to fund $22.7 billion of new investments in traditional and lower-carbon energy and return $30 billion of cash to shareholders through dividends and share repurchases with lots left over. Exxon increased its dividend payment by 3% marking its 40th straight year of dividend growth, and bought back $15 billion of its stock. Even with significant capital spending and increased cash returns to shareholders, Exxon ended the year with almost $30 billion of cash on its balance sheet. That drove its net debt ratio down to 5%, well below its target range of 15% to 20%.

On the prowl

Analysts have speculated that Exxon could use its massive and growing cash war chest on an acquisition. There were rumors last year that Exxon was interested in acquiring Denbury Resources (DEN 0.62%). A potential tie-up made a lot of strategic sense because Denbury is a leader in carbon dioxide. Exxon believes carbon dioxide could eventually become a multi-billion-dollar business.

However, Exxon appears to have moved past Denbury and is now eying Pioneer Natural Resources and others. According to the Wall Street Journal, Exxon has held informal talks about a merger with Pioneer. The talks might not lead to a deal. Price is a potential sticking point since Pioneer already has a $49 billion market cap. Exxon would need to pay a sizable premium to that valuation to get a deal done. It could also pursue another target or opt against making an acquisition.

However, the interest in Pioneer makes a lot of sense. It’s a leading player in the Permian Basin, one of Exxon’s four core investment focus areas with LNG, Guyana, and Brazil. Pioneer boasts a top-tier inventory of future drilling locations:

Acquiring Pioneer would enable Exxon to add to its extensive resources in the area. That would further increase the company’s scale, which would help lower costs.

Exxon’s CEO Darrin Woods noted on the fourth-quarter conference call that the company is forecasting to reach 1 million barrels of oil equivalent per day (BOE/D) from the region by 2027. It added 90,000 BPD of production last year, growing its output to 560,000 BOE/D. That makes Exxon the sixth largest producer in that region, where Pioneer led with an output of about 650,000 BOE/D last year.

Woods discussed the prospect of making an acquisition in the Permian Basin on the fourth-quarter call. He noted that the company is “looking at where we can take advantage of our capabilities and skills to bring additional value to acquisition targets.” He stated: “We do think with time, the work we’ve been doing in the Permian will provide a value opportunity that we can leverage when the market is right.” In particular, it’s looking for an “opportunity of bringing value for undeveloped resources in the Permian.” Given Pioneer’s vast undeveloped resources in the Permian, it fits Exxon’s strategic vision.

An interesting potential catalyst to watch

Pioneer Natural Resources is undoubtedly a strong strategic fit for ExxonMobil. It would significantly enhance its scale in the Permian, where it could leverage its expertise to potentially extract more value from that company’s vast undeveloped resources.

However, whether a possible deal would pay off for shareholders comes down to the price. Woods stated on the call that while Exxon is looking for an opportunity, it’s waiting for when the market is right. If it can find the right deal at the right price, it could pay big dividends for investors over the long term. Exxon could leverage its expertise to generate enhanced profitability from a larger Permian position.
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