Exxon Mobil Q3: The Old Adage Of Letting Your Profit Run (NYSE:XOM)

Funding thesis and Q3 recap

I revealed my first article on Exxon Mobil (NYSE:XOM) in Sept 2021, entitled “Exxon Mobil has turned a nook“. At the moment, its worth was ~$55 and it simply witnessed its ROCE (return on capital employed) sinking to a depressing 6% within the earlier quarter, as you possibly can see from the next chart. The title already gave away the thesis. And certainly, its ROCE saved climbing in tandem with its inventory costs, because of a mess of catalysts since then.

Now, quick ahead to its current Q3 earnings report (“ER”), which may be correctly summarized by a cliché – it’s definitely firing on all cylinders. As proven within the chart beneath, it reported greater than $24.4B in Q3 working money circulation, setting a document for essentially the most profitable quarter ever. The document earnings have been pushed by sturdy oil and pure gasoline costs, expanded refining volumes, and efficient value controls that produced a complete of $6.4 billion in structural financial savings.

Because of this, the inventory costs now hover close to a document peak of $113, a tempting level for a lot of traders to money out. And this results in me the thesis of this text: there may be nonetheless extra room to let your revenue run at this level.

Within the the rest of this text, you see why I see its fundamentals are largely unchanged since I wrote my first article greater than 1 yr in the past. And additionally, you will see that the temptation to promote at this level is not any totally different than the numerous new highs its costs have pushed prior to now ~1 yr. And should you have been subjected to the temptation at any of these factors, you’d missed out on a big portion of the 113% complete return it has generated up to now.

A potent mixture: document ROCE and wholesome CAPEX

Let me begin with its ROCE. The chart beneath is similar chart proven above however with extra context this time. The ROCE is computed based mostly on its quarterly TTM outcomes since 2019 Q1. As seen, its ROCE nosedived from a wholesome 15% in 2019 to solely 6% in 2020 This autumn within the aftermath of the COVID pandemic. To place issues into perspective, its long-term (“LT”) common ROCE is about 15.2%, and the ROCE for the entire vitality sector represented by XLE is about 14.6%. And these have been my key concerns to argue in 2021 Q2 that its profitability was turning a nook. I merely don’t see A) that vitality costs ought to keep as compressed as again in 2020, or B) the journey disruptions would persist for too lengthy.

Certainly, its ROCE has staged an ideal V-shaped restoration since then. Its ROCE reached 29.9% in Q2 2022 and isn’t at a document excessive of 36.7%. These numbers should not solely excellent in absolute phrases. They’re additionally greater than 2x greater than its personal long-term common of 15.2% or the general vitality sector’s 14.6%.

After all, there are many the explanation why such document ROCE can’t final (and we’ll element among the causes within the danger part later). Nonetheless, XOM traders don’t want such document ROCE to take pleasure in an honest return. Subsequent, we’ll see that even a decrease ROCE, when mixed with a wholesome reinvestment fee, can already ship strong returns within the years to come back.

XOM’s capital allocation flexibility

XOM has been struggling constrained capital allocation throughout 2019~2020 as you possibly can see from the chart beneath. The chart reveals its use of money as a share of its money from operations (“CFO”). As seen, its natural funding fee has been virtually 0% between 2019 Q1 and the top of 2020. Throughout that time period, the enterprise didn’t even generate sufficient CFO to cowl its CAPEX and dividend obligations.

The image fully modified since Q3 2021. In that quarter, its dividend and CAPEX obligations mixed dropped beneath 100% as a share of its CFO for the primary time since 2019. The image saved bettering since then, and consequently, XOM now has loads of flexibility to deploy its free money circulation to drive natural progress.

To wit, as of Q3 2022, its dividend payouts solely require 20% of its CFO and CAPEX one other 22%. These two objects mixed solely require 42% of its complete CFO. To offer a reference level, its long-term common dividend fee ratio is about 54% of the CFO, and LT common CAPEX is about one other 54% of its CFO. So XOM is in a really sturdy place to reinvest in itself and reward shareholders.

As seen within the subsequent chart, throughout Q3, it distributed $8.2 billion to shareholders, together with $3.7 billion in dividends and $4.5B in share repurchases. It spent $5.7 billion in CAPEX throughout Q3, bringing the year-to-date CAPEX complete to $15.2 billion, in step with its full-year goal vary of $21 to $24 billion. As one other unequivocal signal of economic energy (along with share repurchases), it additionally elevated its dividend funds to $0.91 {dollars} per share throughout Q3.

XOM’s projected progress charges and returns

As aforementioned, even a decrease ROCE, when mixed with a wholesome reinvestment fee, can already ship strong returns for XOM shareholders within the years to come back. And the desk beneath summarizes my projections about its return potential within the subsequent 3~5 years. These projections have been made beneath the belief that dividends develop on the similar tempo as earnings with no dividend reinvestment.

The traditional case assumed a pressured ROCE of 15.2%, on par with its LT common (which is why I referred to as it the conventional case). This case additionally assumes a reinvestment fee of 10%. For the bull case, I assumed the ROCE to be 25% (above its LT common however considerably beneath its present document stage) and the reinvestment charges to be 15%. Recall that it at present solely wants 42% of its CFO to cowl its dividends and CAPEX. Below these parameters, the long-term natural progress fee can be about 1.5% every year for the conventional case (15.2% ROCE x 10% reinvestment charges) and about 3.8% for the bull case (25% ROCE x 15% reinvestment charges). I imagine it’s justifiable so as to add a 2.5% inflation escalator, as argued in my earlier articles:

I really think about a 2.5% inflation escalator to be very conservative for XOM. In the long run, the oil worth has been rising way more rapidly than inflation. For instance, common inflation has been 3.9% CAGR on common prior to now 50 years. However oil worth has risen at a tempo of 5.9% CAGR, beating inflation by an entire 2%.

With a 2.5% conservative inflation escalator, the nominal progress fee can be 4.0% within the regular case and 6.3% within the bull case). And that is the place I disagree with consensus estimates (proven within the second chart beneath) essentially the most. As seen, consensus estimates undertaking its EPS to say no. My view is the other – I merely don’t see how its EPS can decline given the sturdy ROCE, sustainable reinvestment fee, and likewise share depend discount at such compressed valuations.

Lastly, by way of valuation, my estimates beneath additionally assumed a 10x PE a number of for each circumstances. As a reference level, the historic common PE has been about 15x PE for XOM.

All informed, even beneath these extraordinarily conservative assumptions, the way in which I see issues, each the conventional and bull case can result in outsized complete returns within the subsequent few years. The traditional case is projected to result in a complete return of 62.3% and the bull case 79.2%.

Dangers and ultimate ideas

By way of dangers, there’s a danger of COVID resurgence different variants might nonetheless disrupt journey, vitality demand, and likewise its chemical compounds. Notably, it reported decrease chemical margins reflecting softening demand in North America, Europe, and likewise in China as a result of COVID restrictions. Up to now quarter, European provide issues drove pure gasoline costs to a document stage. And the NG costs might undergo a retreat if the Russian-Ukraine state of affairs eases, which might additionally result in moderated crude oil costs too. Oil and gasoline costs might flip right into a political difficulty too, as evidenced by the truth that windfall tax proposals resurface sometimes.

All informed, XOM’s peak Q3 efficiency and document inventory worth remind me of the outdated adage of letting your revenue run. Regardless of the spectacular worth rally of greater than 100% prior to now yr or so, I’m nonetheless seeing good causes to be bullish. In reality, I’m seeing the identical forces nonetheless in play in comparison with these I argued for about 1 yr in the past. I anticipate its present peak ROCE to proceed, given the structural supply-demand imbalance, a results of years of underinvestment in our vitality provide infrastructure. Though given the renewed capital allocation flexibility, XOM traders can count on a wholesome return even with ROCE reverted to a historic imply of round 15%. My estimates undertaking one other 60% to 80% upside potential from right here from a mix of wholesome ROCE, sustainable reinvestment fee, and likewise share depend discount at extremely accreditive valuations (solely 8.1x FW PE at present).