Raymond analyst James James Jenkins, who is bearish on Exxon Mobil Corp. (NYSE: XOM) since 2018, has become bullish on the oil giant after taking into account the improved outlook for the energy sector and the attractive valuation level of the company. According to a research note sent to clients, Jenkins wrote on April 14:
“With the stock’s recent decline (~ 10% over the past month), we believe now is the right time for our outlook for Exxon Mobil to be less negative. Q1 2021 results indicators show a solid improvement, which pushes the company in the right direction of this part of the show me story. “
Even though Exxon’s stock is down nearly 10% in the past four weeks, the company’s market value has appreciated over 40% in the past 12 months, mainly due to the stellar recovery in crude oil prices. Even on the back of these high returns, Exxon still appears to be priced very low in the market, providing value investors with an opportunity to invest in a mature, cash-flow positive company at a fair price.
The energy sector is still very cheap
All major US stock indexes are trading near their all-time highs, suggesting that there may be a bubble forming. Stock prices are supposed to be forward looking and investors are currently focused on the expected recovery of the US economy in the second half of the year. While it is not surprising to consider the forward-looking nature of the market, there is reason to believe that some companies and industries have already appreciated beyond reasonable levels. However, this is not true for the energy sector. As illustrated below, this struggling corporate sector remains the cheapest in terms of Shiller’s price-to-earnings ratio. To add a little more color, the energy sector is trading at a nearly 50% discount to the S&P 500 index.
The outlook for the sector continues to improve, however, even if the performance of the energy stocks market does not fully reflect these improvements. According to data collected by Morningstar, global demand for crude oil fell below the level of supply in the market in the second quarter of 2020, causing inventory levels to rise sharply. This, on the other hand, has put pressure on oil prices for most of 2020. As illustrated below, Morningstar predicts a substantial drop in inventory levels in 2021 as well as the expected recovery of the global economy. .
According to these estimates, oil prices are expected to stabilize around the current price of $ 63 as of April 16 or even gradually increase until the end of 2022. This will pave the way for low-cost oil producers to signal a strong growth in their income and profits.
Exxon’s Focus on Conventional Oil Drilling Will Help Business Thrive
Many big oil giants, including BP PLC (NYSE: BP) and Royal Dutch Shell PLC (NYSE: RDS.A), have taken the first steps to diversify their activities in the renewable energy sector. Policymakers around the world should support the adoption of renewable energy over the next decade with the aim of promoting sustainable alternatives to fossil fuels. Given this change in regulators, it makes sense for oil companies to implement changes in their business strategy by embracing renewable energy. Exxon Mobil, however, is sticking to its proven strategy of prioritizing the fossil fuel business, which should help the company achieve strong financial results over the next five years.
Exxon’s strategy will have two contrasting implications for investors.
- The focus on fossil fuels will help the company generate higher revenues and profits in the short to medium term.
- Many large oil companies are likely to trade at higher valuation multiples against Exxon due to their focus on environmental, social and governance factors.
At this point, it’s difficult to assess which of these factors – higher earnings or worsening investor sentiment towards Exxon – will dominate the oil giant’s stock performance. In the long run, it would be reasonable to assume that profits will dictate the terms of any other factor in determining the market value of a business, creating an opportunity for value investors.
A best-in-class dividend is offered to investors
Exxon Mobil is well known for generously rewarding investors by distributing profits through dividends and share buybacks. The company has paid a dividend in each of the past 39 years, a testament to the shareholder-friendly nature of current and past executives of the company. Even when oil prices collapsed last year due to the economic recession, Exxon failed to cut its quarterly dividend by 87 cents per share.
Although many Wall Street analysts have suggested that it would be a better decision to cut the dividend and reallocate savings to paying down debt, company management has repeatedly pointed out that due to its business model. As a cash-rich company, it would continue to prioritize shareholder distributions over debt reduction. As a mature company that does not have huge growth potential, Exxon appears to be doing the right thing to create shareholder value, which makes investing in this oil giant even more attractive to value investors. . As illustrated below, the company has consistently hedged dividends with free cash flow over the past 30 years with the exception of a few rare cases including 2020.
Given the expectations of rising oil prices in the coming years, it would be reasonable to assume that the worst is over for Exxon and the energy sector. Improving macroeconomic conditions are likely to trigger Exxon dividend hikes as well, which would be further compensation for investors who are now taking the risks associated with the company.
Crude oil prices have already fully recovered from the lows seen last year and the outlook is improving thanks to the success of the vaccination program. Exxon, which is one of the very few oil companies to continue to focus on a traditional business strategy focused on fossil fuels, is well positioned to prosper in the years to come thanks to stable oil prices. The oil giant’s lack of focus on renewables will hold back stock performance in the short term, but corporate earnings are likely to dominate long-term performance, presenting a good opportunity for value investors. .
Disclosure: The author owns shares of Exxon Mobil.
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About the Author:
Dilantha De Silva
I am an investment professional with 5 years of experience in the financial markets. I specialize in US equities and incorporate a top-down approach to identify developing trends at the macro level and which companies would benefit from such trends. I am convinced that the best investment opportunities could be found in the undercover stocks.
I am currently working with leading financial publications including Refinitiv, Seeking Alpha, ValueWalk, GuruFocus, and TradeGrill to produce investment related content.
I am a CFA Level 3 candidate and an associate member of the Chartered Institute for Securities and Investment (CISI, UK). I am also a registered candidate for the Chartered Wealth Manager program. In my free time I like to read.