Shares of this oil giant has been hit hard in 2020, and it’s burning more cash than usual.
From the desk of Willie Keng
Wed, 3 Sep 2020
So… I sat in a cafe one hot, sunny afternoon with my hedge fund manager friend from Hong Kong. I could never forget what he said to me.
“Willie, if there’s one business I don’t touch is the oil business.” sipping his latte.
“Why?” I curiously asked.
“Because it’s driven by one very uncertain variable…”
“Oil…” as my friend exclaimed.
I know you think that oil stocks could be a bargain now, or what “smart” investors say — trading at a deep discount.
But here’s what I really think:
“The gold of yesteryear is stressing many oil majors.”
Let me explain.
I recalled reading the $73.7 billion Exxon and Mobil 1998 merger. At the time, ExxonMobil (Ticker:XOM) is the largest oil company and 3rd largest company in the world.
However, things have changed after a century. After Exxon used to be called the Standard Oil Company of New Jersey in 1923.
XOM’s shares have been absolutely hammered. It’s not even funny if you’d XOM since 2013, when shares were at all time high of $101.30.
What’s going on here?
You see, when I started investing 10 years ago, oil was $100/barrel. And everyone thought it’d stayed that way.
Today, it’s $44/barrel.
Source: EIA, Bloomberg, Refinitv
Lower oil prices have devastated these oil majors, screwing up their production plans — Royal Dutch Shell, BP have also cut their dividends.
XOM is one of the last few oil Dividend Aristocrats standing.
The company has increased its dividend over the past 37 years. And management wants to maintain that.
Well… I’m doubtful.
XOM is already out of the Dow 30 after its 91-year streak — the longest period a company has ever stayed in the Index.
Here’s the thing about The Dow. It’s meant to reflect the American economy, and energy is a huge part of the economy. Oil majors make up a declining portion of the stock market — in 2008, energy stocks were 15% of the S&P 500. Now, it’s 2.5%.
I don’t think XOM will face bankruptcy, but it’s bouncy revenues and shaky earnings are worrying me.
When I took a peak at its latest annual report, what I found surprised me.
In 2019, XOM generated only $5.3 billion free cash flow, while it paid $14.6 billion dividend to its shareholders. It had to borrow debt, sell some of its assets to make up the shortfall.
This is important — its cash flow isn’t enough to maintain its increasing dividends.
As operating costs increase, while oil price stay low, XOM’s free cash flow is going to dry up.
What this means for dividend investors — XOM is struggling to keep up its dividend pay outs. As a result, higher debt load, more cutbacks in spending and asset sales.
This is happening already.
In its latest announcement, XOM will reduce its 2020 capex by 30%, operating costs by 15%. This is in response to low commodity prices resulting from oversupply and demand weakness from the Covid-19 Pandemic.
And you know what’s more?
I noticed its dividend payout ratio has increased, which is a bad sign here. XOM is paying out more dividends from its shaky earnings over the past 3 years.
Even with a major OPEC+ production cut, today’s oil price levels aren’t going to make XOM grow its earnings in the future.
Oil has always been a political tool for government and lobbyists — hence production levels can always change.
Oil price, like what my hedge fund manager friend explained later, becomes very erratic.
If you’ve to rely on a single commodity — like oil, to determine a company’s profitability, you might want to question its business durability.
And my friend, unfortunately was right.
My thoughts on XOM — “Oil Giants Are Getting the Boot”
Of course, XOM is still one of the largest listed energy companies in the world. it employs over 70,000 people globally.
Not going bankrupt is very different from outperforming. It’s tough to see XOM — or any other oil companies — thrive in a world where there’s so much oil around.
The point is this: XOM isn’t going to make the cut for a dividend growth investor.
I focus on revenue and earnings growth, both of which XOM doesn’t have. The company has a declining free cash flow, and it’s expected to borrow more debt to maintain its increasing dividends.
Well, I’m probably going to avoid this stock for now even though it’s giving me a juicy 8.8% dividend yield (as I’m writing). Highest yielding doesn’t mean highest quality.