3 Key Trends Driving Our $107 Price Estimate For Exxon Mobil

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Exxon Mobil

Exxon Mobil is the world’s largest publicly traded international Oil and Gas Company. It generates annual sales revenue of more than $420 billion with a consolidated adjusted EBITDA margin of ~14.7% by our estimates. We recently revised our price estimate for Exxon Mobil to $107/share, which values it at around 13.4x our 2014 GAAP diluted EPS estimate of $7.96 for the company. Here, we discuss the three key trends driving our price estimate for Exxon Mobil.

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Improving Upstream Volume Mix

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Exxon’s total hydrocarbon production can be broadly split into two categories – liquids, which include crude oil, natural gas liquids, bitumen and synthetic oil, and natural gas. Liquids made up more than 60% of Exxon’s total hydrocarbon production in 2009. However, its percentage contribution declined significantly after the company acquired XTO for $41 billion in 2010, which increased its natural gas production by 31% y-o-y that year. More importantly, most of the increase came from the U.S., where natural gas prices have been significantly depressed by international standards due to a sharp rise in production from unconventional sources. (See: Key Trends Impacting Natural Gas Prices In The U.S.)

Liquids have generally become more profitable to produce than natural gas because of higher price realizations. Last year, Exxon sold liquids at an average price of around $95 per barrel, compared to just around $41 realized per barrel of oil equivalent (BOE) of natural gas. This is the reason why the company has been trying to improve the proportion of liquids in its production mix over the last couple of years. Last year, liquids made up 52.7% of Exxon’s total hydrocarbon production, up from 51.5% in 2012. [1]

During the first half of this year, Exxon’s total liquids production decreased by 90,000 barrels per day, or ~4.1% y-o-y, primarily due to the expiry of the Abu Dhabi onshore concession agreement. The company lost its 75-year rights to the emirate’s oldest producing fields this January, when the Second World War-era contract expired. However, excluding the impact of the Abu Dhabi onshore concession expiry, Exxon’s liquids production actually increased by 1.8% y-o-y during the fist two quarters of this year. On the other hand, its natural gas production declined by almost 0.9 billion cubic feet per day, or more than 7.3% y-o-y over the same period. Although, lower weather-related demand in Europe exaggerated the decline in its natural gas production during the first quarter, we expect the overall trend of improving volume-mix to continue for the rest of the year. The company expects its liquids production to grow by ~2% y-o-y and natural gas production to decline by around 3% for the full year. This is expected to drive better price realization per barrel of oil equivalent and improve its unit profitability. [2]

Thinner Downstream Margins

Exxon’s downstream margins have been under a considerable pressure over the past few quarters. This has been primarily due to industry overcapacity amid sluggish demand and higher crude oil prices. There have been certain bright spots as well, such as refineries in the Midwest U.S. that have been gaining from lower crude oil prices due to the fast-growing supply from unconventional plays in the U.S. and a lack of midstream infrastructure. However, a sharp decline in international crack spreads over the past few quarters has more than offset this advantage for Exxon. During the first half of this year, Exxon’s international downstream earnings declined by more than 44% y-o-y, primarily due to thinner margins. [2]

Going forward, we expect global refining margins to continue to remain under pressure in the short to medium term due to industry overcapacity, which stems from the fact that governments in different parts of the world are willing to run uncompetitive crude refineries at very low or no returns to sustain employment and reduce their reliance on imported fuels. We currently forecast Exxon’s adjusted downstream EBITDA margin to improve marginally to around 2% in the long run, which is more than 30 basis points below the historical average by our estimates. (See: Key Trends Impacting Global Refining Margins)

Declining Capital Expenditures

While Exxon’s total hydrocarbon production has remained relatively flat over the last decade, its capital expenditures have soared from around $18 billion in 2005 to over $42 billion in 2013. This is a clear indication of how difficult the oil drilling business has become over the years. However, the company believes that 2013 was a peak year of capital expenditures and it would not spend more than $40 billion on leasing rigs, floating oil platforms, installing pipelines and repairing oil-refineries this year. If we go by Exxon’s performance during the first six months of this year, the company is well on track to meet its 2014 capital expenditure target. It has so far spent just $18.2 billion on purchasing, repairing, and upgrading its physical assets, such as property, plant, and equipment, compared to over $22 billion during the first two quarters of last year. [3]

Beyond 2014, Exxon expects its capital expenditures to decline further to an average of less than $37 billion annually. We believe that it would not be an easy task for the company amid growing pressures to increase its production, as hydrocarbon finding and development costs continue to swell. Therefore, we currently expect Exxon’s total annual capital expenditures to remain around $40 billion in the short to medium term. However, if the company is able to successfully achieve this target through efficient capital allocation, it could provide a much-needed boost to its declining ROCE, which stood at just around 17% last year. Moreover, it could also result in additional upside of around 10% to our current price estimate for the company. [1]

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Notes:
  1. Exxon Mobil 10-K Filings, sec.gov [] []
  2. Exxon Mobil Corporation 2Q14 Earnings Presentation Slides, exxonmobil.com [] []
  3. Exxon Mobil Corporation 2Q14 Press Release, exxonmobil.com []