This page has been archived and commenting is disabled.
Exxon Apostasy
I wrote this article in January 2009, but this analysis of Exxon (and other religion stocks) still applies today.
A basic property of religion is that the believer takes a leap of faith: to believe without expecting proof. Often you find this characteristic of religion in other, more unexpected places–like the stock market.
It takes a while for a company to develop a “religious” following: Only a few high-quality, well-respected companies with long track records ever become worshipped by millions of investors. The stock has to make a lot of shareholders happy for a long period of time to form this psychological link.
The stories (which are often true) of relatives or friends buying a few hundred shares of the company and becoming millionaires have to percolate a while for a stock to become a religion. Little by little, the past success of the company turns into an absolute and eternal truth. Investor belief becomes set: The past success paints a clear picture of the future.
Gradually, investors turn from cautious shareholders into loud cheerleaders. Management is praised as visionary. The stock becomes a one-decision stock: buy. This euphoria is not created overnight. It takes a long time to build it, and a lot of healthy pessimists have to become converted into believers before a stock becomes a “religion.”
Religion stocks are held on faith. The traditional analysis is rarely applied, as it is perceived that these companies operate in a different gravitational field and that the laws that drive the valuations of the rest of the market are suspended when it comes to them. Take General Electric. Until recently, it was perceived as an infallible, can-do-nothing-wrong corporate icon. Its shares were passed from generation to generation with a whisper: “Never sell GE.”
However, once the religious, unconditional, in-GE-we-trust veil was lifted, many found it to be just another complex, un-analyzable financial conglomerate that is suffering from addiction to the commercial paper market. There is nothing new I can really say about GE except that it represents what is wrong with religion stocks–it is bought (and actually in most cases held) on faith. Few attempted to value it beyond looking at reported ruler-like earnings that were played like a fiddle by management by manipulating pension plan assumptions and shifts in reserves in opaque GE finance.
Today’s discussion is not about GE but about another religion stock that is about to get its religious veil stripped. I have to warn you, it is another infallible corporate icon that can do nothing wrong: Exxon (XOM 62.6 ↑0.14%) Mobil–the biggest (nongovernment-owned) oil company in the world, the $400 billion market cap gorilla that brought wealth to generations of people.
What is wrong with Exxon? On the surface, very little. It has $25 billion of net cash (cash less debt); it grew revenues and earnings on per share basis at 16.5% and 25%, respectively, over the last five years; it pays a decent dividend of 2.1%; and the stock is a true bellwether, as it is down only 15% year-to-date, when the market is down at least double that. Here is the best part: It trades at only nine times estimated 2008 earnings of $8.75 per share.
Wait a second, this does sound like a perfect stock! This type of superficial, on the surface analysis is only granted to religious stocks. Their long-term track and an aura of reverence establish the leap of faith that eases us into drawing straight lines from the past into the future, and this is very dangerous.
Arguably, a similar “religious” attitude created by a consistent 12% a year, ruler-like performance and a blue chip pedigree ( as a founder of Nasdaq) allowed Bernard Madoff to lower the guard of even very sophisticated investors and deprive them of billions.
If you were to take off the religious veil from Exxon and look under the surface, you’ll find quite a different story. The incredible double-digit revenue and earnings growth came completely from the big rise in oil and natural gas prices. XOM spent close to $90 billion finding new oil and natural gas, but oil reserves have not increased at all. Gas reserves are up 25% since 2003, but gas production increased very little.
I invite you to spend some time with XOM’s annual report. You’ll find that volumes of production and reserves in all its segments have not moved much since 2003. In many cases, they declined. So the magic behind all that growth over the last five years had little to do with XOM’s operating performance but was totally driven by commodity prices and share buybacks.
You might say that XOM is at only nine times earnings, and there’s not much growth built into the stock. Keep in mind, however, that XOM only trades at that valuation if it can earn what it earned in 2008 when oil prices were between $85 and $150. Unfortunately for XOM, fortunately for rest of us, oil prices are making five-year lows, revisiting the mid-30s.
My motto in life that I borrowed from Keynes is “I’d rather be vaguely right than precisely wrong.” Let’s figure what XOM’s vaguely right valuation is.
Exxon’s earnings overstate its true earnings power. To estimate XOM’s earning power at today’s prices, let’s look what it made when oil prices were in the 30s and 40s. In 2003 and 2004, when oil prices averaged $28 and $38, XOM made about $3 and $4 a share, respectively. Since XOM’s reserves are not growing, it is reasonable to expect no growth of production in the future. Don’t deceive yourself: XOM is just an operationally leveraged proxy for oil (and natural gas).
If oil stays where it is today XOM will not earn $8.75, as the Street expects it to earn in 2008. Is earnings will be around $3 or $4. It is trading at 20 to 25 times these earnings. This is a very high valuation for today’s environment, where companies with similarly strong balance sheets, with pricing power (XOM is a price taker), and whose cash flows are increasingly independent of what commodities are doing (non-cyclical) pay higher dividend yields and trade 10 or 12 times true earnings. Yes, there is a 50% downside in XOM’s stock.
My crystal ball on oil prices is as good as the next guy’s, but it is reasonable to expect that demand for oil will only be declining while the global economy is in a recession that only started in earnest a couple of months ago. Also, despite OPEC’s “production cuts,” the economies of its members are one-trick-ponies–they export petro chemicals and import everything else. As their oil revenues collapse, despite their threats, they cannot afford to produce less oil, and they have to keep building those golden palaces in the desert. So demand is declining, and supply may actually rise.
Let’s call today’s $30-$40 oil the seminormal case, though it could get worse. But what if oil prices go to $150? It is an unlikely scenario, at least while the global economy is in a recession, but in this case XOM has an upside of about 20%, as this summer it traded in the 90s when oil went to $147.
Exxon may be a great company. It made a lot of investors happy, but its success is in the past–it is simply too big to grow and it can barely find enough oil to replenish its reserves. Probably not in the very distant future its reserves will start declining–over 90% of oil reserves are owned by foreign governments, and they are not really looking forward to parting with them. Investors who own Exxon are gambling on oil and natural gas prices, and the odds are stacked against them: tails (high probability) you are down 50%, heads (low probability) you are up 20%. Even Vegas slot machines have better odds.
Emotions have no place in investing. Faith, love, hate and disgust should be left for other aspects of our life. More often than not, emotions guide us to do the opposite of what we need to do to be successful. Investors need to be agnostic toward “religion stocks.” The comfort and false sense of certainty that those stocks bring to the portfolio come at a huge cost: prolonged underperformance.
P.S. There are couple additional but important caveats to XOM’s valuation: XOM bought almost a quarter of its shares since 2004, thus if XOM were to make the same income today as it did 2004 for its EPS would higher (net income divided by lower share count gives you higher EPS). Second, costs have increased substantially: cost of finding new oil doubled from 2003 and getting oil out of the ground up 40% from 2003. These two factors cancel out each other.
Another point on valuation: XOM’s capital expenditures exceeds it depreciation expense thus on free cash flows – a true determinate of company’s worth, is lower than net income by about 30%. For the simplicity of the analysis, I used P/E with unadjusted E, but you really need to adjust your E down to reflect lower free cash flows.
Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007). To receive Vitaliy’s future articles my email, click here.
- advertisements -
...
.
XOM has been underperforming the market, as a whole. That's reason enough to dump it. No need to beat your brains out wondering whether it's overvalued.
Balance sheet and income statement data paint a good picture of where a stock is now. Unfortunately, it doesn't tell you much about the FUTURE price of the stock.
I agree with the general premise of the post. No stock should be seen as having permanently attractive qualities. Once it's clear they're not performing up to par, buh bye.
I think there are more fertile areas of "overvaluation" in the equity markets than ExxonMobil.
http://www.pbs.org/newshour/bb/business/jan-june10/makingsense_06-15.html
Exxon relies heavily on the taxpayer teat - to the tune of 3 billion $US alone. Collectively, it only gets worse:
http://www.grist.org/article/2010-06-07-iea-stunner-global-subsidies-dir...
Come to the mountain top to be with me, says the Prophet. Yes, yes, cry the faithful. Many die on the trek as the region is populated not only by bandits but many storms manifest out of nowhere. But stil the love for the Prophet drives them to reach the mountain top.
Upon reaching the top the hardy faithful rejoice at the vista they behold.
"But where is the Prophet?"
The leader and head of the steering committee spies a note on a flat rock secured in place by a smaller rock. He reads, "The next lesson is that there is no mountain."
He looks about to see who may have been looking over his shoulder. No one!
"Ah fellows, the Prophet says, All is well with him and he has been recalled to be with the Heavenly Father and will return when you need him most."
As the CONgregation rejoice in the joyous news and prepare a celebration, the leader gathers his family and close relations.
He says, "Everyone I must go on a sacred journey back to the valley in order to secure trade routes to our new home. Be well and I shall return when I can."
Peace be with you.
I agree with the author's view of GE being a "religion stock", From a simplistic analysis, (light bulbs to aircrafts..or something to that effect), GE was/is sold to investors as a play on the overall economy/country, i.e. a stable company with good yield and growth and more importantly limited downside risk, hence the counsel "Never Sell GE".
However, nowhere in “Light bulbs to Aircrafts” line is a passive investor (in GE) made aware of the fact, that lurking behind this image of a meat and potatoes kinda stock is a highly complex financial entity, a behemoth of sorts (~800B balance sheet, contributing almost 40% to GE’s earnings, the last time I checked), an epitome of risk, that follows a shortsighted policy of short-term borrowing (CP) for long-term funding. Blessed with a AAA (until recently), GE was able to pursue ever increasing yields, untethered, with increasing leverage, without ever fully appraising the average shareholder, that he was taking on more risk than he had asked for, when he bought GE Stock.
As an e.g. of the risk exposure an average GE investor is unawarely subjecting his investment to, consider GE Real estate’s (GE Capital’s subsidiary) investments in eastern european real estate (apartments/Flats) in the go-go days of 2006-07.
Now coming to Exxon, I agree with the author about Exxon being a “religion stock” to a certain extent, however, I disagree that Exxon is just that a “religion stock”. Or in other words Exxon pales in comparison in terms of hidden risks when compared to the Hydra, that is GE
In my opinion (without a deep dive into Exxon’s 10-k), I see Exxon more as a pure play than GE and have to agree with Falkmeister, that Exxon at this point in time, is more of a Dollar hedge than an annuity for the passive investor in search of higher yields with limited risk.
In conclusion it fair to say that an average investor buys GE for its stability and dividend, unaware of the magnitude of risk he is taking on, and in most cases guided by the “religion stock” sentiment as Mr. Katsenelson puts it.
However, an average investor in Exxon may still be making a good investment although his investment thesis for making the investment may be completely wrong (yield, stability and growth as opposed to dollar hedging), and hence will not be affected by the “religion stock” syndrome as much as a GE investor.
You cannot analyze Exxon as a normal company. There will be no significant growth in world oil production. Exxon is a reverse mortgage that is a perfect dollar hedge. A while back, I calculated that their oil reserves meant you were paying $30 per barrel, as long as the company is well run (check), sticks to their core business (check), that value will be realized. Short of another post-Lehman massive deleveraging spike-down, I do not see oil ever trading south of $60. And if it does, it will be only for a short time. I will gladly trade fiatcos for oil at that price.
There are reasons not to own the company: I like dividends, Exxon should be paying at least the 10 yr treasury yield, it ain't and thats my complaint. There are better plays than Exxon in the oil-patch, but this a solid comapny that is part of any portfolio that will weather the coming storm, and yes, I too have Gold, Bitches.
"...it pays a decent dividend of 2.1%"
Since when is a dividend of 2.1% "decent"?If you buy a stock that has a yield several percentage points BELOW the cash rate, you're making a highly 'pointed bet' on capital gains.
I realise that the S&P yield is hovering at about 2-3% - but that is ridiculously low by historical standards, and is usually associated with periods of sub-normal capital gains.
I understand that distribution policies in the US are partly due to the preference for buybacks over distributions due to differential taxation of dividends versus capital gains because of the STUPID lack of proper tax imputation on dividends... an issue that legislators in properly advanced countries dealt with two decades ago.
If it's trading at 9x earnings (an earnings yield of 11%) then it is only paying out a little over 1/5th of earnings as dividends; again, partly due to tax-driven distribution policies, but also implicitly a recognition by .
The observation that its earnings growth was driven primarily by global growth in the price of its product... that's something that any investor ought to be aware of: if people plonk money into a stock without having performed a proper disaggregation of the contribution of that sort of factor into EPS, then they are numpties. Output prices, exchange fluctuations (less important for XOM because it's all in USD), how the hedge book contributed... nobody should call themselves an "investor" unless they KNOW these things.
I hadn't held a position in an individual stock for YEARS (except for a CFD-based short of GS and INTC earlier this year) until my recent dabble in BP - which is ongoing - but it took less than 15 minutes of perusal and calculation to see that long-term it's a lay-down misère, and that daft numpties (including pension managers who are paid to think harder) are dumping the stock at the tail end of a media frenzy that ill be ancient history in 3 months - or will become the subject of 20 years of litigation (pace Exxon Valdez), whereby inflation will pay more than half of any bill.
Cheerio
GT
In my Humble opinion, sheer nonsense. OOps, sorry, Humble was bought by Exxon, no?
One has to wonder what's in store for XOM with the regulations (literally) going off the deep end and more environmentalists in charge. Add in cap & trade, and a portion of their profits will move to traders / exchanges. I also expect to see an FDIC-like charge for future spills, with the monies being protected as well as social security was under the lockbox. Then' there's the wildcard; Soros, Petrobras & the O-team $2B contribution. Brazil will invest over $200B in the next few years, drilling deeper wells than BP's GoM catastrophe, and without the insight of the braille team at MMS.
Petrochina, Petrobras and ?? seemed better poised for growth than XOM in the long-term, that is, until the US changes its anti-corporate / anti-shareholder /anti-bondholder policies for non-restricted investors (political club members excluded of course).
Jim Chanos agrees with VK. XOM is a self-liquidating intregrated oil co.
http://www.zerohedge.com/article/chanos-shorting-majors-ford-discusses-ways-express-chinese-bearishness
I believe this analysis is dated and I have an opinion contrary to the author. It's fine to short the smaller speculative exploration and production companies that have significant debt, but Exxon is the most politically connected and financially savvy firm in the energy industry. Please do not refer to this as an 'oil and gas company' because the petrochemical business of XOM is just as big as Dupont and Dow.
Plus, just like the investment banks, the integrated oils (Exxon/Shell/Conoco/Chevron) have engineering students, from around the world, who beg to work there.
There is a reason that Buffett has his personal , non-Berkshire wealth in Exxon, UPS and Coca-Cola. These companies will earn money globally for years to come.
Buffett is old and clining to the past, selling himself on CNBC. Every company eventually hits a wall e.g Welch kept the mirage of GE being a great company for decades before getting toasted. Chanos is short XOM for the same reasons as the author.
I would not be surprised if a bull(sh**) market develops in solars, geothermal, algae, wind companies.
Totally agree with you about Buffett. He's totally sold out to government, whom he sees as his partner in insurance, banking (GS, GE and WFC) and utility operations.
Women in summer would like to become beautiful. Everything can grab other's eyes is their best friends.Products make them beauty and confident is their favourite. Look in the street,you can see many different types of make up to show women's personality.
Welcome to the shop, the following is our products, free shipping.
Soccer Shoes Cheap Soccer Shoes Nike Soccer Shoes Adidas Soccer Shoes Nike Soccer Shoes sale Adidas Soccer Shoes sale UGG UGGs UGG Boot UGG Boots UGG Boots Sale Cheap UGG Boots UGG Boots Cheap Women UGG boots ugg boots cardy ugg cardy boots Nike Air Nike Air Max Nike Air Max Shoes Nike SB Nike Dunk Nike Dunk SB Nike Dunk SB Shoes Nike Shox Nike Shox Shoes Timberland Timberland sale Timberland boots Timberland boots online Timberland on sale New timberland boots Women Bags Women Bags Sale Women Handbags Women Handbags Sale Women New Bags Cheap Bags Cheap Bags On Sale UGG UGG boots UGG boots sale UGG boots short Short ugg Short ugg boots Ugg boots tall New women bags New women bags sale New women bags sale online Louis Vuitton Handbags Gucci bags Nike Nike Shoes Nike Shoes Sale Nike running Nike running shoes Nike trainers Nike trainers shoes Timberland Timberland boots Timberland boots sale Timberland boot Timberland boot sale Timberland boots cheap Men timberlands MBT MBT Shoes MBT Chapa GTX MBT Men Shoes MBT Women Shoes Discount MBT Shoes LV Handbags Gucci Handbags Chanel Handbags Chloe Handbags D&G Handbags Dior Handbags Fendi Handbags Hermes Handbags Jimmy Choo Bags Marc Jacobs Bags Miu Miu Handbags Mulberry Bags Prada Handbags Versace Handbags Yves Saint Laurent Balenciaga Bags Burberry Handbags LV Handbags Gucci Handbags Chanel Handbags Chloe Handbags D&G Handbags Dior Handbags Fendi Handbags Hermes Handbags Jimmy Choo Bags Marc Jacobs Bags Miu Miu Handbags Mulberry Bags Prada Handbags Versace Handbags Yves Saint Laurent Balenciaga Bags Burberry Handbags
Those who want to become most beautiful in the world should try them. Just ones can make you different. Girls who want to grab your boyfriends's heart is necessary to use them.