Just a few short weeks ago, energy investors were running for cover as the demand erosion caused by efforts to stem the spread of the coronavirus whipsawed stocks and futures. The price of WTI oil fell below $30, $20, $10 and even went negative for a while. Remember, the commodity started the year at around $60 a barrel. This led analysts to sharply reduce their forecasts for the oil sector components. Investors got spooked too, and responded with a broad sell off in equity that included integrated majors like ExxonMobil XOM and Chevron CVX – both falling to multi-year lows.
The oil collapse and the subsequent stock price decline brought to the fore the question as to whether the two U.S. oil energy behemoths continue to make sense for conventional investors.
Right now, the clear answer is a ‘yes’.
Let's take a look at the reasons:
Impressive Q1 Results: The first-quarter results 2020 were out a few weeks ago, and the so-called supermajors put up an impressive show. Defying the price plunge, they actually beat on earnings, producing EPS that was significantly higher than the Zacks Consensus Estimate.
ExxonMobil’s earnings per share of 53 cents easily surpassed the Zacks Consensus Estimate of 4 cents, thanks to growth in production volumes from the prolific Permian and Guyana oil resources. Chevron, meanwhile, reported adjusted first-quarter earnings per share of $1.29, above the Zacks Consensus Estimate of 64 cents. The beat was driven by strong production from the Permian Basin and higher margins on refined products.
Integrated Structures: Both companies are fully integrated, meaning they participate in every aspect related to energy — from oil production, to refining and marketing. As such, they are the ones that are best in adapting their business model to the prevailing scenario.
Thanks to their integrated structures, companies like ExxonMobil and Chevron are able to withstand plunging oil prices better than the rest and protect their top and bottom lines to a certain extent. With the refining unit of these conglomerates being buyers of crude – whose price is in a freefall – their profitability improves due to a fall in input cost.
Upstream Results Should Keep Improving: Both reported dismal first-quarter results in the upstream segment, which deals with oil and natural gas exploration, field development, and production. ExxonMobil and Chevron faced the wrath of plunging crude and natural gas prices in the quarter. While output gains contributed positively to results, the historic meltdown in realizations put pressure on the companies’ E&P segment profits. ExxonMobil’s quarterly earnings of $536 million plunged from $2.9 billion a year ago, while Chevron’s upstream segment income was down 6.5% year over year to $2.9 billion.
But it seems that crude’s worst losses are in the rear view mirror with signs of gradual rebalancing. Therefore, going forward, it is highly probable the upstream portfolios for both ExxonMobil and Chevron will see improved profitability due to recovery in oil prices in particular. Additionally, their low-cost structures and high-margin production should help prop up segment margins.
Dividend Safety: Investors are typically attracted to ‘Big Oil’ companies, thanks to their reliable dividends and defensive characteristics. These oil and gas industry kings usually consider high payouts as sacrosanct and do their utmost to continue paying them. But this time things seem to be different. This earnings season, Norway’s Equinor ASA EQNR cut its dividend, becoming the first oil major to reduce payouts amid a steep oil price plunge in a bid to preserve liquidity. But what caused the greatest shock among investors was the decision by Royal Dutch Shell RDS.A to cut its dividend.
ExxonMobil and Chevron - the only two energy stocks on the list of Dividend Aristocrats – have said that they would keep paying shareholders a quarterly dividend. ExxonMobil has a $3.48 annual payout and a 7.5% yield, while Chevron’s yearly dividend of $5.16 offers a yield of 5.5%. With the companies portraying their dividend resilience during the bust cycle of energy prices, the expected rise in levels of net income in tandem with oil price recovery should give income investors even more confidence in the payout holding out.
Balance Sheet Strength: A sustainable dividend is more than just yields and payouts. A company must maintain a strong balance sheet to sustain their dividends when the going gets tough. In that respect, net debt (or total debt less cash) is of paramount importance. Of the two companies, Chevron has a net debt of $23.9 billion, followed by ExxonMobil’s $20.4 billion. In other words, ExxonMobil and Chevron have a healthy balance sheet.
Next, we look at gearing, or the ratio of net debt to total capital. ExxonMobil and Chevron’s low net debt translates into gearing ratios of just 9.3 and 14.2, respectively - very manageable indeed. Further, both carry high investment grade ratings, which translate into low borrowing rates.
Focus on Capital Discipline: If there's one thing the commodity price crash has taught oil and gas companies, its capital discipline. In view of the coronavirus-induced demand destruction for oil, ExxonMobil has slashed its 2020 capital budget by 30% to roughly $23 billion. The integrated firm has also decided to lower planned cash operating expenses for this year by 15%. Meanwhile, Chevron now expects to spend $14 billion for the year, compared to its previously lowered estimate of $16 billion and 30% less than its initial projection. The company is also targeting $1 billion in operating cost cuts.
As it is, over the past few years, ExxonMobil and Chevron have made dramatic progress in lowering their operating cost structures, with a barrel of production now costing around 30% below 2014 levels across most regions. The cost improvements should support operating profitability and lead to greater cash flow.
Given how much volatile commodity prices are, it would be prudent for the conservative income investors to stick to companies with proven track records. There are none better in this regard than ExxonMobil and Chevron. Both these firms have restructured their operations, divested lower margin properties and positioned themselves to thrive even amid the wild price swings.
With oil prices set to rise in the near-to-medium term, the supermajors appear attractive plays for investors right now. Both carry a Zacks Rank #2 (Buy), further validating their potential. Even if oil prices continue to stay weak for a long time, ExxonMobil and Chevron should continue to see solid cash flows, earnings and revenues.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Right now, their stocks are affordable with a favorable risk-reward profile. Investors looking for safe energy bet can, buy ExxonMobil and Chevron for income and capital appreciation.
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