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Make money from oil? Try Exxon Mobil
High prices mean that Exxon Mobil is making tons of money and building a huge cash reserve. And you can buy this industry leader at a discount.
By Robert Walberg
Bolstered by higher commodity prices, Exxon Mobil ended 2004 with record net income of $25.3 billion on sales of $291.2 billion. It continued to pile up money in the first quarter, saying Thursday that it earned $7.86 billion, or $1.22 a share. The company's robust earnings streak is leaving it with a mass of cash, and investors are beginning to wonder when they'll get a bigger piece of it.
If cash is king, then Exxon Mobil is Midas. The company has amassed $18.5 billion in cash and cash equivalents. Since it generated more than $28 billion in free cash flow last year, investors should expect the cash total to continue climbing in the quarters to come.
Exxon on Thursday did show that it's using some of that cash, saying that it'll boost its share buyback by $1 billion this quarter.
But Exxon's management team is noted for being conservative with its balance sheet, and that's a good thing. While cash on hand has gone to $18.5 billion from $7.1 billion over the past five years, its debt-to-capital ratio has fallen to 7.3% from 15.4%. The end result is a favorable debt rating and tremendous financial leverage.
A deal? Not likely
Though there have been a number of mergers in the oil patch in recent weeks -- the most recent being Monday's announcement that Valero Energy (VLO, news, msgs) is acquiring Premcor (PCO, news, msgs) for $8.7 billion -- don't expect Exxon Mobil to use its cash to join the party. With the deal, Valero will become North America's largest refiner, surpassing Exxon Mobil. But it's paying a hefty price to do so. In fact, the deal is apt to put a strain on Valero's finances for years, not to mention the potential difficulties that tend to arise when merging two separate corporate cultures.
Related oil news and commentary
Obviously, Exxon Mobil has the financial wherewithal to make the kind of deal Valero did for all cash, but company history suggests that management will take a more prudent, albeit boring route. Two likely uses for the company's cash are increased dividends and continued share buybacks.
For the past 22 years, Exxon Mobil has averaged a 4.8% increase in the annual dividend rate. The dividend currently stands at $1.08 per share per year, for a yield of 1.82%. With so much cash on the books and more coming in each quarter, don't be surprised if management bolsters the dividend rate by one to two cents per quarter, pushing the yield to around 1.9%.
Boosting earnings via buybacks
Raising the dividend would be a nice gesture and consistent with management's practice of enhancing shareholder value. But it won't make much of a dent into the current mountain of cash. So management is likely to continue its aggressive share buyback program. By reducing shares outstanding, it boosts earnings per share. The buyback plan is one reason why Exxon Mobil has enjoyed better-than-peer earnings growth for the past decade.
With 6.4 billion shares outstanding, the company should have no trouble buying back stock. But once again, while that action helps increase shareholder value over the long term, it's unlikely to make a serious dent into the cash reserves.
What other options does Exxon Mobil have for all of that cash? Well, the company could announce a one-time cash dividend to shareholders similar to the one paid by Microsoft (MSFT, news, msgs) late last year. (Microsoft publishes MSN Money.) But with the demand for oil expected to grow considerably over the next couple of decades, it's unlikely that Exxon Mobil's management would want to significantly alter its financial leverage or freedom by making a large one-time distribution.
Though the decision to hoard cash might not appease some investors hoping for a big payout, look for management to stay the course and continue building its financial resources to ensure that it's in the position to expand its upstream capabilities as demand dictates. Unfortunately, in the oil business it can take years before investments in drilling begin to pay off. As the company continues to extend its reach into more emerging oil markets, it'll want plenty of cash on hand to fund ongoing development so that it can maintain its industry leadership position.
Rock-solid financials and more
Exxon Mobil might not offer the excitement or share-price volatility of smaller oil companies, but what it does offer investors are rock-solid financials, a proven, conservative management team dedicated to enhancing shareholder value, relatively consistent earnings growth and steady dividend increases.
Now, all of that is being offered during one of the sector's strongest up cycles in decades -- and it's available to investors at a discount. Traditionally, Exxon Mobil trades at a modest premium to the Standard & Poor's 500 ($INX) based on forward estimates. However, the stock is trading around a mere 13.4 times estimated 2005 earnings of $4.45. By comparison, the S&P 500 is trading at just over 16 times this year's projected earnings.
The discount becomes even greater if you assume that the high price of crude will enable Exxon Mobil to easily beat the consensus numbers. Assuming earnings closer to $4.90 to $4.95 for this year, or about 10% above current estimates, Exxon's forward price-to-earnings ratio slips to about 12, making it a big-time bargain, especially considering that the company is likely to buy back shares and raise its dividend.
It's rare to find a sector leader in the midst of a record-setting industry upturn trading at a considerable discount to the market. When you do, don't fret over how management might spend the growing cash on hand. Just thank your lucky stars and go out and buy the stock.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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