Exxon Mobil’s Back to Growth

I don’t want to nitpick, but you have to work extremely hard to find any disparaging points about Exxon Mobil’s ($XOM) business, especially when the company is second only to Apple ($AAPL) in the race to be the largest company in the world according to market cap.

As much in love as I have been with Chevron ($CVX), Exxon has no rival when assessing its ability to convert oil and gas into cash flow and dividends. Not to mention, its impressive history of returns on capital. But the company has been far from flawless.

Lately, Exxon has been dealing with some operational deficiencies, which have worried investors. Not only has management dealt with rising costs, but also energy projects — which have in the past generated strong returns — have underperformed. And weak production growth, particularly in North America, has threatened the company’s long-term status as an energy power.

On the heels of a weak third-quarter report from rival Royal Dutch Shell (RDS-B), Exxon investors were chewing their nails in anticipation of the numbers the company was going to produce. But Exxon didn’t disappoint. The company posted a profit of $7.87 billion, or $1.79 per share, which beat Street estimates by 2 cents. This is despite a slight increase in costs and a 2.4% drop in revenue.

There was some uneasiness about Exxon’s revenue decline, which has been a struggle over the past several quarters. But unlike, say, the tech or financial sectors, revenue growth is not as important in the energy sector. The ability to replenish worldwide oil and gas consumption, which is known as “production,” is what drives Exxon’s earnings. While the company has done relatively well amid what remains a weak oil-priced environment, this quarter’s turnaround shouldn’t be understated.
Management grew production by 1.5% year over year. At first glance, this number might seem unimpressive. But what’s important here is that it ends the streak of eight consecutive quarters of production declines. When digging a bit deeper, organic production growth was actually closer to 3% when removing external factors, like requirements from OPEC (Organization of the Petroleum Exporting Countries).
What’s more, given that Exxon’s year-over-year liquid production advanced more than 5%, it’s fair to say that the company is now back to production growth. Plus, that the chemical business grew earnings by 30% means that even though the company’s expenses are on the rise (15% increase this quarter), management is using capital in ways that benefit shareholders. As I’ve said on more than one occasion, growth is not free.
To that end, given the uncertainty that still remains regarding oil prices, Exxon’s main challenge will continue to be production and exploration. I don’t see any other way to address the recent decline in the company’s refining unit. Not to mention, the continued struggle in the downstream business due to (among other things) weak margins. Management will need to find untapped oil resources, which also means an increase in production projects.
Exxon isn’t lacking in cash to fund growth. The question, though, is how much of the company’s existing capital is management willing to risk, given that recent returns on projects have underperformed? There’s been an environment of “throwing good money after bad.” But I believe the greater risk lies in doing absolutely nothing.
Despite the soft revenue and year-over-year decline in profits, Exxon has not lost its leadership role in the energy sector. While the stock is not going to excite investors with strong upswings, those who value safety can still do well here. Not to mention, Exxon is one of the best dividend payers in any sector at 2.8%. There’s no question that Exxon has seen better days. But with the slight uptick this quarter in production growth, I believe the worst is over.

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