Exxon Mobil: Sometimes The Turtle Beats The Hare

Over the past 15 years, the average difference between the bottom-up EPS estimate...and the final EPS number for that year has been +10.3%. In other words, analysts on average have overestimated the final EPS number by about 10% one year in advance. Analysts overestimated the final value...in ten of the fifteen years and underestimated the final value...in the other five years. [When correcting for the effects of recession events] final EPS number for that year has [overstated actual earnings by a rate of] +5.5% over the past 15 years.

Exxon-Mobil (XOM) missed the consensus in Q1 by $0.03, which equates to a miss of just under 3%, which in the grand scheme of things represents statistical noise. And while the long term tendency for analysts is to overstate earnings, there can also be non-synchronistic pessimism as it relates to laggards. This fact creates an imbalance between optimism and pessimism in financial markets, as analysts are not immune to the social pressure to pander to itching ears. In other words, analysts are prone to deliver rosy outlooks to well-performing sector peers, with inimical outlooks to underperformers.

The energy sector��and the oil sector in particular��have encountered a rather lengthy downturn. Swift increases have given way to retracements, and the market clearing price per barrel has (over the past four years) rapidly eroded due to the varied dynamics of oil shale. This, in itself, should not have a long term impact on profitability. In the short term (measured over a handful of years) it has been disruptive.

The question from an investment thesis is why invest in a laggard in the industry? ExxonMobil has underperformed the market on the basis of share price over the past few months. Reviewing fundamentals is a good place to start, but ultimately is not the answer for investors seeking to outperform the risk-adjusted market index (there is a concise aggregator to the myriad of fundamental ratios: price per share - which is to say that the equity price already largely reflects fundamental aspects). It is not therefore surprising to find some headwinds in the Exxon fundamental sail, given the relative stagnation of share price during a wild readjustment in the energy segment.

Exxon is by far the biggest U.S. integrated oil company. There is little question that Exxon is at the mature phase as far as the business cycle goes, which means that production growth will be low (with EPS dynamically tied to price per barrel), and a relatively substantial portion of investor return will take place in the form of the dividend. A considerable aspect for share growth lays in the ability to increase dividend payments, which Exxon has done reliably for 36-years. The 6.5% dividend increase this year represents definite added value to the long term investor, as long as such dividend growth can be maintained in the future.

Downside in the Oil Industry

There has been increasing indications that future technologies will become progressively less dependent on fossil fuels. The clearest market indication of this is Tesla (TSLA) who, at a Market Cap of $47B, is just $5B below GM. This is a remarkable statement of support by the market in favor of the long term necessity and sustainability of electric vehicles, given the fact that GM revenues are well over ten times Tesla��s; Ford��s net income is currently $10B more than Tesla��s -2.3B (GM recently took a massive write-off due to taxes, so the comparative is less contiguous).

The potential demise of oil would, of course, decrease investor value in the oil side of the energy sector. Consider this particular condition to be something of a nebulous risk; the degree to which we need to adjust our energy sources is a matter of great debate, and even if transportation predominantly shift to electric, this will merely increase demand for natural gas. There is no consensus forecast the has renewables capable of handling the majority of energy demand in the next twenty years.

It is possible that we will move entirely away from oil, engage in a hybrid energy source, or discover a cleaner formula (either with oil, or hydrogen, or some other source) which the energy sector can pivot to. If the future of energy ends up being in chemical production on a large scale (which in some form or fashion seems likely) it seems likely that the energy infrastructure will provide the basis for new production. Think of Apple (AAPL) and Microsoft (MSFT) pivoting to the cloud, among other paradigm shifting technologies.

The future of energy consumption exists on the unpredictable long term horizon. Shorter term dilemmas relate to the dynamics between oil shale and traditional oil wells. Shale is much easier to deploy on the basis of relatively short term increases in oil price, as shale (though more expensive to drill) has a more compressed lifespan, which means it is less sensitive to price shocks. An increase back to $100 plus oil is not likely short term. It is probably not in the cards for the next several years. But a range of $70-$85 certainly is. A prolonged decrease to sub $50 oil is possible as well, though it is becoming progressively less and less likely at outlooks progress.

Exxon Upside

The contrarian method revolves primarily around the idea that persistent, negative sentiment will sometimes give way to misevaluation of an equity. If the broad market is convinced that a stock is on its way up (which is the case anytime price is increasing) it becomes difficult for analysts to not succumb to the temptation to tell the people what they want to hear: if you tell people what they want to hear and are wrong, there is generally little consequence. If you tell them something that they do not want to hear (that they will lose money) you had better be right, and even then you will not necessarily be liked. This is a universal form of human peculiarity.

When an entity in a beleaguered industry stagnates comparative to its peers, pessimism becomes more natural. The long state of underperformance can create an internal reluctance among the broad analytical population which will poison (or at least temper) projections. ExxonMobil, as a part of the integrated oil sector, has emerged from a multi-year hiatus to significant underperformance as compared to the broad market. Topped onto this, the new corporate tax rate (which is broadly beneficial to corporate bottom line) is not producing an immediate positive for Exxon. The current earnings call disclosed somewhere between $700-900M per quarter in hits associated with the tax change throughout the remainder of the year.

On the contrary, companies more invested in refining such as Phillips 66 (PSX) and HollyFrontier Corp (HFC) have found themselves in a much more advantageous position to realize significant earnings growth, while simultaneously capturing tax gains. Still, increases in oil prices traditionally produce headwinds for refiners�� margins. If you are not already holding shares, now may not be the time to gain entry (at least as far as a contrarian is concerned) in a refiner.

This is not to say that a pure contrarian will outperform the market (if they did, we would soon all become contrarian), just that under certain circumstances a contrarian can. So can a value investor, or a technical trader, or any of the other hundred techniques. You do not use a wrench for every job. Sometimes a screw driver is superior, or a hammer. So the question here is not what the contrarian position is with regards to Exxon (and, frankly, a decision to buy Exxon right now may not technically even be contrarian��though underperforming its market index, Exxon has nonetheless been appreciating) but rather whether the market attitude with regards to Exxon goes beyond neutral analysis into secular pessimism, which is the wheelhouse of contrarian gain.

The integrated oil sector has underperformed the market by quite a bit over the past 5 years. Still, with competitor Chevron (CVX) appreciating significantly, this reality is clearly (in and of itself) not a hindrance to optimism. History can produce pricing drag, but it is easily be overcome by the combination of good earnings results and a positive sector outlook.

An odd smattering of other factors has conspired to hold ExxonMobil down. The tax disadvantage is one, but again it is not entirely unique to Exxon. Another is the downfall of Rex Tillerson. The former Secretary of State under Donald Trump (which is a contentious position to begin with), Tillerson lost his title on March 31st. Not only was Tillerson widely linked in the media to his former job as CEO for ExxonMobil, but the contentious loss of his title has the intonation of costing ExxonMobil influence. It is impossible to create a discount on the basis of Tillerson��s career in government, but that does not mean that it does not influence to some degree the subjective portion of analysts�� conclusions.

More directly influential is the stumbling from the starting block that Exxon has encountered following the resurgence in crude prices. Quarterly results inflect varying degrees of noise, but of note for Exxon investors was a short statement on the most recent conference call by Jeff Woodbury - Vice President, Investor Relations: �� Oil equivalent production in the quarter was 3.9 million barrels per day, a decrease of 3% compared to the fourth quarter of 2017��[and] oil equivalent production decreased 6% compared to the first quarter of 2017.��

Woodbury goes on to specify upcoming projects which underlies that the production shortage is not the result of a lack of resources to generate earnings, but instead reflects a shift in resource production that generated a transient production shortfall. Given the scope of ExxonMobil holdings it should be an easy explanation to accept, yet the market has so far proven conservative in assigning a premium on the basis of a forward ability to translate increasing oil prices into bottom line cash flow. When you are dealing with a low beta company, you should expect conservative price projections; it is possible that this (on a case-by-case basis) creates a correlation between stagnation as related to price appreciation, and the actual appreciation that will occur over the next few years.

Conclusion

When comparing integrated oil conglomerates Chevron and ExxonMobil, the delta in price appreciation between the two is striking. While Chevron has a more rosy growth outlook, it is certainly not worthy of the multi-digit percentage that relative price appreciation would indicate. There are three options here: that Chevron is overvalued and will fall back to Exxon levels (unlikely, unless oil prices significantly retract); that Exxon is in the midst of a double-digit decrease in earnings (itself highly unlikely); or that secular sources have produced headwinds to Exxon investor appreciation. I contend that the third option is the most likely. Ultimately future earnings will detail Exxon fortunes. Betting in the short term against secular motion is a fools game. For the long term investor, Exxon rewards the wait for a return to normative value with a 4% dividend.

Disclosure: I am/we are long XOM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.