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By Will Ashworth
| November 2016
Mike Mozart via Flickr
With just two months left in the year, investors are beginning to look farther down the road, to 2017 and beyond. Out with the old, in with the new; you’re stocking your portfolio with a bunch of winners that will deliver market-beating returns for years to come. Many of you are likely to consider Exxon Mobil Corporation (XOM).
For the next 12 months, XOM is dead money — perhaps longer. Here’s why I believe this to be the case.
Ildar Sagdejev via Wikipedia
Although you might be tempted to consider XOM stock given its performance over the past 16 months — Exxon Mobil stock is up 4% since the end of July 2015, which is better than the Energy Select Sector SPDR ETF (XLE) and S&P 500 in that time — there are better options if you’re looking for a rebound from large-cap energy stocks.
Goldman Sachs is so convinced that Exxon stock is dead money that it has taken XOM off its conviction buy list, downgraded it to “neutral” and lowered its target price by $5 to $93. Not surprisingly, XOM stock dropped on this news. Of course, a poor third-quarter 2016 earnings report didn’t help. But I’ll get to that.
In the meantime, it’s important to remember that Goldman Sachs has a history with XOM. In March 2015, it resumed coverage of Exxon Mobil with a buy rating and a $97 target price. Four months later it upgraded XOM to a conviction buy and a new target price of $95, two bucks lower than in March.
A strange move, I’ll grant you, but the energy sector is anything but predictable these days.
When Goldman Sachs resumed coverage of XOM on March 9, 2015, it closed trading that day at $85.16. When it added the stock to its conviction buy list on July 22, 2015, it closed trading at $81.79. On Monday, Exxon Mobil closed at $83.32, 1.8% higher than Goldman’s July 2015 upgrade but 2.2% below its price when it first resumed cover earlier that year.
A skeptic might say that Goldman Sachs doesn’t know what it’s doing. That’s a real possibility. However, it’s equally possible that Goldman has given up hope that Exxon Mobil will do anything in the next 12 months to warrant its stock price moving higher. Sometimes walking away is the best solution.
Now, Goldman Sachs feels Chevron Corporation (CVX) is the horse to ride.
If you’re curious, CVX stock is up 12% since Exxon Mobil was added to Goldman’s conviction buy list, more than 10 percentage points better than its rival over the same period.
Brian Katt via Wikipedia
InvestorPlace energy guru Aaron Levitt regaled readers recently with the good, the bad and the ugly of Exxon stock. He pointed out something that corporations these days are doing far too much and that’s paying out more in dividends than they generate in earnings.
In Exxon’s case, it paid out $3.1 billion in dividends and earned just $2.7 billion. Now, that might not be a problem if it generated sufficient free cash flow to cover the dividend payout but that wasn’t the case. Net cash provided by operating activities in Q3 2016 was $5.3 billion; capital expenditures were $4.2 billion leaving $1.1 billion in free cash to cover $3.1 billion in dividends.
It wisely didn’t repurchase any of its shares in the quarter.
The hypothesis for buying Exxon Mobil stock at this point, as far as I can tell, is to get paid a reasonable dividend yield of 3.5% per annum until oil prices recover and then watch as the billions roll in and XOM stock goes to the moon.
That’s great if oil prices recover. But what if they don’t? How long can Exxon continue to pay this wonderful dividend if its cash flows are moving sideways on a sequential basis?
Not very long.
To make money in the oil business, you have to spend money. That’s why Goldman’s looking to Chevron instead of Exxon Mobil. It can’t keep cutting capital expenditures like it’s some junior oil company on the Toronto Stock Exchange. It has to feed the beast.
I’m not a huge oil guy but it seems Exxon has been facing this production dilemma for many years now and if it won’t make an acquisition to prime the pump it’s going to have to spend organically to deliver future cash flow.
Until it does one or the other I don’t see how XOM stock can move anywhere but down.
The last reason XOM is dead money has less to do with its business and more to do with the stock market in general. The S&P 500 was up 4% through Oct. 31. Energy stocks, meanwhile, are up 12.6% in the same period with oil and gas exploration and production companies up an additional 470 basis points compared to the sector as a whole. With the exception of the utilities sector, energy stocks are the best-producing sector in the index so far in 2016.
That’s the good news.
The bad news is that the S&P 500 is up for the eighth consecutive year. A Hillary Clinton victory in the presidential election might keep the gravy train going for a little while longer, but eventually, there is going to be a big correction and energy stocks like Exxon won’t be immune to the downturn.
Goldman originally liked Exxon Mobil stock because it was a defensive play in the energy sector. Now it feels as though big oil has to go on the offensive to generate production growth and future profits.
Exxon’s not exhibiting the traits of a company on the hunt for oil and that’s going to hurt it should the markets start reversing course.
For these three reasons, I see Exxon Mobil as dead money.
This article is by Will Ashforth of InvestorPlace. As of this writing, he had no position in any stock mentioned.
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