ExxonMobil (NYSE: XOM) is a $300 billion company trading at nearly 12 times earnings. Has this super major oil company reached a peak valuation -- or should these shares be an immediate addition to your portfolio?
My take: ExxonMobil is a buy. I have five reasons for it.
1. Easy oil is gone.
In the early days of the oil business, oil lurked, somewhat reliably, in certain geological formations. Wildcatters sought to capitalize on this untapped wealth. And while the oil business was never really "easy," it seemed like there was an unlimited supply. But that was not the case, and as many of the United States' largest fields have been tapped. Finding major new fields is becoming harder and harder. Most onshore oil reserves are government-controlled.
That's great news for Exxon. As a capable cost manager and with a reputation for delivering results on time, it's the go-to oil company to help nations develop their petroleum reserves. In the next two years alone, Exxon will start major projects in Qatar, Canada, Russia and throughout Africa, with scores of additional smaller projects to follow.
Easy oil might be over, but Exxon has access to vast reserves.
2. Easy oil is gone.
It's a good point, and it bears repeating. One of the lessons the public learned from the Gulf oil spill is that drilling technology is critical, especially in the difficult terrain where much of the world's remaining oil is to be found -- notably in places like the mountains of Afghanistan, where a trillion dollars worth of mineral wealth may reside.
That's another point in Exxon's favor. Not only it is a capable manager of drilling projects, but it recently paid $41 billion for XTO Energy, which has some of the industry's leading "non-conventional" drilling techniques. (The combined companies have more than 8 million acres of non-conventional reserves to explore.)
3. Strong forecasts.
Wall Street sees operating profits rising sharply in 2010. Some analysts see Exxon improving after-tax operating earnings by more than +50%. That growth will slow in 2011, but only to about +15% to +20%, as production increases (on the strength of a slew of major new projects) and as economic conditions improve worldwide, which will increase the demand for petroleum.
The market itself, the economy and most companies simply cannot compete with this level of growth, which should, in my opinion, have a favorable long-term impact on Exxon's share price.
4. Massive share buybacks.
One thing about the oil business is that it consistently produced the some of the strongest long-term return on equity available. When it puts capital to work, it expects to earn a rate of return. Disciplined oilmen will tell you they are just as proud of the deals they have not done as they are of the deals they've done.
One of Exxon's major deals of late has been a massive stock buyback plan. A buyback decreases the number of outstanding shares and has the effect of increasing earnings, as profits are spread over a smaller number of shares. In 2009, Exxon returned $26 billion to shareholders though dividends and buybacks. In the second quarter of 2010 alone, Exxon allocated more than $1 billion to buybacks.
If a company with the ability to earn some of the best returns available thinks its own stock is a good deal, that tells me something.
Exxon is clearly one of the world's leading oil companies, with huge revenue from so-called "upstream" activities like oil exploration and production as well as from "downstream" businesses like transportation, refining and retailing.
But Exxon does even more than that. It also has a strong chemical unit. The division showed a +273% increase in second-quarter earnings versus a year ago. This unit brings in 11.0% of Exxon's revenue, but more than carries its own weight, contributing fully 17.3% of net income to the bottom line, which not only is a nice boost to earnings but also helps to mitigate the inherent swings in prices to be expected in a volatile, commodity-based industry.
Action to Take --> With strong government ties to the world's largest reserves and a treasure trove of drilling ability and technology that can be deployed anywhere in the world, Exxon is a good buy. Add in strong growth potential, a commitment to shareholder returns through massive share buybacks and a diverse business line, and Exxon shares emerge as a great buy and a worthwhile addition to any long-term investor's portfolio.