As long-term dividend investors, beaten down dividend aristocrats always pique our interest. We often screen through the 150+ dividend stocks that have increased their dividends for at least 20 consecutive years, looking for those that have fallen out of favor. XOM has been one of the twenty worst performers on the list due to, you guessed it, the oil crash.
We love finding sources of safe, predictable, and growing income, but we hate dividend cuts. Anytime a long-term winner has fallen as fast and as hard as XOM has, you need to ask yourself if something has truly changed to warrant such a crash in the company’s valuation.
If the events causing the downfall are deemed to be short-term noise, you could have yourself a great buying opportunity.
In XOM’s case, we see enough to warrant adding it as a core position in our Conservative Retirees dividend portfolio.
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Viewing XOM’s key fundamental and dividend data helps us save hours of time finding and researching quality dividend stocks and is the source of most of the data referenced in our analysis below.
XOM is the world’s largest integrated oil company, providing it with more of a balanced portfolio than some of its peers. In an environment of crashing oil prices, this diversity helps cushion some of the blow faced by upstream operations.
As seen below, XOM’s upstream earnings are down about 70% YTD compared to last year, but the company’s downstream and chemical businesses have seen profits increase, resulting in a total profit decline of 49%. Far from pretty, but better than a 70% fall.
XOM’s capital discipline, quality assets, scale, and integrated portfolio have allowed it to generate superior returns on capital relative to its peers:
Source: Exxon Mobil Investor Relations Presentation
XOM has invested significantly in upstream projects in recent years, which supports future production growth. Last quarter, XOM produced 4 million oil-equivalent barrels per day, up 3.6% compared to the comparable quarter in 2014. Ramping production at some of XOM’s larger project sites should support low-single digit production growth over the next few years and downstream / chemical businesses will continue growing, but oil price will be the big wild card determining overall profit growth.
With oil being the determinant of XOM’s total return potential and safety of the dividend, let’s go under the hood to look at the company’s recent financials.
Exiting Q2, XOM’s cash balance stood at $4.4 billion. Through the first half of 2015, the company generated $2.8 billion in free cash flow ($3.9 billion including asset sales) but returned a whopping $8.8 billion to shareholders in the form of dividends ($6 billion) and share repurchases ($2.8 billion).
In other words, free cash flow was nowhere close to covering the amount of money returned to shareholders, so XOM either needs to use its cash on hand (only $4.4 billion) or tap the debt markets if it wants to continue its current return of capital to investors.
XOM did just that earlier this year, borrowing an additional $8 billion of debt to pay down near-term maturities and fund the dividend and buyback programs.
If oil prices stay put and XOM continues to generate around $6 billion in free cash flow every year (maintaining its existing pace), it would need to borrow $6 billion per year just to cover its dividend without dipping into its $4.4 billion in cash on hand.
Before panicking about a company borrowing to pay its dividend (yes, it is a wealth transfer), let’s review some of XOM’s key balance sheet metrics.
First of all, XOM’s Net Debt / TTM EBIT ratio is a very conservative 0.4x – in other words, the company’s net debt would be covered with less than half a year’s worth of EBIT. There is plenty of room for XOM to take on more debt if the current oil environment persists, and the company remains in very good standing with creditors – as recent as June 2015, Standard & Poor’s maintained XOM’s AAA credit rating and maintained its “stable” outlook.
Standard & Poor’s did downgrade XOM’s liquidity rating from “strong” to “adequate”, noting it will need about $60 billion to finance debt maturities, capex, dividends, and buybacks in 2015 compared to its $90 billion in cash, available credit lines, and expected cash flow generation over the next two years.
In other words, oil prices would likely need to stay low for at least another 6-8+ quarters before XOM’s dividend situation becomes dicey.
No one can predict where oil prices end up or when they recover, assuming they eventually will. With that said, the International Energy Agency estimates global oil demand will rise by about 1.7% in 2015 (up 1.6 million barrels per day to 94.2 million barrels per day). Non-OPEC production is expected to grow 1.1 million barrels per day in 2015 to reach 58.1 million barrels per day, leaving about 0.5 million barrels per day of demand to be met by incremental supply from OPEC, which is estimated to have spare production capacity of about 2.2 million barrels per day with Saudi Arabia holding over 80% of that spare capacity.
Volatility in China could mean oil demand grows a bit slower than the International Energy Agency’s estimates but, again, these things are unforecastable. Assuming non-OPEC production starts to slow in the next 12 months and the world does not enter another recession, gradually rising oil demand seems likely to mop up OPEC spare capacity within 2-3 years, creating a solid floor on pricing if it hasn’t recovered by then. XOM seems well positioned for this type of scenario and could likely take advantage of much weaker peers by buying their assets on the cheap.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. XOM’s long-term dividend and fundamental data charts can all be seen here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
XOM scored a Safety Score of 47, suggesting its dividend is safer than 47% of all other dividend stocks despite the collapse in oil prices and its need to tap debt markets. For comparison’s sake, XOM’s Safety Score topped CVX (43), BP (22), and COP (7).
XOM’s trailing twelve months EPS payout ratio (51%) and free cash flow payout ratio (215%) are elevated relative to history and will force the company to finance a portion of its dividend payments, as we saw happen earlier this year. The company’s credit rating and sturdy balance sheet make this task manageable for at least the next 1-2 years or more. Ultimately, oil prices will need to recover over the long-term if XOM is to continue paying its current dividend. Here’s a look at its historical payout ratios:
For dividend companies with enough operating history, it’s always a prudent exercise to observe how their businesses performed during the financial crisis. XOM’s sales fell 35% in fiscal year 2009, but it still generated free cash flow. As seen below, XOM has a decent amount of operating leverage as operating margins fell from 17.5% in fiscal year 2008 to 11.2% in fiscal year 2009. XOM’s operating margins have been just below 10% in recent quarters, highlighting how extreme the recent oil environment has been.
Despite the company’s cyclicality and sensitivity to oil prices, its scale and quality assets have allowed it to generate free cash flow every year for the past 10+ years. It’s always a bit comforting to own cash generative companies but even better when they have shown an ability to keep growing their free cash flow.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios.
XOM’s Growth Score is 14, meaning its dividend’s growth potential ranks well below the average dividend stock’s growth potential (a score of 50 is “average”). This shouldn’t be surprising given oil’s crash and XOM’s need to finance its current dividend payments. Until oil prices improve, dividend growth will certainly struggle.
As seen below, XOM has increased its dividend for more than 20 consecutive years, sitting at a 10% annualized clip over the last five years. Earlier this year, XOM raised its dividend by 6%. Assuming the company can weather the current storm and continue growing its dividend, it will remain in the S&P Dividend Aristocrats Index.
Yield Score
Our Yield Score simply ranks a stock’s current dividend yield against all of the other dividend yields in the market. A score of 50 means the stock’s yield is right in the middle of the pack. A score of 100 means it has the highest yield. The Yield Score helps assess a dividend stock’s relative value.
XOM’s Yield Score is currently 69, placing it nicely above the market’s average dividend yield and reflecting the fear and pessimism surrounding the energy sector. XOM’s 3.9% yield is appealing if you want to play in the energy space at all given the company’s healthy balance sheet and sheer size.
Valuation
XOM trades at about 18.5 fiscal year 2015 earnings estimates, which seem likely to mark the trough of net income. Looking out a few years, XOM trades at less than 12x earnings estimates built on a more normalized operating environment.
From a dividend yield perspective, XOM currently yields 3.9%, well above its 5-year average yield of 2.5%. XOM’s Yield Score is 69, meaning that its yield is higher than 69% of other dividend stocks’ yields.
Both of these valuation perspectives suggest the stock is reasonably priced, if not cheap.
Conclusion
For long-term focused dividend investors looking to take advantage of the drop in oil prices, XOM offers one of the safest dividends in the energy sector. The company will likely need to keep borrowing to pay its dividend and repurchase shares in the near-term, but its sturdy balance sheet should allow it to do this comfortably for at least 1.5-2 years.
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