Description

Exxon Mobil Corporation (XOM)                                                                                                                 12/22/09

Target Price (NAV): $88.68 using NAV, $95.28 using a 12.0x multiple on 2011 EPS                               

Current Price: $68.57 (77% of Equity NAV)                                                                                                                                        

Recommendation—Long XOM via XTO shares.  See the bottom of the attached sheet for details, but basically my recommendation is that you buy XTO shares for the purpose of acquiring XOM shares once the deal closes.  Currently you can buy XOM shares at a 3.2% discount by buying XTO given the ratio of 0.7098 XOM share per XTO share which gets you to $48.67 (.7098 x XOM stock price of $68.57) compared to the current XTO share price of $47.12.  That spread should close when the deal closes, which is currently estimated to be 6/30/10.  Annualized, that return is 6.4% if the deal closes as planned.  The majority of XTO's assets are U.S. unconventional natural gas, which was the only real hole in the XOM portfolio, and so I anticipate no anti-trust resistance.  The only real regulatory issue would be if hydraulic or other fluid fracturing is prohibited in the U.S. (XOM specifically wrote this into the deal language) which I view as a very remote possibility because it would mean that unconventional gas cannot be retrieved and then immediately we would have a massive gas shortage because shale gas would no longer be accessible, in which case you own XTO which is highly leveraged to gas (although as we discussed before, XTO is disadvantaged in many ways as well, most of which will be solved in the arms of XOM).  The bottom line is that you are buying XOM at a 3.2% discount to XOM stock by buying XTO shares at the current price.  

XOM Thesis:

1) Excellent Risk-Reward: Revisiting the time when everybody thought the world was ending during 2008, ExxonMobil's stock traded down from $94.56/share on May 20, 2008 to $62.35/share on October 15, 2008, and then it revisited these lows hitting $62.22/share on March 5, 2009.  Today, with the world arguably in repair as the result of massive fiscal stimulus and quantitative easing among central banks, XOM stock sits at $68.57 which is only 10% off of its lows in March.  In the meantime, the S&P has rallied ~65%.  One may come back with the argument that on a two-year basis the S&P is still down ~24% through today while ExxonMobil held up better last year, but the fact is that XOM shares are down 28% over the past two years.  It is unlikely that XOM goes back to where it was in March, but if it does you may lose ~$6, which is unlikely given that the company should earn substantially more next year just based on current projects that are starting up and high single-digit production growth on top of higher oil and gas prices assuming the strip.  Based on a NAV analysis, XOM is worth $90.  That is $21 up and $6 down, a 3.4:1 upside-to-downside ratio.  Realistically, you probably have a better risk-reward than that with $2-3 of downside and the same upside.  If the market goes down materially, XOM should go down a lot less, too.

2) ExxonMobil is significantly undervalued relative to almost all methods of intrinsic value appraisal, including NAV and Sum-of-the-Parts and using a simple earnings multiple. On a pro forma basis, XOM has captured 79.5 billion barrels of oil-equivalent resources (52% liquids/48% nat gas before the XTO deal and 49% liquids/51% nat gas pro forma), with 25.3 billion barrels of oil-equivalent proved reserves and 54.2 billion barrels of oil-equivalent potential resources.  XOM is currently trading at 77% of my NAV, which is as cheap as I can find on a NAV basis at least in the last decade.  Another way to look at it is that if you multiply XOM's pro forma 25.3 BBOE of proved reserves by $14.50/bbl for proved reserves (assuming peer proved multiples on proved reserves of $13.20/bbl, and assuming a 10% premium valuation to its peers), you are getting its 54.2B barrels of resource potential and its some of the very best and most profitable refining and chemicals assets in the world for free.  $14.50/bbl x 25.3 BBOE = $366.8B EV, less $7.3B of pro forma net debt = $366.8B of Equity Value just from proved reserves value.  XOM current market cap = $325.5B + XTO current market cap = $27.3B = $352.9B. $366.8B minus $352.9B combined current market cap of XOM & XTO = $13.9B excess value, before taking into account Exxon's Downstream/R&M assets, its Chemicals assets, and its 54.2 BBOE of resource potential.  Lastly, Exxon should generate $6.90/share in EPS in 2010, and $7.94/share in 2011 assuming the commodity strips, which compare favorably to the consensus estimates of $5.82 and $7.51, respectively.  This implies that the greatest, most valuable collection of energy assets in the world is available at <10x EPS when typically it has traded at a significantly higher earnings multiple.

3) Even though it is the largest company in the world at $325B of market cap, analysts and investors do very little work on it and as a result it is probably one of the most misunderstood companies.  Most invest in it because it is in the index and therefore they have to own some of it, when there is a flight to safety investors flock to it, or this year many (including most sell-side analysts) have used it as a source of funds as a short so that they could buy higher beta oil and gas E&Ps and "oilier" integrated companies (CVX, OXY, etc.).  Most deem it too large to add any value by researching it, too difficult to find an "edge."  Exxon is, in fact, analyzable.  The biggest misperception/myth?  Production growth, which the street is obsessed with in each and every report, is key to equity value creation in the industry (this is not the case on a per-share basis).  Sell-side analysts often refer to ExxonMobil as "structurally impaired" in fact, given its size and that fact that it is not growing production--after all it is difficult to grow annual output when you produce ~4.0 MMBOE/d.  The reality is that production growth does not matter if equity holders are diluted repeatedly in order to achieve that production growth (as is the case with most E&Ps and some integrated companies--think CHK, HK, etc.).  

Importantly, analysts are correct that XOM has produced around 4 MMBOE/d for the last decade since the Mobil acquisition (4.3 MMBOE/d in 1998 to 3.7 MMBOE/d in 2008, a -1.5% CAGR); however, the Company has also repurchased 32% of its shares outstanding since 1998 (a -3.8% CAGR), thus production (in Bbls/100 shares) has actually increased from 22 Bbls per 100 XOM shares to 28 Bbls per 100 shares in 3Q'09.  The result has been that Book Value per share has grown from $9.30/share in 1998 to $23.34/share at the end of 3Q'09, a 10% CAGR.  Based on its Balance Sheet and current Upstream/E&P project outlook, and its laser focus on returns, I anticipate that the coming years will see similar per-share value creation.

4) XOM is probably one of the best-managed cyclical companies in the world, which is evident when you examine its returns through the cycle, or its profit-per-unit through the cycle, which in this case is profit per barrel.  Unlike most energy/natural resources companies that are serial destroyers of equity value, ExxonMobil invests counter-cyclically by buying its own stock back at the peak with the strong cash flow from high commodity prices, and then it ploughs cash into prudent acquisitions during depressed years using a 20-year time horizon and conservative commodity price assumptions.  The value created over time accrues to equity holders because of its rock solid balance sheet that at the end of 3Q held $3.02B of net cash ($7.34B of net debt on a pro forma basis, which compared to $75B of pro forma estimated '10 EBITDA is <0.1x leverage).

Catalyst

Earnings estimates are too low for 2010 and 2011 using the NYMEX strip prices, and production growth and returns on invested capital (which should drive the multiple higher) should pick up materially given that production has now commenced on 4 of its 5 large LNG trains (5 of 5 as of 1Q'10) in Qatar where very large sunk costs now give way to exceptionally low-cost production.  As a result, the multiple should also expand.  Additionally, while only ~20% of earnings through the cycle, ExxonMobil's Downstream/Refining and Chemicals segments are cyclically depressed such that any pick up in economic activity should lift both businesses and drive incremental earnings growth.  On the downside, again, if the market retreats materially you have substantial downside protection given that it is only $6 off of its "world-is-ending" level from Oct '08/March '09.