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Analyst Note 03/07/13
ExxonMobil XOM
held its annual analyst day Wednesday where it provided updated
production guidance and shed light on what is shaping up to be a
well-stocked upstream cupboard. At the same time, the firm raised its
capital spending forecast in what seems like an annual tradition.
Downstream operations also took center stage as Exxon highlighted its
advantaged position, particularly in the United States.
After a
disappointing 2012, when production fell nearly 6%, ExxonMobil expects
2013 production to fall another 1%. However, the headline number is not
as negative as it appears, in our opinion, given the underlying mix
change. Liquids production is expected to grow 2%, thanks in part to the
Kearl oil sands project startup, while natural gas will drop 5%. The
decline in natural gas volumes is in part due to natural decline in
Europe, but also a result of the aggressive shift in Exxon's domestic
rig count away from dry gas plays. The company previously stated it has
transitioned two thirds of its rigs to liquid-rich plays. Given the low
natural gas prices, the reduction in activity makes sense. The mix shift
should also help address ExxonMobil's lagging earnings per barrel
metric. CEO Rex Tillerson expressed frustration with the metric's
deterioration over the past few years and stressed that improvement
remains a focal point, even suggesting underperforming assets could be
sold if management cannot identify a path to improvement.
Longer-term
production guidance is for growth of 2%-3% per year for 2013-17. The
growth should be driven by liquids growth of roughly 4% per year and
natural gas of 1% per year. Exxon actually expects natural gas
production to fall through 2014 because of the U.S. dry gas activity
reduction, but to begin growing again in 2015 thanks to the addition of
liquid natural gas projects in Australia and Papua New Guinea. As a
result, liquids-price-linked production is expected to grow 3%-4% per
year. Also, Exxon now expects capital spending to average $38 billion
per year excluding acquisitions through 2017, compared with guidance of
$37 billion (2012-16) previously. We plan to incorporate all the new
guidance into our forecast, but do not expect a change to our fair value
estimate or moat rating.
Thesis 12/06/12
ExxonMobil
sets itself apart from the other majors as a superior capital allocator
and operator. Through a relentless pursuit of efficiency, technology,
development, and operational improvement, it consistently delivers
higher returns on capital relative to peers. However, we think ongoing
low U.S. natural gas prices are likely to prove a drag on returns, which
could fall behind those of more oil-exposed peers.
Longer term, we think Exxon will probably retain its top spot, but
delivering returns on par with historical levels could be more difficult
as it faces the ongoing challenge of reserve replacement. With a
majority of the world's remaining resources in government hands,
opportunities for the company to expand its large production base are
limited. However, we believe Exxon's experience and expertise,
particularly with large projects, should allow it to successfully
compete for resources.
While we believe Exxon has an advantage in the current environment,
that does not necessarily mean production and reserve gains will come
easily or cheaply. Exxon's need for projects of a certain size in order
to contribute meaningfully to its production profile and justify
investment leaves it with an diminishing set of opportunities. In
addition, investing exclusively in large projects exposes the company to
a variety of risks including overinvestment risk, execution risk, and
budgetary risk. Future projects will also probably rely on resources
with higher extraction costs because of their lower quality (bitumen),
location (deeper water) or stimulation requirement (fracturing).
Greater competition is also becoming an issue. Many available large
projects will be done in partnership with national oil companies. To
gain access, Exxon must not only demonstrate its value but may also have
to agree to production-sharing agreements that are not as advantageous
as in the past. More often, management is faced with a tough decision:
Take less favorable terms on more projects, or focus on projects where
its expertise is highly valued. A good example of the latter case is
Exxon's recent deal with Rosneft to explore for oil in the Russian
Arctic. If Exxon is able to exploit similar opportunities where it can
add oil reserves with attractive terms thanks to its value proposition,
then it can probably continue to deliver superior returns on capital.
Faced with these challenges, Exxon is turning to relative political
safe havens to drive growth like the United States and Canada. In the
U.S., growth will largely come from resources added with the acquisition
of XTO. While the acquisition largely consisted of natural gas reserves
and production, it also held acreage in tight oil plays to which Exxon
has subsequently added, namely in the Bakken and Duvernay. It is now
also shifting its drilling activities to these more liquid-rich plays in
light of low prices. Exxon has cut its rig count to 50 from 70 last
year and is using two thirds of those rigs in liquid-rich plays as
opposed to less than half previously. That said, we still expect returns
to suffer as low prices depress profits and shale gas invested capital
sits idle.
Exxon also has promising offshore discoveries in the Gulf of Mexico
that should be developed in the coming years. In Canada, Exxon's
reserves are primarily oil sands, both mining and in situ. Its largest
project, Kearl, will come on line in late 2012. While Kearl initially
will add about 100 thousand barrels a day of oil production, oil sands
mining projects typically fall on the upper end of the cost curve. We
think Kearl is better positioned than other projects because it does not
require an upgrader, but it still is indicative of the move to
higher-cost resources by Exxon in the face of increased resource
nationalism.
Another way Exxon is tackling its growth/reserve replacement issues
is by investing in projects like oil sands and LNG that produce at
plateau production levels for longer than traditional projects, some up
to decades, and reduce its overall decline rates. Also, relatively
little reinvestment is required after the large initial up-front
capital, resulting in significant free cash flow generation after
startup. We estimate nearly 40% of Exxon's production will come from
these types of projects by 2016. However, most are large projects,
especially the LNG developments, and thus hold the aforementioned risks.
Despite growing investment in the U.S., Exxon is not stepping off the
international stage or away from political risk. Asia and Africa
continue to be the company's largest producing regions and we expect
them to continue as such, with numerous projects scheduled to come on
line over the next five years in Nigeria, Angola, and Kazakhstan. Exxon
also has the potential for shale resources in Europe and South America
that would allow it to leverage its acquired unconventional technology
and bolster its value proposition and competitive advantage in the
global competition for resources.
We
are maintaining our fair value estimate of $91 per share after lowering
our long-term natural gas price assumption from $6.50 per thousand
cubic feet to $5.40. The lower natural gas prices reduces our fair value
by $5, all else equal. However, the reduction is largely offset by the
rise in short-term oil prices since our last update. Our long-term
forecasts and assumptions incorporate a more challenging operating
environment as well as a decline in returns on capital relative to
historical performance over our forecast period.
Our fair value estimate is approximately 4.9 times our 2013 EBITDA
estimate of $86 billion. In our discounted cash flow model, our
benchmark oil and gas prices are based on Nymex futures contracts for
2012-14. For natural gas, we use $2.87/mcf in 2012, $4.08 in 2013, and
$4.08 in 2014. Our long-term natural gas price assumptions for 2015 and
2016 are $5.40. For oil, we use Brent prices of $112 per barrel in 2012,
$108 in 2013, and $104 in 2014. Our long-term oil price assumptions for
2015 and 2016 are $99 and $102, respectively. We assume a cost of
equity of 8%.
We forecast a compound annual growth rate for production of 1.1%
during our forecast period. Growth should be more robust in outer years
after falling approximately 3% in 2012. We expect Exxon to actually
increase oil volumes (1.8%) at a greater rate than natural gas (0.4%)
over our forecast period thanks to large project startups over the next
three years. Our forecast is slightly below management's forecast to
compensate for the potential negative effects of higher oil prices
related to production-sharing contracts as well as the risk associated
with larger projects. Full realization of management's guidance could
offer upside to our valuation, while extensive delays or reduced U.S.
natural gas production due to lower prices could result in downside
risk.
Refining margins have staged a recovery in the past year. However, we
model slight margin weakness over the next couple of years with an
improvement in the later years of our forecast. While ExxonMobil should
benefit from highly complex facilities and access to growth markets, it
has only limited exposure to wide U.S. domestic sweet crude discounts.
However, that should change in the future as additional pipeline
capacity brings domestic and Canadian crude to the Gulf Coast, improving
ExxonMobil's access to discount feedstock. Meanwhile, we anticipate
chemical earnings to remain tied to economic activity.
For a company with global operations, geopolitical risk is
always an issue. Past events in Russia, Nigeria, and Venezuela
underscore the risk associated with doing business in those
countries. These risks will only become greater as Exxon expands
its global production portfolio through partnerships with NOCs. By
investing in large, capital-intensive projects, Exxon also runs the
risk that commodity prices will decrease dramatically, making those
projects no longer economical. Deterioration of refining
fundamentals in the U.S. and Europe may continue to damage
profitability long after an economic recovery.
Management & Stewardship
Rex
Tillerson became chairman and CEO in 2006. Previously, he served as
president. He has spent his
career with Exxon, beginning in 1975 as a production engineer. The
recent acquisition of XTO Energy raised concerns that he may be straying
from the returns-focused strategy that has made ExxonMobil great and
instead investing in growth for the sake of growth. ExxonMobil's
subsequent performance has lent weight to this argument as gas volumes
have grown while prices have fallen, resulting in declining returns.
However, while the acquisition has proven to be ill-timed given the drop
in natural gas prices, we think ultimately it can deliver returns that
meet ExxonMobil's requirements as prices rise and it leverages XTO's
knowledge to exploit unconventional plays globally.
ExxonMobil's record of generating shareholder returns deserves an
exemplary stewardship rating, in our opinion. Despite the XTO
acquisition, we think Tillerson is likely to continue a disciplined
capital allocation strategy, given his previous statements, and deliver
the high returns that his predecessor did. Recent efforts to exploit
more lucrative Kurdistan reserves at the risk of losing pre-existing,
but likely lower-returning, Iraqi contracts provides us some evidence to
his focus on returns. As a result, we are inclined to maintain the
exemplary rating.
Returns to shareholders also remain a focus, with share repurchases
the primary tool used to return excess cash. However, Tillerson recently
acknowledged ExxonMobil's relatively low yield and indicated higher
payouts could be in the future.
Overview
As one of the few remaining firms with an AAA credit rating,
ExxonMobil's financial health is beyond reproach. Cash flow from
operations remains sufficient to finance capital expenditures while
increasing dividend payments and buying back stock. More important,
the large cash position and access to cheap debt give the company
resources to make opportune acquisitions.
Profile:
Exxon
is an integrated oil and gas company that explores for, produces, and
refines oil around the world. In 2011, it produced 2.4 million barrels
of oil and 12.1 billion cubic feet of natural gas a day. At year-end
2011, reserves stood at 17.7 billion barrels of oil equivalent (plus 7.3
billion for equity companies), 47% of which are oil. The company is the
world's largest refiner and one of the world's largest manufacturers of
commodity and specialty chemicals.
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