ExxonMobil Is Still An Unloved Cash Machine And Has No Need To Cut Its Dividend

ExxonMobil XOM continues to generate cash and continues to return it to shareholders in the form of dividends.  There has been much speculation in the financial media about the future of Exxon’s $0.87 quarterly dividend.  My analysis, which I detail in the following paragraphs, shows there is no reason for Exxon’s management to cut the dividend.  A token increase (a penny a share per quarter, for instance) announced before Exxon’s earnings release on October 30h would not harm the company’s financial situation.  Exxon has tapped the bond markets for an extraordinary $22 billion of debt financing in 2020, wisely taking advantage of the Fed-driven decline in both short- and long-term interest rates.  

Oil prices remain stuck near the $40/barrel range and Exxon shares have been terrible performers, declining more than 50% this year while the broad-based S&P 500 has retraced all of its Covid-19 losses and actually stands at a 7.9% gain for the year.  It is probably an understatement to say that ExxonMobil is not loved by the “woke,” ESG-crazy folks who fill the airwaves of the nation’s second most popular financial news network (CNBC) and blather on about sustainability. 

So, Exxon and CEO Darren Woods—who has presided over a 62% decline in Exxon’s equity value since he took over as CEO on January 1, 2017—are faced with a very stark choice.  No one wants to invest in a woke oil company.  The actions of European oil majors BP and Royal Dutch to “embrace” renewables are laughably transparent attempts to attract ESG investors to their beaten-down stocks.  

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The folks in Irving need to realize what the motto of my firm Excelsior Capital Partners preaches: cash flow never lies.  Exxon is wisely spending cash flow outside the U.S. (Permian operations have been curtailed as part of Exxon’s capex reduction plan) and are focusing on discoveries like the Stabroek field offshore of Guyana for future capex.  As a shareholder, that is a one—and possibly the only—justifiable use of Exxon’s cash, which is partially mine.  

Even in the second quarter, possibly the worst time in recent memory for consumer-facing companies, especially oil companies, Exxon managed to report operating cash flow of $0.0.  They broke even.  Actually, if we analyze cash metrics and not GAAP earnings, Exxon did a lot better than breakeven,  The reported figure of $0.0 cash flow from operations included a $2.1 billion adjustment for non-cash inventory adjustment, which Exxon attributed to increased inventory value due to higher commodity prices.  So higher oil prices are bad for Exxon?  No, of course not. That’s just a flimsy-accounting-only adjustment and has no real impact on Exxon’s operations,  Exxon’s real 2Q20 cash walk was as follows

Net income:  -$1.1 billion

Reversal of inventory adjustment +$2.1 billion

Depreciation:  +$4.9 billion

That’s the true measure of after-tax cash flow.  That $5.9 billion in net cash flow in the second quarter covered Exxon’s $3.7 billion in shareholder distributions.  So, there’s no need to cut the dividend.  

That analysis ignores Exxon;s $5.1 billion of capital expenditures in the second quarter and also the $10.0 billion in cash Exxon raised from debt offerings in the quarter.  Exxon now expects to spend $23 billion in capex in 2020 (down from the original budget of $33 billion) but this is where Exxon’s leadership needs to accept reality.  The hundreds of charts Exxon can produce showing increasing hydrocarbon demand from a growing world population are not relevant now.  The Market thinks everyone is driving Teslas—even as VW.s ID.3 annihilates Tesla’s sales base in “green” markets like The Netherlands and Norway—and Exxon management needs to roll with this and prioritize all future spending on shareholder value enhancement—dividends and share repurchases.  

The stock charts would probably tell you this, but oil E&P is just not viewed as a great business by the financial markets anymore.  So, Exxon needs to spend more proportionately on its downstream and chemicals businesses, and let the prodigious cash flows from its E&P businesses serve as fuel to BUY BACK STOCK.  

So, with free cash flow being generated, Exxon should massively increase its share repurchase program.  For the first six months of 2020, Exxon repurchased a paltry $305 million worth of shares.  It is interesting to type in “exxon share buyback” into Google.  One of the first articles listed is this Forbes column written by a frustrated shareholder in December 2019  exhorting Exxon to ramp up its share repurchase plan.  Yes, I wrote it.  

Isn’t that just financial engineering?  YES!!! That is exactly what I, and every other Exxon shareholder, wants.  I find the arguments against fossil fuels range from dubious to incredibly stupid, but an investor must never ignore a changing world.  Exxon is more than 100 years old, and for the next 100 years Exxon will never again be viewed as a growth company.  The game has changed.

So, Exxon shareholders should be rewarded for their patience with continued dividend payments—even at a yield of 10%—and share buybacks that, by definition, lower the gross amount of those dividend payments.  Exxon can save themselves 10% per year on the cost of a share outstanding just by buying it and retiring it.  I can’t possibly be the only one has ever done that math.  

There’s the rub.  Corporate incompetence, like the disastrous run of XOM stock during Woods’ tenure as CEO, is always taken care of by the markets.  It’s Darwinian.  As investors like Carl Icahn note the attractiveness of large oil companies, I can’t believe no one has taken a pad and paper and created a spreadsheet showing the massive returns that could be had by buying Exxon, taking it private, using even more leverage and saving the dividend payments.  

That might be the end-game here.  If oil is unpopular in the public markets, then exit them.  But there is still massive demand for petroleum, increasing demand for natural gas, and Exxon’s chemical business produces the polyethylene and polypropylene that make electric cars much lighter and more efficient.  

So, there is a need for Exxon, even if your average fund manager doesn’t see that need in his portfolio. When public market valuations and cash flows diverge, action will be taken by the markets.  I don’t think Exxon will survive as a standalone public company for the next five years.  I have seen some very interesting speculation regarding a combination with Chevron CVX , and , as noted above, an LBO would certainly make sense given the composition of Exxon’s balance sheet.  

Something’s gotta give.  Until that happens, I will collect my $0.87 quarterly dividend. Exxon won’t cut the dividend.  Woods would be committing career suicide to do so.  But that’s a short-term, every-three-months calculation. The bigger picture here points to an unloved cash machine that is just never going to receive a fair valuation from a stock market that wants “the opposite of Exxon.”  

I want more financial engineering from Exxon management, but it might be that the ultimate financial engineering has to come from a management team other than Exoxn’s current squad.  I would take that, too.

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