If there was one stock that I had to buy from the energy sector for capital gains, Exxon Mobil (NYSE:XOM) would surely not be in contention.
The company’s dividend payment has increased at a CAGR of 6.2% over the last 37 years.
From a stock perspective, it is worth noting that Exxon Mobil stock has remained sideways to lower in the last 12 months.
I believe that this trend can potentially sustain.
Exxon Mobil stock is likely to underperform the broad energy sector.
The Permian Concern
Exxon Mobil is likely to focus on investments in the upstream segment between 2019 and 2025.
To put things into perspective, the company plans upstream investment of $46 to $48 billion for 2019 and 2020.
For the same period, the downstream investment is likely to be $9 billion. Investment in the chemicals business for the period will be $8 billion. Clearly, the revenue and EBITDA growth driver in the foreseeable future will be the upstream segment.
Within the upstream segment, the company main focus is on the Permian asset. Exxon Mobil expects 2019-2025 growth to deliver incremental production of 2.5Moebd. Of the incremental production, 40% is expected to come from the Permian Basin.
The company’s resource base in the Permian is 10 billion barrels of oil equivalent. Exxon Mobil plans to increase Permian output to 1 million barrels of oil equivalent per day by 2024.
While these numbers look rosy, there are concerns related to the Permian Basin, which might translate into higher than expected cost and lower than expected production.
The concerns related to the Permian are well summarized in this Bloomberg article. According to the article –
“The constraints are manifold: pipeline limits, reduced flow from wells drilled too close together, low natural gas prices and high land costs. But the most consequential is that shale-well production falls off at such a high rate — as much as 70% in the first year — that you need to keep spending cash on new wells just to maintain output.”
Among the concerns, the cash spending to maintain output is the biggest concern. According to J. David Hughes, an earth scientist: “Of the $54 billion spent on tight oil plays in 2018, 70% served to offset field declines and 30% to increase production.”
With Exxon Mobil having significant asset presence in the Permian, it might end up spending more than estimated to ramp-up and maintain production at higher levels. This will dent the free cash flow estimates from the Permian asset.
While Exxon Mobil can still address the infrastructure bottlenecks at the Permian, cost escalation will be a key challenge.
I am also concerned because the global economy has slowed down and oil price is likely to stay sideways to lower in the foreseeable future.
Asset Sale and Shareholder Value Creation
The concern related to the Permian Basin is likely to keep Exxon stock sideways. However, there is little doubt that dividend will sustain in the coming years.
Exxon is plannning an asset sale worth $15 billion between 2019 and 2021. This will allow XOM to allocate free cash flow from core operations towards sustaining current dividend payout of $3.48 per share.
Between 2019 and 2025, Exxon Mobil expects to generate $190 billion in free cash flow. The target is to allocate $100 billion toward Exxon’s dividend. I believe that the company will pursue a share repurchase strategy for incremental value creation in the coming years. However, a lot will depend on price of crude oil and the possible escalation in cost in the Permian Basin to maintain production.
Bottom Line on XOM Stock
All that said, I am not entirely bearish on Exxon Mobil stock. If you’re an income investor, you should still consider allocating a portion of your portfolio to buying XOM shares … However, I am skeptical about potential upside in Exxon stock due to the headwinds related to the Permian Basin. In addition, if the economic slowdown worsens, oil prices may trend lower, compressing the company’s EBITDA margin and cash flows.
Besides the upstream segment, Exxon Mobil plans to trigger sales growth in the chemical segment through new performance products. The company delivered eight innovative products in the segment in 2018. With focus on innovation, the segment growth is likely to be steady. However, the upstream segment is likely to dictate the stock price trend.
In conclusion, I would wait for production rampup results in the Permian Basin before any chasing meaningful exposure to XOM stock. At the same time, any sharp corrections due to economic factors would make for a prime buying opportunity in Exxon Mobil shares.
— Faisal Humayun
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Source: Investor Place