Exxon Mobil Bull/Bear Debate With David Alton Clark And Callum Turcan
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Summary:
- Exxon Mobil’s stock appears moderately undervalued, with strong balance sheet improvements and potential for growth opportunities.
- The company’s stock has already priced in the positive news, and there are concerns about refining margins and potential economic downturns.
- ExxonMobil’s upstream segment and growing oil and gas production in the Permian Basin and Guyana are promising, but the stock’s technical aspects and potential headwinds may limit its growth.
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Callum Turcan shares his bullish take on Exxon Mobil (NYSE:XOM) (0:30) and Winter Warrior Investor’s David Alton Clark shares his bearish thesis (1:50).
This is an abridged version of our past conversation, Exxon Mobil – Is Good News Priced In? Bull/Bear Thesis With David Alton Clark And Callum Turcan
Transcript
Rena Sherbill: Okay, happy to have you on, Callum Turcan and David Alton Clark, who runs Winter Warrior Investor investing group. Callum and David, it’s great to have you on talking Exxon Mobil. Callum, I’d love to start with you if you could lay out for our audience your bullish thesis for Exxon.
CT: So, ExxonMobil, they’re from 2020 to 2022, you kind of have like a normalized free cash flow of about $30 billion to $31 billion. 2020 would be an example of a bust. 2021 example of like a middle of the road situation. 2022, example of a very good year for Exxon. So within those 3 years, you could argue that you have a good normalized free cash flow. And if you look at what ExxonMobil has done with those free cash flows, it’s paid down a bunch of its debt. It’s bought a lot of its stock, and it’s maintained its dividend payout and marginally increased it.
So my bull thesis is basically, the stock appears to be moderately undervalued using discounted free cash flow analysis. It’s a cash flow generating powerhouse with lot of growth opportunities, and its balance sheet has improved immensely in the past few years. I think from the end of 2017 to the end of March 2023, it’s paid down over $30 billion of net debt. So, strong balance sheet, free cash flow generating cow, very shareholder friendly. That would be my – the summary of my bull thesis.
RS: All right David, I’ll follow-up, what’s your thesis and why are you bearish on the stock?
DAC: Well, I understand what Callum is saying about how Exxon’s gone from being at the bottom of the barrel in March of 2020. The stock is up basically 200% over the last 3 years. So pretty much the top line issue I have for the thesis is the fact that everything Callum has said is already priced into the stock. It’s up 200%, but yet over the past year it’s down 5%. And it’s bounced off of, I believe Callum’s price target is like $122. And the price is — I think it was $105 yesterday. I think it’s dropped 2% or 3% today. It’s in the $102 range.
But it’s tried, it’s attempted several times this year to break above the $120 level, and it just can’t. It can’t do it. And there’s several reasons for that, there’s just so many different reasons. One is that, like I said previously, all the good news is priced in. And when you get to a certain point, like, if you take Callum’s price target of $122 and the price of $105 whatever it is just now, that’s only about a 15% bump from where we are right now.
And on top of that – I don’t know if you guys have ever played the game of Jenga. But Jenga’s where they — you’ve got like 34 blocks or something, and you start-off by pulling one out and putting it onto the top. And in the very beginning of the game, it’s super easy to be right and not be too worried about the whole pile toppling over because it’s strong and it’s just you’re just getting started. But when you get 200% to the highest point of the Jenga game, that’s when it gets really risky, and there’s a big chance that the entire stack is going to come tumbling down.
And so investing is counterintuitive where you want to invest when everyone else is negative on the stock. That was back in March of 2020, when I bought the stock at $35, it was a 10% yield and everyone hated it. It was going to – Exxon was going to go under — we were in the middle of the pandemic. Nobody was driving, it was the worst time in the world to invest. I think oil actually went negative per barrel. So they couldn’t even — they were paying people to take barrels of oil at the time that I bought the stock. And then now it’s 200% higher and it’s bouncing up against the upper edge and a lot of what Callum says in his last couple of articles are pretty much right. ExxonMobil has done a great job over the last few years repairing its balance sheet.
But as far as the price to free cash flow valuation, it’s kind of tipped to the downside due to the fact that the refinery profits have dropped off drastically. So, in my latest article, what I was saying was is that, ExxonMobil is fine, but this isn’t the time to buy ExxonMobil. There’s other stocks, other oil and energy stocks in the sector that have much better upside opportunities and higher yields.
Like, I think there was three recent downgrades of ExxonMobil by JPMorgan, Mizuho and Goldman, all kind of making the same point that I’ve been talking about in my articles. JPMorgan is concerned about the refining margins falling considerably, and on top of the challenging tough economic backdrop, that’s another thing. You got to consider where we are as far as in the economic cycle. There’s this long awaited recession that hasn’t come to fruition yet, but seems like it — more likely than not, we’re going to have some type of a pullback here in the next coming months.
So you might get a much better opportunity to buy into ExxonMobil than you have right now. And Mizuho was the same thing with the refiners, and then Goldman actually downgraded them based on the fact that all of the good news is priced in with a 7% free cash flow yield on 2024 estimates of oil.
CT: Maybe a trivia thing, where you talked about WTI going negative. One of the reasons why that happened is in America, you have to take physical delivery of all — trading oil futures. West Texas Intermediate is based on supplies to Cushing, Oklahoma, you have to take physical delivery of it. So, it went negative because basically, you had to pay people to drive, like semi-trucks with pools in the back to just dump crude into those, where Brent it’s all pay for futures. That was just some trivia thing where you wrapped it up, but March of 2020 things were quite dire.
And then the one I like about ExxonMobil is its commitment to investors because it’s a volatile game, commodity markets. I mean, fundamentally, ExxonMobil’s performance is based on factors outside of its control. So, if you — I mean, they’re selling it — basically they’re price takers, not price makers. So, if you assume that recession is going to happen, commodity companies are not going to be your number one investments opportunity.
But I think that America, Europe, and China, will narrowly avoid a recession, largely because the official unemployment rates in Europe and America remain quite low. And America’s official unemployment rate is less than 4%. People are complaining a lot about inflation, I mean we see prices of things going up, but they’re still employed. They’re still making money. And credit card delinquencies have ticked up, but they’re not — we don’t see the kind of delinquency rates we’ve seen, like, during the great financial crisis.
So, my bullish view on Exxon comes down to I think, though politically and how — like the households are coming under a lot of stress, but we will like narrowly avoid a recession, in part because of things like the Inflation Reduction Act really is just additional fiscal stimulus and the infrastructure act, delay additional fiscal stimulus. So America’s federal government is continuing to pump a lot of money into the economy. The private sector is still quite strong even with interest rates on the rise. And with Exxon, the crack spreads, refining margins they aren’t what they were in the aftermath of the Russian invasion of Ukraine.
I mean in 2022, refineries were making – like crack spreads were north of $20 a barrel. It was — they were doing quite well, but what matters most for ExxonMobil is it’s upstream segment. It’s all about the oil and gas production and the trajectory of oil and gas production. And ExxonMobil, it’s a powerhouse in the Permian Basin.
Its asset is in Guyana, which is a small country in the northern part of South America. I mean, they found over 11 billion barrels of recoverable oil in Guyana. ExxonMobil owns 45% of that venture along with Hess Corporation (HES) and CNOOC (CEO), a Chinese company. And ExxonMobil’s — its major growth drivers will be the Permian Basin in Guyana. As its oil production in these regions continues to grow, so too will its cash flows that are keeping oil prices constant.
So I think what I like about ExxonMobil is gaining exposure to a tried and true unconventional play and this emerging oil export like powerhouse in South America because unlike, if you look at the production sharing contracts in OPEC nations, oil companies, they’re recovering their operating costs and getting like $2 a barrel. If you operate in Iraq, it’s the Iraq National Oil company that’s keeping most of those profits. ExxonMobil, BP, Chinese state majors, state run majors, they’re just getting a little cut of that. But if you are a powerhouse in Canada, America, and Guyana, you get to keep a large chunk of those profits.
So ExxonMobil has an attractive upstream asset base, and that is what I’m most focused on. Like, it’s downstream based their refineries to petrochemical plants because they have only a modest amount of exposure to Europe relatively speaking. They have lot of plants in America and Southeast Asia. They’re better positioned than European majors, but when you look at ExxonMobil’s outlook, basically its upstream outlook is now finally promising, like, they were having problems boosting their production than the 2010’s decade, their output of oil and gas, like, marginally shrunk. But now because of the Permian Basins of Guyana and because of their exposure to Tanzania’s emerging LNG markets, their oil and gas production outlook is quite promising.
So if you look at the net debt reduction, I was talking about during my intro, $30 billion of net debt reduction, helps reduce their annual interest expenses. They’re also shaving $9 billion in costs off their operating expenses, largely through layoffs, corporate consolidation. So by the end of this year, their operating costs should be $9 billion lower on an annual basis compared to 2019 levels, and they’ve already achieved most of their savings.
So, I like ExxonMobil because at a constant oil and gas pricing outlook, they should be able to steadily increase their earnings and cash flows through stronger — reduced operating costs, reduced financing costs, and oil and gas production growth in attractive regions.
But I will concede that the downstream outlook is — it’s not as promising as it was because you’ll never be able to replicate 2022 in terms of, like crack spreads, you’re more than tripling overnight, and that’s a black swan, once in a life event.
What I’m most interested in ExxonMobil, it’s a longer term play. You’re talking about you should assess investors, what they want. Exxon, for the short term opportunity, there’s all different kinds of ways to use, like, leveraged ETFs if you want to predict where oil will go in the next month or two.
But what I like about ExxonMobil is the steady eddy-ness of this dividend aristocrat because so we’re talking about, like, it’s the per share quarterly dividend has not grown much, since the oil pricing bust of late 2014.
In late 2014, a crescendo happens where non-OPEC production of America and Canada’s — like Canada’s oil sands, America’s fracking boom, all of a sudden, you have, like, millions and millions of barrels being added per day to the global supply, and that OPEC decided to fight for market share.
So from late 2014 to early 2021, you basically had a prolonged oil pricing bust. Oil prices kind of recovered in 2017, 2018, but they weren’t – it wasn’t like the heydays of the 2010, the 2012 period.
So, what I like about Exxon going forward is, as its cash flows boom with oil prices recovering, instead of increasing its dividend aggressively, it first focused on paring down its debts. So, like, I would talk about $30 billion net debt reduction. That’s kind of where a lot of its cash flows have gone. It’s just repairing the balance sheet because of this prolonged oil pricing bust. So over the past few years David’s right, the dividend has not grown much on a per share basis. However, when you look going forward, ExxonMobil is now in a position, ExxonMobil is now in a position where it can start to aggressively reward shareholders.
Like, we’ve seen its share buybacks, like they spent, I think, around $15 billion last year, buying back their stock because that’s an easy lever to pull because you can, if you increase your dividend, you’re increasing your cash flow outlays perpetually into the future, where if you buy back the stock, you can flex it up or down.
So they started out by rewarding investors by buying back $15 billion dollars of their stock last year, and they pushed through at 3% or 4% sequential increase in their dividend in the final quarter of 2022.
Going forward like this upcoming October or September, they’ll probably announce a much larger dividend increase because they’ve already done the hard work of repairing their balance sheet. So, I think that dividend growth story, it’s about to start… they’ve maintained their payouts during a prolonged oil pricing bust.
DAC: But nobody said that. Right, Callum? You’re just guessing that. Right?
CT: Oh yeah. This is purely — I would speculate they will push through a sizable per share dividend increase during the final quarter of this year, and the speculation is built on they’re going to achieve their cost reduction targets of reducing their annual operating cost by $9 billion versus 2019 levels.
Their annual interest expenses have shifted. They’re shifting lower from like 2020 they spent $1.2 billion on their interest expenses. They spent $0.8 billion last year. So their interest expenses have gone down as their net debt load has been brought under control.
And then I would add because their oil and gas production base is finally growing again, they’ll have a growing oil and gas production base, they have a repaired balance sheet, and they’ll be able to push through some sizable dividend increases, something that they haven’t done in the past. Like, I’ll concede that ExxonMobil’s Dividend Aristocrats status was maintained in part, like, by just very marginal payout increases from the 2015 to 2021.
The outlook for ExxonMobil, though now it’s pretty bright at $70 WTI, Brent environments. But you can’t predict the price of oil. I mean, you could — if you think a recession’s going to happen, stay away from commodity names because I mean, recessions just kill commodity prices in almost every scenario.
But if you think a recession is going to be narrowly avoided, all this, like, commodity names, it should like I think there’s a lot — there’s some modest capital appreciation opportunities and a meaningful amount of income generation potential for companies that have repaired their balance sheets.
What I like about Exxon is the Steady Eddy-ness of it. So it is — a lot of the positives are well known, but those positives they’re very needle moving. So, you look at its huge exposure to the Permian Basin.
Recently Darren Woods, the Chairman and CEO of Exxon, he’s talked about how they’re pursuing new fracking technologies to try to boost the oil recovery rates there. The recovery rates of unconventional plays, it’s about 10% like, in the North Sea and the Gulf of Mexico. You can recover north of 50% of the oil in place. Fracking, we’re just scratching surface there.
So, like, one thing that’s working for ExxonMobil’s favor is you can see where the upside opportunities lie. So, like, before I get there’s always the oil and gas prices and where that goes will influence the short term movements in ExxonMobil. If you look at it, there’s a lot of technology improvements that could happen in fracking plays. This is not low hanging fruit that we’ve seen over the past decade. This would be something like, you got to get all your PhDs down there in Texas and in New Mexico to work this out.
Because we’re talking about how do you keep the fissures open when you frack a well open longer? Because you use sand as a proppant to keep those fissures open, to get the oil flowing. I know they’re — I don’t know exactly what they’re testing out because you didn’t get too specific into it. But if ExxonMobil could increase recovery rates in the Permian Basin from 10% to 12%, 20%, or something that, like, starts to mirror like half of what you would put on a conventional play I mean that would be an immense amount of upside that’s not priced too.
And I think like in Guyana, everyone knows Guyana is like a huge growth driver for Exxon, but it continues to deliver in steady eddy success where every year you’ll hear ExxonMobil and its partners announce a couple new big discoveries, another 1 billion barrels or 2 billion barrels of recoverable oil has been found. ExxonMobil, you can see the upside and they continue delivering where if you talk smaller oil and gas companies, there might be a lot of hidden potential there, but also a lot of hidden risks. Like, maybe their assets aren’t as productive, whatever the situation is.
DAC: The stock’s up 200%. So it’s about the stock. For me, it is a big part of it, not just the headwinds coming on. I also think the stock has gone – it’s something on a parabolic run if you look at the chart, and it’s rolled over in the last year. And so it’s in the middle of a rollover.
So as far as talking about the technical aspects of the stock is an issue for me as well, not just the macro view and those types of things. I think that’s going to be one of the reasons why it does continue on a downward stroke. When – based on the technicals right now, a lot of people have different ideas about the importance of the technical aspects of a stock. But for me, it’s basically just telling you who’s in charge. Are the bulls in charge or the bears in charge?
And so for the last three years, the bulls have been in charge, and they’ve just – everyone has just been piling in and piling in. The story was horrible in March. And then all of a sudden, everyone’s like, hey, guess what, oil and gas is where it’s at right now. Nobody has invested in that. So it’s just been going up, up, up, up and they’ll finally, it hit that range where it’s almost at your point where you say, hey, the future cash flow model says it should be 120. Well, that’s where it was.
And so a lot of people are like, okay, it’s fairly valued here. It’s time to take profits. And so it’s rolled over. So now, kind of seems like the bears are in charge. And so we’ll just have to see.