To The Moon

$Exxon Mobil(XOM)$ $Chevron(CVX)$

A recent study on the top-performing stocks revealed some surprising results. Leading the list was Altria Group, a company known for its addictive tobacco products—a performance that’s perhaps unsurprising given the nature of their business. Another notable mention, however, was Exxon Mobil, the only energy company among the top 30 performers. Today, we'll discuss why Exxon Mobil remains a solid investment and what the future holds for the company.

Oil Is Still Gold

Oil remains a critical resource, and despite the growing popularity of electric vehicles (EVs), its demand shows no signs of waning. While many predict that EV adoption will curb oil usage, projections for "peak oil demand" generally hover around 2030, roughly five years away. However, a Goldman Sachs report offers a different perspective, suggesting peak demand could still be a decade off. A key driver of this continued demand is Asia, where rapid economic growth and rising consumer spending in emerging markets indicate oil’s enduring importance.

In these markets, a burgeoning upper class is purchasing an increasing number of goods—many of which rely on oil for production. Contrary to the assumption that oil is predominantly for diesel and gasoline, its applications extend far beyond transportation fuels.

Electric vehicles, particularly competitively priced models from manufacturers like BYD in China, are beginning to make headway in emerging economies. While this shift may reduce gasoline consumption, Goldman Sachs highlights that the growing demand for petrochemicals will more than compensate for this decline. Their breakdown of oil usage illustrates that around 70% of a barrel of oil is allocated to diesel, heating oil, and gasoline, while the remaining portion supports the production of diverse products such as plastics and other petrochemical-based goods.

Oil's pricing, like other commodities, is subject to supply and demand fluctuations, often resulting in significant volatility. Historical price swings—such as oil surpassing $120 per barrel before plummeting—underscore the challenges faced by oil companies. These companies must balance investments carefully, avoiding assumptions that prices will remain perpetually high or low. Strategic planning, including hedging and preparation for uncertainty, is essential for navigating such an unpredictable market.

Exxon Mobil, as one of the industry’s leaders, exemplifies this approach by developing robust strategies to adapt to market dynamics. Its ability to thrive in a volatile environment highlights oil's continued relevance, even as the global energy landscape evolves. With prudent hedging and planning, the company aims to thrive in a volatile industry, making it a compelling choice for investors who recognize oil's continued relevance in a diversifying global energy landscape.

Exxon’s Leadership in Energy

Exxon Mobil stands out as a global leader in the energy sector, ranking second in oil production worldwide, just behind Saudi Arabia. Among U.S. oil producers, Exxon Mobil holds a dominant position, as reflected in its 22% weighting within the popular energy ETF, XLE.

When investing in specific industries, particularly in niches like energy, it’s wise to prioritize market leaders. This approach aligns with dividend growth investing, which often focuses on high-quality, established companies. Exxon not only demonstrates its leadership through sheer size but also excels in key performance metrics. Today, we’ll highlight one of those metrics to underscore Exxon’s prominent position in the energy market.

Exxon’s Capital Allocation Strategy

Exxon Mobil’s approach to capital allocation highlights its focus on generating and managing cash flow effectively. As the saying goes, "Profit is an opinion, but cash is a fact." This means that while accounting practices can adjust reported profits, the cash a business generates and deposits in the bank is a straightforward indicator of its financial health. For mature businesses like Exxon, consistent cash flow from operations is a hallmark of stability and profitability.

Unlike disruptive tech firms that often operate with negative cash flows due to heavy investment in rapid growth, mature companies like Exxon prioritize generating positive cash flow. This enables them to reinvest in future growth, return value to shareholders, and maintain a financial buffer for challenging times. The oil industry, in particular, requires a disciplined approach due to long lead times and the inherent volatility of commodity prices.

Exxon’s 2024 cash flow data provides a clear picture of its financial management:

• Year-End 2023 Cash: Starting with $31.6 billion.

• Cash Flow from Operations: Generated $42.8 billion in the first three quarters of 2024.

• Asset Sales: Added $1.8 billion to cash reserves.

• Capital Expenditures (CapEx): Invested significantly in business operations and future growth, a critical component of long-term sustainability.

• Free Cash Flow: After subtracting CapEx, the remaining free cash flow demonstrates the company’s capacity to allocate funds strategically.

Exxon utilized its free cash flow in several ways:

• Shareholder Returns: Distributed $26 billion, with $12 billion as dividends and the remainder for share buybacks.

• Debt Management: Maintained a focus on reducing debt, exemplified by repaying $20 billion in 2021.

By the end of the most recent quarter, Exxon held approximately $27 billion in cash reserves. This substantial "war chest" ensures the company is prepared for downturns, such as the extreme price drops experienced during the COVID-19 pandemic.

Exxon’s strategic use of cash flow—from reinvesting in operations to rewarding shareholders—illustrates its commitment to navigating the volatile energy market while securing long-term growth and stability.

Exxon’s Innovative Business Model

Exxon Mobil’s business model exemplifies integration and resilience, leveraging multiple segments to create a natural hedge against market volatility. Here’s a breakdown of their operations:

Upstream Operations: This involves identifying, extracting, and producing crude oil and natural gas—the core products. Revenue from this segment is straightforward: price multiplied by quantity.

Downstream Operations: Instead of selling all the extracted oil to third parties for refining, Exxon processes much of it in its own refineries, turning raw commodities into usable products like jet fuel, gasoline, and diesel. As the world’s largest integrated refiner, Exxon owns 19 refineries globally.

Natural Hedge: When oil prices are high, Upstream thrives, generating substantial revenue. However, high input costs squeeze Downstream profitability. Conversely, when oil prices fall, Downstream benefits from cheaper inputs, even as Upstream revenues decline. This built-in balance adds stability to Exxon’s earnings.

Chemical Operations: Exxon is one of the world’s largest chemical producers, processing refined products further to create both commodity and specialty chemicals. These operations are supported by 16 major industrial complexes worldwide.

Low Carbon Solutions: Exxon is also investing in biofuels and other low-carbon technologies. While biofuels have faced economic viability challenges in the past, this remains a focus area for Exxon as part of its long-term strategy to diversify its portfolio and reduce carbon emissions.

Segment Contributions and Cash Flow Insights: A breakdown of Exxon’s cash flow shows:

• Upstream: 68% of cash flow, reflecting its dominant contribution.

• Downstream and Chemicals: Provide additional, steady cash flow streams.

• Low Carbon Solutions: A smaller but growing segment.

Future Growth Plans: Exxon’s 2023 investor deck outlines ambitious plans for $4 billion in earnings and cash flow growth between 2023 and 2027. This growth will stem from:

• Upstream Enhancements: Increased production efficiency and value-added operations.

• Product Solutions (Downstream and Chemicals): Cost optimizations and expanded product offerings.

This integrated approach positions Exxon to generate robust cash flows, enabling reinvestment in growth areas, debt reduction, and shareholder returns (e.g., dividends and share buybacks). The combination of market adaptability, operational excellence, and diversification ensures Exxon’s continued leadership in the energy sector.

Exxon’s Growth Potential

Exxon Mobil has demonstrated a clear strategy for sustained growth and profitability, focusing on cost efficiency, strategic investments, and adaptability to market conditions. Here's a breakdown of their approach:

Upstream Investments and Cost Efficiency: Structural Cost Reductions: Exxon’s commitment to reducing costs is expected to drive significant earnings growth in the Upstream segment. Their forecasts are based on an assumed oil price of $60 per barrel, with sensitivity analyses conducted for scenarios at $40 and $80 per barrel.Return on Investment (ROI): Impressively, 90% of their investments in oil and gas are projected to generate over 10% ROI even at a low price of $35 per barrel. This positions Exxon to maintain profitability in challenging market conditions.Competitively Advantaged Assets: By 2027, over half of Exxon’s production will come from assets averaging $9 per barrel in earnings, significantly higher than their base portfolio. This focus on high-margin projects reflects disciplined capital allocation.

Downstream and Product Solutions: Exxon’s downstream growth mirrors its upstream strategy, emphasizing structural cost reductions and strategic investments.Concrete Growth Projections: Projects with detailed forecasts include volume impacts, operational timelines, and anticipated earnings uplifts, showcasing the company’s meticulous planning.

Diversification into New Markets: Exxon is venturing into lithium production, with first output expected in 2027. While this initiative appears promising, it’s uncertain whether it will significantly impact the company’s overall performance given its scale.

Cash Flow and Profitability: Surplus Cash Flow Projections: At Brent crude prices of $50, $60, and $80, Exxon anticipates substantial cumulative surplus cash flows. By 2027, they aim to achieve a break-even cost of $35 per barrel, underscoring their commitment to cost efficiency.Share Repurchase Program: Exxon has accelerated its share buyback initiative. This strategy hinges on shares being competitively priced, with the company using metrics like price-to-earnings (P/E) ratios to gauge value. While historical P/E trends suggest shares are currently in the mid-range, debates persist regarding the program's timing and motives.

Focus on Shareholder Returns: Exxon’s growth strategy includes returning value to shareholders primarily through dividends and share buybacks. For many investors, dividend growth remains the preferred method of capital return, emphasizing the company’s strength in generating cash.

Exxon’s growth potential reflects a combination of operational excellence, strategic foresight, and disciplined financial management. By balancing investments in high-return projects, managing costs, and leveraging market opportunities, Exxon continues to position itself as a leader in the energy sector.

Exxon’s Dividend Growth

Exxon Mobil plays a crucial role in our dividend growth strategy as part of our quantitative analysis. Using our QCore calculator, which evaluates dividend-paying companies, Exxon ranks well, though its Q score of 17 is lower than Chevron’s 20+. This difference stems from Exxon being penalized for two factors:

• Five-Year Dividend Growth: Below the 4% benchmark.

• 10-Year Earnings Growth (10E): Below the 5% threshold.

These metrics have affected Exxon’s Q score. When we initially invested, these penalties were not a concern, and we continue to monitor the company closely. The only reason we would divest from a dividend champion like Exxon is if it stopped increasing its dividend, which appears unlikely at this time.

Dividend Growth Trends

Looking at Exxon's dividend growth over the past five years:

• 2020: During a challenging period when oil prices went negative, Exxon prudently raised its dividend by just a single penny, effectively maintaining its long-standing track record.

• 2023-2022: A 3.7% growth in dividends.

• 2024: A 4.3% growth, showing a slight acceleration.

While recent growth is modest, the potential for greater acceleration remains.

Cash Flow and Dividend Sustainability

From the $26.4 billion in free cash flow Exxon generated, $26.1 billion was returned to shareholders, with only $12 billion allocated to dividends. This results in a free cash flow payout ratio of less than 50%, indicating ample room for future increases.

Future Expectations

While Exxon's dividend growth is improving, it hasn’t yet returned to the 8% average growth rate typical of our core universe of dividend champions. This is a target we’d like to see Exxon achieve, given the robust performance of peers in this space. The company’s substantial free cash flow and ability to execute amid fluctuating oil prices suggest it has the capacity for more significant dividend increases in the future.

Exxon remains a leader in the energy sector, with strong fundamentals and a secure dividend. However, we’ll be closely watching for improvements in dividend growth to ensure it aligns with our expectations. For those evaluating between Exxon and Chevron, our comparison piece offers detailed insights into these two energy giants.