Exxon Mobil (XOM) 59.50: If you ask Exxon Mobil where it thinks oil prices are going, it would say, "we have no idea." What does this tell us? No one knows where oil prices are heading. Considering the tightness in the market and political uncertainties in Iraq, Iran, Venezuela, and Nigeria, most believe prices are likely to remain at elevated levels. The current contention in the futures market is that the downside risk for the near-term is the mid-50's level. One only needs to look at the economics of the oil markets to understand why prices have remained at these levels. By year end, demand is expected to be roughly 86 mln barrels per day, while supply is expected to be 83 mln barrels per day, barring any unforeseen event on either side of the equation.
Getting back to those Exxon folks, the largest company by market cap reported its second quarter results before the bell. Expectations were high going into the report with analysts continually raising expectations. Exxon's earnings rose 32% to $7.64 bln, or $1.23 per share excluding items, a penny ahead of the Reuters consensus. Profits reached a quarterly record for the 123-year old company, which sells 1 out of every 10 barrels of oil consumed in the world. Revenues grew 8% sequentially and 25.3% yearly to $88.57 bln - roughly the GDP of the Ukraine.
Its upstream earnings, basically profits from oil and natural gas, surged 28% to $4.9 bln on strong demand and record prices. Production fell 4% to 3.9 mln boe per day, roughly equivalent with Q1. There were some seasonal effects here from gas sales in the North Sea. Downstream made up for any weakness in E&P as earnings jumped 47% to $2.2 bln, as expected, with refining margins widening to their highest level ever. The primary source of Exxon's upside over the last few quarters has been on the refining side. This quarter, refining profits, or what Exxon makes from converting crude to refined fuels, rocketed 34%. Baseline cracks reaccelerated to a record $11.17 per barrel during the quarter due to demand for gasoline and diesel demand. Chemical earnings grew $207 mln to $814 mln.
With all of the world's largest oil fields in decline, the greatest challenge for the exploration and production companies is to drive production and reserves. Reinvestment is key in this business and where Exxon has been spending most of its hordes of cash is in Africa and the Middle East. It has been effectively barred from the Russian market, as have other multinationals, after the government there took over Yukos, putting a stop to any foreign investment. Management has stated it will add organic projects worth 1.2 mln boe per day over the next three years - 5% growth. In Q2, capex rose 25% y/y to $4.5 bln, with most spending on the upstream operations. On today's call, the market will be looking for Exxon to reinforce production growth expectations.
Exxon continues to build cash reserves with over $30 bln on its books. Exxon has and will continue to return value back to its shareholders through buybacks and dividends. It bought back $3.7 bln in shares in Q2, which it plans to raise to $5 bln in Q3. The question is, what else does Exxon plan to do with all this cash? Management has stated it's building reserves for when prices come down and other companies are getting cash strapped. In their minds, management feels this would be the opportune time to make an acquisition. With soaring prices, the economics of a large scale deal, which is likely, would be certainly more appealing as prices ease. Yet, for the near-term, all this cash does dilute returns and increases Exxon's returns on capital.
Exxon's shares have done little over the last two months as other sub-sectors have taken the lead from the drillers to the oil services names. Exxon is executing on all fronts. With its clear earnings momentum and growth expectations, particularly downstream, coupled with compelling shareholder value, Exxon continues to be a strong long-term investment. The key for the near-term is cost management and reinvestment to drive production growth for the longer-term. The stock is trading at 12.4x, near the low end of its historical range, and below the market multiple of 19.7x. ---- Kimberly DuBord, Briefing.com
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