Shares of the integrated energy giant ExxonMobil (XOM -1.05%) plunged in 2020 as oil prices plunged to historic lows. With stock set to be started from Around 30, is this the end of an era or an investment opportunity for those who want to step in when others are afraid? Here is an overview of some of the main risks to understand before making a final call to this oil company.
Let’s get rid of the biggest potential risk right off the bat: an Exxon bankruptcy is highly unlikely in the near term. At present, the company has one of the strongest balance sheets of its integrated peers. Exxon’s leverage ratio is about 0.38 times. Although Chevronit is (CLC -0.76%) 0.25 times is lower, all European players have much higher debt ratios. At the top is PB to about 1.1 times. The truth is, 0.38 times is actually a pretty reasonable number, leaving Exxon with enough headroom on its balance sheet to weather more adversity.
Bankruptcy, however, is the worst case scenario. Besides Exxon, there are many things that can go wrong for investors.
2. A dividend cut?
Exxon has increased its dividend for more than three decades. During Exxon’s Second Quarter Earnings Conference Call Management again reiterated the importance of returning shareholder value through a stable and growing dividend. However, major energy industry peers like BP and Royal Dutch Shell have both cut their dividends at this point, and it is hardly unreasonable for investors to think that Exxon could end up following this trend. In fact, at this point, the company’s commitment to the dividend is really the only thing keeping it at its current level. Exxon’s cash flow is not sufficient to cover its dividend payments at this time.
Which brings the balance sheet back into play. Exxon’s leverage ratio started the year at around 0.24x. As oil prices and demand fell in the face of COVID-19[feminine]– related to economic shutdowns, the company added debt to cover its capital investment plans and the dividend. That’s to be expected – the oil space is highly cyclical and Exxon has used this tactic before. But there’s a fly in the ointment. During the second quarter conference call, management also hinted that it was unlikely to issue more debt. This limits where Exxon can find additional cash if it needs it. A simple way to free up capital is to cut the dividend, which costs Exxon about $3.7 billion a quarter and nearly $15 billion a year.
The dividend is likely secure for at least the rest of 2020. But after that point, there’s a lot more uncertainty. If oil prices remain moribund, a cut in the dividend is not out of the question.
3. Is oil dead?
As noted, Exxon is currently in the middle of a major investment program due to low production figures in recent years. There’s a bigger upside here, in the sense that Exxon is essentially doubling its oil consumption at a time when peers, like Shell and France Total (TTE -0.44%) turned to electricity. The logic behind this change is quite simple: carbon-based fuels are being replaced by cleaner options, impacting everything from transportation to utility-level power generation. Exxon, however, pointed out that energy transitions have historically taken time and that oil will remain an important source of energy for decades to come. This position is supported by the long-term outlook of the International Energy Agency, even in a scenario where reducing carbon emissions is a global priority.
And yet oil prices literally fell to zero at the start of 2020, hinting that things are not well in the energy space. The fact that oil drillers, for a brief moment, paid customers to take their oil is chilling. However, prices rallied back to $40 a barrel, suggesting that oil’s near-term demise is greatly exaggerated. As a commodity, oil is subject to supply and demand, with the current low prices (due to COVID-19 related demand shocks) causing a major jolt in the industry. Many exploration and production companies, particularly in the American onshore space, filed for bankruptcy. Eventually, although it may be painful, supply and demand should balance out again. Financially strong Exxon will be positioned to benefit when this happens. For bearish investors on oil, Exxon’s decision to step up its efforts on black gold should however be very worrying.
The risks increase
There are very important risks to consider when looking at Exxon and they are difficult to quantify. Although Exxon is unlikely to go bust anytime soon, continued weakness in energy prices could lead to a cut in dividends. And the oil space, which drives the company’s turnover and results, is clearly changing today. Exxon, once an appropriate stock for conservative investors, doesn’t have quite the same risk profile as it did just a few years ago. If you’re considering the company’s high 8% yield, you’ll want to think twice before jumping on board this name today. You might be better off with Chevron, which is on a stronger financial footingor Total, which is diversifying its business by adding electrical assets to its portfolio.