ExxonMobil Corporation (NYSE:XOM) is one of the largest energy companies on earth. Today it sports a historically high yield of around 4%, roughly twice what you could get from a fund tracking the S&P 500 index. It also has a low debt level, with long-term debt accounting for less than 10% of its capital structure. But the really exciting thing about Exxon is all too often viewed as a drawback. The second half of 2018 provided 880 million reasons why that’s not the case.
Big and beautiful
One of the key features with Exxon is its size. With a market cap of more than $300 billion, it dwarfs most of its peers in the energy industry. While size can provide economies of scale, which Exxon definitely benefits from, there’s another factor to consider — diversification. Exxon is not only big, but it is spread across multiple sectors of the energy industry. To put that into perspective, consider some competitors.
ConocoPhillips (NYSE:COP) is focused on drilling for oil and natural gas. Its performance is tied tightly to the prices of these commodities. Falling oil prices are a bad thing for ConocoPhillips’ top and bottom lines, and ultimately led to a dividend cut in 2016. (Exxon has increased its dividend for 36 consecutive years and counting.)
Valero Energy Corporation (NYSE:VLO), meanwhile, is focused on refining, turning oil and natural gas into other products, like gasoline. Its business is driven by the spread between the cost of its feedstocks and the cost of what it makes. Low oil prices are usually a net benefit here, a fact that helped boost the company’s results in the back half of 2018 (more on this below).
And then there are companies like Magellan Midstream Partners (NYSE:MMP), which own the pipes and storage facilities that connect drillers and refiners (many midstream companies also own refining assets). Midstream companies generally charge a fee for the use of their assets, avoiding commodity price volatility as much as possible. Results tend to be fairly steady over time.
Exxon’s business isn’t focused on any one of these industry niches. Its business spans them all. It drills, transports, and processes oil and natural gas all the way to the point where it delivers it to the end customer, in many cases. The thousands of Exxon, Mobil, and Esso stations around the world are the most visible proof of this, but are only one piece of the equation for a company that makes everything from specialty chemicals to jet fuel and gasoline.
The benefits are huge
On the surface, it’s easy to see the benefit this offers. Take 2015 as an example. Oil prices were tumbling at the time, pushing earnings in the company’s upstream (oil drilling) business lower by a massive 75%. However, its downstream (refining and chemicals) operations use oil. With the cost of this key input falling, Exxon’s downstream business was able to roughly double earnings. That softened the blow of falling oil prices, leaving overall earnings down just 50% year over year.
Some investors see this and note that Exxon doesn’t benefit fully from rising or falling energy prices. That’s true, but for more conservative investors, the balance provided by diversification in 2015 should be more than enough to show just how beneficial diversification is and why investors should appreciate a Goliath like Exxon. But there’s more to the story than even that, and the back half of 2018 gave the company a chance to highlight just how important it is to be spread across the entire energy value chain.
Oil prices declined sharply toward the end of 2018, actually falling into a bear market in the fourth quarter. But all oil prices didn’t move in lockstep. There are bottlenecks in North America that have left an excess of oil in some spots, pushing the prices of oil from these particular regions below the prices that other regions, with greater access to markets, have been able to achieve. The swift increase in onshore U.S. drilling is largely the cause of this, but the reason for the problem is less important than the disparity here.
Exxon happens to have a huge business in North America, spanning both the continent and the entire value chain. So it can actually pick and choose what oil it uses in its refining operations. That’s possible only because it owns or controls drilling, transportation, and refining assets. By picking the lowest price feedstock for its refining business, Exxon estimates it was able to boost refining results by $280 million in the third quarter and another $600 million in the fourth quarter. So, all together, the energy giant was able to achieve an $880 million benefit from being huge and diversified.
Those benefits are generally hidden under the blanket of diversification. They only came to light today because of the unique and notable pricing discrepancies in North America. That and the fact that Exxon’s stock is out of favor, so management is trying its best to explain how the company’s business model is built to be strong through the entire cycle in an industry known for volatile ups and downs. In other words, it made an effort to point out the unique benefit so investors could better understand the company’s business model.
Worth a deep dive
If you have avoided Exxon because results have lagged those of its peers, you should take a second look. There are problems, to be sure, but management is dealing with them. And in the end, it truly has the financial strength and business diversification to roll with just about anything the market throws at it. The unique oil pricing conditions in the second half of 2018 show just how flexible this giant can be as it takes advantage of its broadly diversified business. Diversification may not be sexy, but it makes the Exxon business model stronger through the inevitable ups and downs in the energy industry.
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