ExxonMobil's Focus On Margins Rather Than Growth Will Help It Cash In On Tight Supply

Key Takeaways

• Oil supply will remain tight leading to a higher and more volatile oil price.
• Volatility will favor large well capitalized energy companies.
• The focus on profitability and high value assets will lead to steady earnings growth.
• Share buybacks will be the primary driver of EPS growth.
• Exxon may make opportunistic acquisitions, in both fossil fuel and renewable assets.

Catalysts

Industry Catalysts

Oil And Gas Markets Will Remain Tight Despite Slowing Demand Growth

Demand for fossil fuels will continue to rise for at least five years, with peak demand occurring sometime in the next decade. However, narratives and uncertainty around the long term outlook for fossil fuels will result in lower investment in production than would otherwise occur. 

OPEC will also work to influence any price weakness with production quotas. This means supply will on average be quite tight relative to demand, and the crude price will average $90 to 2028.

The uncertainty around ‘peak oil’, geo-political tension and inventory cycles will mean oil and gas prices are likely to remain volatile too.

Volatility And Uncertainty Will Favor Large And Diversified Incumbents Like Exxon

Smaller operators are likely to struggle with funding given the uncertain outlook for fossil fuels. Investors were burnt during the 2014 to 2017 period and interest rates are likely to remain higher than they were during that period.

This will contribute to supply constraints over the long term and is likely to lead to industry consolidation and the opportunity to improve efficiencies. Exxon has strong cash flows and little debt which will allow it to make acquisitions during cyclical downturns.

ExxonMobil  Debt vs Equity and Cash Source: Simply Wall St

Company Catalysts

Focusing On Efficiency Will Lead To Improved Margins

ExxonMobil is prioritizing profitability over growth with a focus on high value assets. Current cost saving measures are on track to deliver $10 billion in annual cost savings. In time these measures will be partially offset by inflation related cost increases.

By keeping production steady, the company will be able to focus on integrating various parts of its supply chain to improve efficiency and reduce costs.

Exxon’s two areas of growing production are Guyana and the Permian Basin, both of which have low breakeven levels and are increasing production at around 20% a year. The company has also expanded its Beaumont refinery to process increased production from the Permian Basin.

XOM Current Expansion Projects  Image Credit: ExxonMobil

The recent decision to pull out of one of the Guyana blocks due to unsatisfactory survey results is a sign of Exxon’s commitment to focussing on high value assets ie. those with low production cost.

Production To Remain Flat

The company has stated that it expects production to remain flat at around 3.7 million barrels ( oil equivalent) a day through 2025. With higher oil prices, this will translate into only slightly higher revenue for the upstream business.

However, the focus on the product mix and recent investments in midstream and refining capacity will also lead to slightly higher revenue for other segments. Exxon will be able to improve coordination across the supply chain which will result in higher margins for downstream operations.

ExxonMobil Revenue and Expenses Breakdown Source: Simply Wall St

Renewables Unlikely To Feature Anytime Soon

Exxon has made quite modest investments in renewable energy, and has also been criticized for this. The company may begin to make more substantial clean energy investments in the near future. However, these are unlikely to have a meaningful impact over the next five years.

Assumptions

For these assumptions I’m using the 12-months to June 2023 as the base period. For reference the average crude price was $81 and the net margin was 14%.

FY 2028 Revenue Will Be 15% Higher 

I’m assuming total production remains at 3.7 million barrels a day through 2028, though it may in fact rise slightly.

Efficiency and refining capacity will result in higher revenue from downstream segments including energy, chemical and speciality products.

With a slightly higher crude price ($90) and higher downstream sales, I’m assuming total revenue will be 15% higher in 2028.

Margin To Dip In The Short Term, But See Improvements By 2028

In the short term net margins will most likely fall to historical levels below 10%. I expect margins  to then rise gradually due to improved efficiencies and increased production from lower cost assets. By 2028 the net margin will be at a more permanent 13%.

Share Buybacks Will Be The Biggest Contributor To EPS Growth

With improved cash flows, and low debt, I assume Exxon will continue to repurchase shares. I’m estimating an 8% decline in shares outstanding by 2028. Repurchases may well be higher, but I’m making some allowance for acquisitions and investment in renewable energy assets.

I also assume the dividend will remain at around 30% of net income.

With Margins Trending Higher, The Share Will Trade At 14x EPS

Although revenue growth will be low, the market will be happy to pay at least 14x earnings due to the improving trend in margins, the stable dividend and low debt levels.

Risks

• Exxon has been criticized for not expanding its reserves and this may affect the price multiple in the future. With regard to this I expect a new strategy to evolve over the next five years involving acquisitions/and or investments.
• If Exxon’s diversification into renewables accelerates it may put pressure on margins in the next few years.
• OPEC may decide to focus on volume rather than price if its members believe US production is very constrained. This would put pressure on the oil price and Exxon would not be able to increase production.