As momentum gathers behind the seismic shift that's promising to radically transform energy markets, it's become crucial to closely evaluate the long-term viability of investing in big oil stocks, such as Exxon Mobil (NYSE:XOM).
Betting on top oil stocks has never been without risks. The biggest challenge investors face when evaluating energy stocks is correctly predicting the direction of oil markets. This, of course, is an almost impossible task given the extremely volatile nature of the commodity.
Even if you’re a long-term energy bull, picking the right stock from among the energy "supermajors" has become more complicated given the uncertain, long-term, demand-supply outlook in the context of the ever-increasing use of renewables, electric cars and the global push to curb climate change.
The performance of Exxon Mobil shares reflects this challenging operating environment for oil giants. The stock has fallen 11% this year when the S&P 500 has delivered 3% returns. During the past five years, the performance of this once most valuable firm on earth has been more disappointing. Its shares plunged 34% during that period, while the S&P 500 surged about 60%. They closed yesterday's session down 1.4% at $61.88.
Given this dismal performance, it's important to ask this question: will Exxon Mobil be able to provide dividend growth which is the only plausible reason for investors to buy this stock in this environment?
Exxon has been a generous dividend payer, hiking its shareholder payout every year for the past 37 years. With its 5.5% annual dividend yield—the most since the mid-1990’s—Exxon stock has become one of the highest yielding blue-chip stocks on the S&P 500.
Negative Headwinds
But the company’s recent financial performance is raising concerns about its ability to fund its dividend payments. In the fourth-quarter, Exxon’s cash from operations failed to cover capital expenditures and it was the fifth quarter in a row in which the company relied on asset sales or borrowing to cover its dividend payments.
As the future of Big Oil becomes uncertain, some of the world’s largest research firms are becoming more open in advising investors to stay away from these stocks.
Morgan Stanley said in a note this week that Exxon is "most exposed" to negative headwinds in the industry, including oversupply in oil, natural gas and liquefied natural gas. Goldman Sachs, at the same time, downgraded Exxon to "sell" and slashed its price target to $59 from $72.
"We do not see a compelling case to own XOM relative to other energy stocks with more attractive returns profile," Goldman analyst Neil Mehta wrote.
One big reason that investors have started to stay away from Exxon stock is the company’s quite radical approach to creating value. At a time when other oil firms are focusing on strengthening their cash positions by avoiding large ticket investments, Exxon is spending big on new initiatives.
Despite bleak oil demand forecasts, Exxon CEO Darren Woods believes the oil and gas industry needs trillions of dollars of fresh investment to meet global demand for energy products by 2040. With this in mind, Exxon is investing in low-cost mega-projects that will help maintain the company's dominance in oil and natural gas markets for decades.
That approach, though not investor friendly, is showing some success. Exxon's output from the Permian Basin has gained 79% since 2018. And the company has discovered more than 8 billion barrels of oil in Guyana — a find that led Rystad Energy to name Exxon its explorer of the year in both 2018 and 2019.
"We believe strongly that investing in the trough of this cycle has some real advantages," Woods told analysts during a conference call last week. "We have a very healthy balance sheet, which was built for times like this."
In the short-term, however, this impressive growth plan has been a major drag on the company’s shares and stability of its dividends. In November, Moody's Investors Service lowered Exxon's outlook on its top-notch debt to negative due to a “substantial” cash burn to fund growth.
“The company’s high level of growth capital investments cannot be funded with operating cash flow and asset sales at projected levels given Exxon Mobil’s substantial dividend payout,” according to Moody’s.
Bottom Line
At a time when other integrated producers such as Chevron (NYSE:CVX) ), ConocoPhillips (NYSE:COP) are returning more cash to investors and energy markets’ long-term outlook remains weak, Exxon stock doesn’t look like a winning preposition, despite its attractive dividend yield. In addition, the company’s heavy investment outlay makes it a more risky bet among the oil stocks.