Understanding ExxonMobil

By Financial Times [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons

Warren Buffett / Charlie Munger’s Four Filters + Risk Factors

  1. Understand the Business
  2. Enduring Competitive Advantages
  3. Able and Trustworthy Managers
  4. Risk Factors
  5. Bargain Price = Margin of Safety (I will not explore this as everyone should devise their own fair value)

1. Understand the Business [Updated Sep 29th 2015]

ExxonMobil is a primarily oil and gas company, involved in upstream, downstream and chemicals activities.

Upstream involves “the searching for potential underground or underwater crude oil and natural gas fields, drilling of exploratory wells, and subsequently drilling and operating the wells that recover and bring the crude oil and/or raw natural gas to the surface“, and as of its 2014 Annual Report, generated 78.92% of its Earnings after Income Taxes before deducting Corporate and Financing.

Downstream involves “The downstream sector commonly refers to the refining of petroleum crude oil and the processing and purifying of raw natural gas, as well as the marketing and distribution of products derived from crude oil and natural gas“, and as of its 2014 Annual Report, generated 8.72% of its Earnings after Income Taxes before deducting Corporate and Financing.

Chemical Activities involves collecting chemical feedstock from the Downstream oil refineries to produce polymers and chemicals & fluids. The reason why this is important is because when ExxonMobil’s Downstream oil refineries collect petroleum (aka crude oil), not everything refined from the petroleum can be used for energy carriers such as gasoline, jet fuel, diesel fuel, so the production of petrochemicals with what’s left of the petroleum is a natural fit for ExxonMobile considering being the largest oil refinery naturally yields large sources of chemical feedstock while also providing further diversification from a purely upstream company with full exposure to the cyclical nature of commodities. As of its 2014 Annual Report, Chemical Activities generated 12.36% of its Earnings after Income Taxes before deducting Corporate and Financing.

2. Enduring Competitive Advantages [Updated Oct 1st 2o15]

There are 4 competitive advantages I believe make a huge difference for ExxonMobil: Legacy low cost assets, Disciplined capital allocation, Oil reserves, Triple A credit rating

Currently, ExxonMobil’s legacy low cost assets has allowed it to produce oil/gas at $20 USD / boe (barrel of oil equivalent), as compared to the $60 USD / boe average of US upstream industry.

Combined with a management team (Rex Tillerson and co) and company culture that has a track record of disciplined capital allocation of investing only in projects that provide good return on invested capital and returning excess capitals in the form of growing dividends consecutively for 33 years. There maybe questions posed on Tillerson and co’s ability of disciplined capital allocation with XTO, but they have been quick to “dramatically cut U.S. natural gas production, divested lower-margin assets, and exited from fixed fee per barrel contracts“.

Disciplined capital allocation’s effect is further magnified by ExxonMobil’s oil reserves of 92 billion boe and a Triple A credit rating. With a combination of legacy low cost assets producing at a third of the industry’s cost and a 92 billion boe reserve (worth $3.7 trillion USD using a 10 year low of $40 USD / boe), it allows ExxonMobile enormous amount of leeway to be patient and make only the best capital allocation decisions over an extremely long time horizon.

The ability to tap into Triple A credit ratings for low cost loans also present ExxonMobil an advantage to be aggressive in acquisitions of low cost oil / gas fields at cheap valuations when there’s a recession or cyclical oil market crash. This is important since I deem ExxonMobil to not have any significant advantage in obtaining low cost oil / gas fields at cheap valuations unless competitors or partnership governments are forced to sell assets at a discount due to liquidity issues.

3. Able and Trustworthy Managers [Updated Oct 1st 2015]

One aspect of ExxonMobil’s management was explored in the aforementioned “disciplined capital allocation” section below “2. Enduring Competitive Advantages”

The other aspect of ExxonMobil’s management is financial prudence, which is different to disciplined capital allocation in a sense that I view capital allocation as offensive (deploying capital to generate more capital) while I view financial prudence as defensive. As of 2014 Dec, ExxonMobil’s 0.11 Debt to Equity (~10% of assets is debt) and dividend payout ratio of 33.20% provides huge margin of safety for ExxonMobil to navigate unforeseen negative circumstances.

4. Risk Factors [Updated Oct 1st 2015]

There are three risk factors I deem able to decimate ExxonMobil: Boe Replacement Difficulties, Trend of Gas > Oil, New Energy Sources, Financial Health Deterioration

It is no secret that days of easy Boe Replacement are long gone, with most “Western oil-producing companies… finding most accessible oil fields… tapped long ago, while promising new regions are proving technologically and politically challenging.” This issue is exacerbated by the fact that ~40% of the world’s crude oil supply is controlled by OPEC, meaning that the scramble for Boe Replacement will only get costlier as supplies outside of OPEC deplete and upstream companies play an increasingly negative sum game to bid for newer supplies.

The Trend of Gas > Oil is also worrying, since “gas sells for less than the equivalent amount of oil“, which may see ExxonMobil’s margins to suffer permanently if the quantity of gas recovered doesn’t offset the eventual decreased quantity of oil recovered.

New Energy Sources due to technological advances may also pose a grave threat to ExxonMobil if they cannot participate in profiting from such sources. Even though it seems unlikely that oil and gas would be displaced as the dominant energy source of choice overnight (best case scenario is 100% renewable energy source in 40 years), it is definitely something to be wary of for ExxonMobil.

Financial Health Deterioration is also a potential time bomb. As of 2014 Dec, Exxon Mobil’s Current Ratio, Debt to Equity and Dividend Payout Ratio has been deteriorating over the past 5 and 10 years. Exxon Mobil’s Current Ratio of 0.88 is worse than its 5 year average of 0.91 and 10 year average of 1.17, Debt to Equity of 0.11 is worse than its 5 year average of 0.06 and 10 year average of 0.06, and Dividend Payout Ratio of 33.2% is worse than its 5 year average of 27.4% and 10 year average of 25.52%. Although the Current Ratio, Debt to Equity and Dividend Payout Ratios are all currently on manageable levels, it’s hard to say the same if the trend continues.

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