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Ticker: XOM Sector: Oil & Gas Industry: Integrated Oil & Gas Recommendation: HOLD Pricing: 9/07/07 Closing Price $85.75 52-wk High $93.62 52-wk Low $63.87 Cost Basis $89.62 # of Shares 200 Acquisition Date (07/16/07) Approx: 1.3% now After buy: 2.6% Stop-Loss(1% por)~54.00 Recommend: $82.00 ExxonMobil Exxon Mobil Corporation (Exxon Mobil) is an international oil and gas company. Exxon Mobil operates facilities or market products in many countries, and explores for oil and natural gas on six continents. Exxon Mobil is involved in the exploration and production of crude oil and natural gas; the manufacture of petroleum products, and the transportation and sale of crude oil, natural gas and petroleum products. Exxon Mobil is a manufacturer and marketer of commodity and specialty petrochemicals, and also has interests in electric power generation facilities. In addition, the Company conducts research programs in support of these businesses1. Here are some excerpts from the company’s website on its business operations: Exxon Mobil’s Exploration Company is organized to identify, pursue, capture, and evaluate all high-quality exploration opportunities. The opportunities they pursue span the full range of resource certainty: Market Data Market Cap Total assets $475.59B $219.015B Valuation EPS (ttm) P/E (ttm) PEG Div Yield $6.99 12.27 2.19 1.60% Profitability & Effectiveness (ttm) ROA 18.87% ROE 34.71% Profit Margin 11.0% Oper Margin 16.49% Gross Margin 41.9% New exploration concepts and tests of new plays, which if successful, will provide significant long-term resource growth; Further exploration of established plays. These typically have the potential for near-term additions to the resource base; and, Mature exploration plays and discoveries that are undeveloped or only partially developed. Exxon Mobil has a development portfolio of more than 110 projects with potential net investment of more than $120 billion. Built on the success of its exploration strategy, it is this portfolio from which they select the best projects for investment and delivery of superior returns. Upstream capital spending has increased steadily since 2001 to develop major new resources. Their highly disciplined approach to pursuing and selecting the most attractive investment opportunities continues to distinguish them from their competitors2. Matthew J Wagner 1 2 http://finance.google.com/finance?q=NYSE:XOM http://www.exxonmobil.com/Corporate/About/what_we_do.asp ANALYST NAME Analyst email address.edu 1 Exxon Mobil is the world’s largest supplier of lube base stocks and a leading marketer of finished lubricants and specialty products. Anchored by Mobil 1, the world’s leading synthetic motor oil, they leverage three strong global brands, Mobil, Exxon, and Esso. Many of the world’s top original equipment manufacturers trust them to deliver technically superior products that provide the lubrication they need to keep their vehicle engines and industrial machines running at peak performance. Their dedicated organization and strong distributor network supply high-quality lubricants and provide technical application expertise to customers around the world 3 . Leveraging Brands and Technology Exxon Mobil’s leading lubricant brands – Mobil, Exxon, and Esso – continue to meet customer needs for transportation and industrial applications around the world. Customers rely on Mobil, Exxon, and Esso branded products because of their quality, reliability, technological leadership, close association with many leading original-equipment manufacturers, and their demonstrated ability to withstand performance stresses, including those of motor sports racing such as NASCAR, American Le Mans, and Formula 1. They are also backed by a variety of technical services designed to provide customers with worry-free operations3. Exxon Mobil continues to grow market share in this very profitable part of the finished lubricants business. Mobil 1 has more endorsements, recommendations, and/or approvals than any other engine oil in the North American market. The growing list of automotive manufacturers recommending Mobil 1 for their highperformance vehicles include the makers of Acura, Aston Martin, Bentley, Cadillac, Chrysler, Corvette, Dodge, Mercedes-Benz, Porsche, and Saab automobiles. New high-endurance Mobil 1 Extended Performance, Mobil Clean 7500, and Mobil Clean 5000 products drew praise from the chairman of the California Integrated Waste Management Board, who issued a letter commending the introduction of these products, especially the reduction of used oil resulting from the longer drain intervals. In Europe, the new Mobil 1 ESP Formula, a low-ash lubricant designed for diesel engines, was named the “Best OEM-Approved Lubricant 2005” by the U.K. Institute of Transport Management, based on its ability to prolong the life of emission systems of cars and trucks. Through the introduction of the new high-endurance product family of Mobil lubricants, consumers can now confidently extend their drain intervals to meet vehicle manufacturer’s recommendations3. Not only is the company the largest supplier of lube base stocks, it is also the largest refinery in the world. This distinction gives them more cost control over there extensive network and the ability to meet new challenges within its operating structure with more precision than some of its smaller competitors. 3 http://www.exxonmobil.com/Corporate/About/lubricants.asp 2 Exxon Mobil breaks down its revenues into three different categories: Upstream, Downstream and Chemicals. The company uses “Return on Capital Employed” to value the growth of its business. Essentially this calculation is net PPE minus all liabilities (S-T and L-T). Since the industry is very capital intensive it has high barriers to entry; since XOM has been a long time industry participant, it has the resource base to fund new operations and remain competitive within the industry. The above table summarizes the amounts of capital employed and the various sources of that capital (the most prominent being shareholder’s equity). Earnings Breakdown Upstream 67% Chemical 11% Downstream 22% Clearly, Exxon Mobil’s upstream business brings in the most earnings. 3 4 4 4 http://exxonmobil.com/corporate/files/corporate/xom_2006_SAR.pdf 5 5 6 5 6 http://exxonmobil.com/corporate/files/corporate/xom_2006_SAR.pdf http://exxonmobil.com/corporate/files/corporate/xom_2006_SAR.pdf 6 7 7 http://exxonmobil.com/corporate/files/corporate/xom_2006_SAR.pdf 7 8 Oil Industry Outlook There is an undeniable relationship between the stock market and energy prices. It is a well known and proven fact that as the stock market in the United States rises so do energy prices, most notably oil. As prices of energy related products continue to rise so do the profits that these companies make. The following chart shows the past 5 years of returns on the S&P 500 and the integrated oil sector: While there still remains a lot of uncertainty about the short term (what is the next Fed move, how the credit crisis is going to unfold, and are we in recession) the basic underlying economics of the market never change. Where there is great demand, there will be great supply and great profits (if a company is run effectively). There is still is not an efficient and profitable solution to fossil fuel demand. Looking at the open interest for light crude oil options on the NYMEX prices of oil are expected to stay within the 70-80 range8 for the next few months or so, and oil reports by the IEA continue to forecast at least a 60% increase in demand over the next 25 years9. Most of this new demand will come from developing nations, such as China and India. Even with OPEC talks about raising output, the current refinery capacity is at its peak. The only option to meet the rise in demand will be refinery expansion. 8 9 See Appendix A http://online.wsj.com/article/SB118397769578260737-email.html 9 Another short term aspect to the recent high oil prices have been the rise of many alternative energy companies. Most of these companies are in their infancy and it is still too early to see if they will remain if oil prices ever subside. The fact that these companies are dependent on a certain price strategy makes them a speculative bet at best. There is no energy substitute for oil in the near future. Many blame major oil companies for the lack of innovation into these products. According to an article in Forbes magazine Exxon Mobil acquired many patents on solar energy in the 70’s, but after a brief unprofitable period the company decided to stick with its core operations and has been very successful as of yet10. As more companies are going green, Exxon is trying to “clean up” its act by researching ways to reduce carbon emissions from its products (please note the reference from Exxon’s website in the previous section on its lubricant brands). The fact that alternative energy is such a small scale industry and their whole market strategy relies on high oil prices makes them more speculative than an average investment into a strong integrated oil and gas company. If oil prices are low, demand will still be there to make a profit (only the largest competitors with ample cost strategies would be able to still turn a profit); and if oil prices are high, demand for these products reacts very slow to subside, due to the lack of an efficient alternative and profits can still be made. It is my opinion that once oil supply starts to wane, large energy companies stand to fill the gap with alternative energy sources. But, until we see companies like Exxon Mobil or BP starting to go into solar power, we can bet that there is still plenty of life left in the oil industry. 10 http://money.cnn.com/magazines/fortune/fortune_archive/2007/04/30/8405398/index2.htm 10 Looking at the returns of Exxon Mobil compared to the S&P 500 over the last 10 years we can see how much the company has grown relative to the market: 11 Over speculation into the oil and gas industry might account for a portion of the returns in the past couple of years, but much of that is also reflected in net income growth over the same period. Net income YOY % change Common Base ('99) 2006 39500 9% 399% 2005 36130 43% 357% 2004 25330 18% 220% 2003 21510 88% 172% 2002 11460 -25% 45% 2001 15320 -14% 94% 2000 17720 124% 124% 1999 7,910 The company clearly is growing its earnings on a tremendous scale; but the company also is thoughtful of its shareholders. During the same periods of earnings growth, the company increased its dividend policy by 7.6 billion dollars (representing almost 20% of net income for the year) and repurchased shares in the amount of 25 billion dollars (which was around 64% of net income for the same year). The cumulative distributions for the last five years have been over 92 billion. 12 Industry Comparison: DIRECT COMPETITOR COMPARISON Market Cap: Employ-ees: Qtrly Rev Growth (yoy): Revenue (ttm): Gross Margin (ttm): EBITDA (ttm): Oper Margins (ttm): Net Income (ttm): EPS (ttm): P/E (ttm): PEG (5 yr expected): P/S (ttm): Shares outstanding XOM 473.26B 106,400 BP 218.89B 97,000 CVX 186.89B 62,500 RDS-B Industry 256.41B 134.75B N/A 73.57K -1.00% -0.40% 4.00% 17% 20.30% 366.24B 263.89B 189.82B 318.13B 114.90B 34.89% 19.01% 33.39% N/A 34.89% 72.36B 34.25B 38.58B N/A 34.24B 16.49% 9.31% 13.99% 11.77% 14.59% 40.28B 6.988 12.21 21.15B 6.47 10.61 18.89B 8.725 10.05 27.17B 8.58 9.36 12.11B 6.47 12.27 2.12 1.29 1.84 0.83 2.24 0.98 0.92 0.81 1.83 1.3 5.55B 3.17B 2.13B 3.18B BP = BP plc CVX = Chevron Corp. RDS-B = Royal Dutch Shell 11 While the data may show stronger growth in some of the competitors, the sheer size of XOM gives it the economies of scale advantage when it comes to earnings. Continued share repurchases will give the company industry leading EPS figures into the future. 11 http://finance.yahoo.com/q/co?s=XOM (added the # of shares outstanding from www.finance.google.com) 13 12 12 http://exxonmobil.com/corporate/files/corporate/xom_2006_SAR.pdf 14 Valuation: Using the Warren Buffet Owner’s Earning Model gave the following values: *Sensitivity analysis shows the effect of different discount rates and growth rates (growth rates are held constant at 6% and 3% for the (k) analysis; the (k) was held constant at 10% for the growth analysis. Warren Buffett Owners' Earnings Model assuming discount rate (k) of 10.00% (k) Sensitivity 99.35 Owner Earnings in 2006: 8% 201.99 9% 133.23 Net Income $ 39,500,000,000.00 10% 99.35 Depreciation $ 11,416,000,000.00 11% 79.38 Amortization $ 12% 66.32 Change in A/R $ (1,458,000,000.00) 15% 45.38 Change in A/P $ 2,962,000,000.00 Capital Expenditures $ (19,855,000,000.00) Owner Earnings $ 2008 2009 - 32,565,000,000.00 Year: 2006 Prior Year Owner Earnings $ First Stage Growth Rate (add) Owner Earnings 32,565,000,000.0 $ 6.0% $ 2007 34,518,900,000.0 $ 36,590,034,000.0 6.0% 6.0% 38,785,436,040.00 $ 2010 41,112,562,202.4 6.0% 6.0% 34,518,900,000.0 $ 36,590,034,000.0 $ 38,785,436,040.0 41,112,562,202.40 $ 43,579,315,934.5 Discounted Value per annum $34,518,900,000.0 $33,263,667,272.7 $32,054,079,371.9 30,888,476,485.65 $29,765,259,158.9 Sum of present value of owner earnings $160,490,382,289.2 Residual Value Owner Earnings in year 10 1st Stage (g) Sensitivity $ Second Stage Growth Rate (g) (add) Owner Earnings in year 2011 $ Capitalization rate (k-g) Value $ 3% 60.61 3.00% 4% 69.36 44,886,695,412.6 5% 81.44 4.00% 6% 99.35 1,122,167,385,314.51 7% 128.90 Present Value of Residual $432,644,105,024.69 Intrinsic Value of Company $593,134,487,313.87 Shares outstanding assuming dilution Intrinsic Value per share 99.35 43,579,315,934.5 2nd Stage (g) Sensitivity 99.35 1% 97.95 5,970,000,000 2% 98.65 $99.35 3% 99.35 4% 100.06 15 The company announced growth in earnings of 8% in 2006 over 2005 and projects a higher growth rate for future years. I decided to stick with conservative estimates since this company is out of its growth (infancy stage). Analyst estimations have the growth at 6.7% for this year versus 1.6% for the industry and 7.0% for the sector. I also valued the company using DCF and an Earnings Forecast Model with comparative ratios. For the DCF I calculated a value of 97.21 per share and with the comparative ratios I found a price target of 92.78-95.40 for this year and a range of 105.35 to 108.32 for next year (see Appendix A and B). Appendix C shows analyst recommendations. I do not put too much value into these since it does not list who recommends these and why. Some other resources offer explanations for a fee which is out of the cost scope of the assignment (since I am not being compensated to take the course or make the recommendation). Recommendation: Exxon Mobil has major competitive advantages over its peers in the refining and lube basestock components of the integrated oil and gas industry. Its size gives it cost advantages that its competitors are not able to match. The company has continued to outperform its peers over the last ten years, and has invested in research and development so it can remain at the top for years to come. If we are looking at this company through the long term binoculars, it is clear they will continue to provide superior returns to their investors compared to other companies in its industry. I recommend purchasing additional shares on the premise that this is a strong company and will be for many years. I do not think we will see much capital appreciation over the next few months or even within the next year or so; I am solely recommending this as a long term play. I believe it will outperform the money market rate we are earning on our cash holdings in the short run, but do not forecast any huge returns that could be had in more speculative industries. This company is well established and poised to make profits in good and bad times. Over the last 15 years this stock has returned over 2300%, which is 15.33% per year. A price of 91.00 now would mean a growth to 105.00 by this time next year for a 15% return. This is the low estimate of the ratio comparison valuation. 16 Appendix A: (numbers in millions) Operating Profit %increase in FCF Avg % increase in FCF (over last 7 yrs) Operarting Current Assets Operarting Current Liabilities Tax Rate Growth Rate Total Oper Capital Net Investment in TOP FCF 2006 2006 2005 2004 2003 2002 2001 2000 33538.8 28921.8 21057.6 13493.4 8610.6 12204.6 13938.6 0.159637 0.373461 0.560585 0.567068 -0.294479 -0.124403 1.625862 0.409676 72504 40784 6208 573946.8 29551 Total Value Value to NonEquity Value of Equity 603497.8 28387 575110.8 Value/share 139199 97.2621 4% 80.3142 5% 97.2621 6% 122.684 7% 165.0537 8% 249.7932 27330.8 Value of Operations (based on FCF of 2006) Nonoperating Assets #of shares 70080 37891 0.4 0.05 145407 1999 5308.2 5913 97.2621 17 Appendix B: 2001 2002 2003 2004 2005 Revunues Sales and Operating Equity Affiliates Other Total 208715 2174 1896 212785 200949 2066 1491 204506 237054 4373 5311 246738 291252 4961 1822 298035 358955 7583 4142 370680 365467 401233.6 440500.4 6985 4500 4500 5183 3000 3000 377635 408733.6 448000.4 0.097865365 Costs (Expenses) Crude Oil and product purchases Production and Manufacturing SG&A Depreciation Exploration Merger Related Exp Interest Sales Based Taxes Other taxes and duties Income to minority interests Total 92257 17743 12898 7848 1175 748 293 21907 33377 569 188815 90950 17831 12356 8310 920 410 398 22040 33572 209 186996 107658 21260 13396 9047 1010 139224 23225 13849 9767 1098 185219 26819 14402 10253 964 182546 29528 14273 11416 1181 204535.1 32144.14 14516.02 12151.78 1182.003 229172.9 34992.07 14763.17 12934.98 1183.007 0.120457786 0.088598747 0.017026218 0.064451376 0.000849259 207 23855 37645 694 214772 638 27263 40954 776 256794 496 30742 41554 799 311248 654 30381 39203 1051 310233 747.6462 32082.77 40268.42 1164.174 338792 854.7015 33879.87 41362.8 1289.534 370433.1 0.143189836 0.056014446 0.027177113 0.10768194 23970 8967 17510 6499 31966 11006 41241 15911 59432 23302 67402 69941.52 77567.36 27902 27976.61 31026.94 102 215 449 25330 6482 36130 6266 39500 41964.91 46540.42 5913 5775.576 5641.346 EBT Income Taxes Discontinued Ops Extraordinary Gain Accounting Change Net Income (earnings) Average Common Shares Outstanding Net Income per share P/E ratios Industry Average (Yahoo) Company P/E (9/18/07) Price(Industry Average P/E) Price (Company P/E) 2006 F2007 F2008 Geometric Avg 550 15320 6809 11460 6753 21510 6634 -0.023240994 2.249963 1.697024 3.242388 3.907745 5.766039 6.680196 7.265926 8.249878 12.77 13.13 12.77 13.13 92.78588 105.3509 95.40161 108.3209 18 Appendix C: RECOMMENDATION TRENDS Current Month Last Month Two Months Ago Three Months Ago Strong Buy 5 6 6 6 Buy 4 3 3 3 Hold 11 11 11 11 Sell 0 0 0 0 Strong Sell 0 0 0 0 Data provided by Thomson/First Call 19