Not many companies can miss their quarterly EPS target by 15% and not pay a pretty steep price in the market, but then Exxon Mobil (NYSE:XOM) isn't just any company. With the downside in the second quarter coming almost entirely from the refining business, it seems like investors remain focused on the far larger (and in line) upstream exploration and production operations. Although I don't see any particular risks to the thesis that Exxon will remain an income-producing conduit for investors who want exposure to the energy space, I think a little shopping around can turn up better alternatives.
E&P Carries On
Exxon reported a 2% yoy decline in E&P production this quarter (down 7% sequentially), with liquids production basically flat. That was by and large on target versus Wall Street expectations. Operating costs continue to rise, though, and the 12% drop in unit earnings brought operating profits about 3% below sell-side estimates. On a per-barrel basis, Exxon's unit profits fell 11% to $17/boe, which continues to be better than BP (NYSE:BP), but inferior to Hess (NYSE: HES). Likewise, Exxon has running below Chevron (NYSE:CVX) of late in unit profitability, and that will likely continue this quarter.
SEE: Oil And Gas Industry Primer
If the upstream business was basically okay, the downstream operations were a total mess. Although Valero (NYSE:VLO) and Phillips 66 (NYSE:PSX) primed investors to expect more challenging conditions in refining, the 71% drop in refining profits led to a result that was only about one-quarter of the estimate. Even if you add back one-time issues like a refinery writedown, it was still a sizable and disappointing miss. Performance in the chemicals business wasn't robust either, as profits declined 8% from last year's level.
It's A Long-Term Capital Return Story
I'm not too surprised that the market is not reacting all that badly to Exxon's reported results. If anything, I would have thought the guidance for a slowdown in share repurchase activity (from about $4 billion in the second quarter and $5 billion for many quarters before that to $3 billion) would have been the bigger worry.
Be that as it may, Exxon isn't a stock to own for quarter-to-quarter wiggles. The basic thesis here remains the idea that Exxon can cost-effectively boost production by 2% to 3% across the next five years, with a variety of projects including major offshore gas developments, unconventional crude reservoirs, and various other global projects. Rising production costs are a concern, of course, but it looks like the major oil and gas companies are being much more conservative with their capital spending in this cycle – to the detriment of companies like National Oilwell Varco (NYSE:NOV).
Will Exxon's Advantages Remain So?
Exxon may boast that it thinks in decades, but the reality is that the company cannot control all of the factors that will drive its performance over the next decade. To that end, consider the refining business – although Exxon should have a relatively “advantaged” position in U.S. refining given its exposure to areas like the Mid-Continent (along with Marathon Petroleum (NYSE:MPC)), that didn't spare the company this quarter.
Likewise, being the largest North American producer of natural gas isn't so advantageous when gas prices are so low and the company can't offset it with better earnings through the chemicals business. Last and not least, it's worth remembering that while Exxon's reserve base is about 51% liquids, close to half of that is in bitumen and syncrude assets – a business that has been generating an increased negative focus in the press.
The Bottom Line
Frankly, these negatives don't strike me as serious long-term issues for Exxon. Bitumen/syncrude/tar sands may not be popular, but people want sub-$4/gallon gasoline. Likewise, I think the long-term outlook for natural gas prices is still pretty positive.
The bigger issue I have with Exxon is that I just don't think its all that cheap right now. Exxon has long enjoyed a premium multiple in the sector, but even with that factored in I think the shares are about 5% above fair value, while alternatives like Chevron and BP look considerably cheaper. If you regard Exxon as a long-term cornerstone of your portfolio, I see no reason to do anything about it, but if you're looking to add new money to the mega-cap energy space, I'd suggest Exxon may not be the best destination.
Disclosure: At the time of writing, the author did not own shares of any company mentioned in this article.