Posted on 29 February 2012.
Oil is surging right now, driven wild by fear and inflation.
The first issue is Iran. The country, which is the world’s third largest exporter, cut off exports to Great Britain and France. These two countries may not account for much of Iran’s revenue in and of themselves, but European countries do account for roughly 18% of the country’s oil exports and there is talk that Iran halt shipment to other countries in the Eurozone going forward. In fairness, half of Iran’s revenues come from oil; if it continues to shut countries out it will have to bear the burden on its bottom line.
An embargo planned for July 1 would like have increased oil prices anyway, but what we are dealing with here is a matter of perception – and perception, especially fearful perception, has been known to have a disastrous effect on stock prices, leading companies to be priced higher or lower on trading momentum rather than anything to do with the stock itself. The second issue is the US dollar. When the dollar goes lower, like it is now, oil prices start to swell. There is also the issue of the economy. Despite all the doom and gloom in the media (like George Soros saying in January, “The best-case scenario is a deflationary environment. The worst-case scenario is a collapse of the financial system.”), the economy has been showing pockets of strength. In any case, these are the facts and oil prices reflect them.
Billionaire oilman turned hedge fund manager T. Boone Pickens is saying that oil will end up trading at an average of $110 to $120 this year. He’s probably right. Benchmark oil prices are over $109 a barrel, while Benchmark crude has increased by 9 percent year-to-date in 2012. This will drive up the price of gas at the pump, obviously, but it will also push oil company stock prices higher.
The question is, where will your money earn the most profit?
ExxonMobil (NYSE: XOM) is one option. The company is one of the leaders in the major oil and gas industry and it has plenty of upside. Exxon recently traded for $87.34 a share on a mean one-year target estimate of $93. If analysts are right, the stock will return roughly 6.5% in the next year, plus another 2.20% for its $1.88 dividend – that’s an upside of roughly 8.7%. Exxon is also priced low at 9.72 times its forward earnings, and it is one of the best run companies in the world, which is saying something given its size. Management runs the company well but they also look after shareholders – in terms of dividends, stock repurchases, etc. One of Exxon’s biggest advantages is that it takes a long-term view of everything it does – that is part of the reason it has been able to grow as large as it has.
But, the company isn’t coming up all roses. Analysts predict that Exxon’s earnings will fall -2% this year, with most of the loss coming in the current quarter. They estimate that its earnings will increase by 9.0% next year, all in all producing an earnings increase of 7.36% on average per annum over the next five years. That’s less than its industry, which is expected to grow 51.20% this quarter, 26.20% this year and 16.19% over the next five years. That’s even less than the S&P, which is predicting to grow by 10.49% a year on average over the next five years.
So, why the long face? One reason is that Exxon has a comparatively large exposure to natural gas and, right now, natural gas prices are at the lowest they have been in years. However, that may play out okay if the company wasn’t so bullish about natural gas. Right now, most companies in the oil and gas industry are going in the opposite direction, pushing their extra cash flows into the activities that would earn them the most – namely crude. They are cutting back on natural gas activities while Exxon has increased its focus and actually ramped up plans to increase production. In its annual report, Exxon announced that it would continue investing $37 billion annually for the next several years. Even if Exxon is right in the long term, until then its focus on natural gas is going to be like a headwind, preventing it from achieving maximum shareholder value.
In addition, for as low as Exxon is priced, its rivals are priced even lower. ConocoPhillips (NYSE: COP) is priced at 8.68 times its forward earnings and pays a higher dividend ($2.64 or 3.60% yield at its recent price of $75.95), but there is a trade off. ConocoPhillips also has an earnings growth estimate of just 4.41% a year on average over the next five years and it doesn’t have the upside – it has a mean one-year target estimate of $78.98.
Competitor Chevron (NYSE: CVX) has the greatest predicted upside of the three – it recently traded at $109.08 a share on a mean one-year target estimate of $124.43 – and it pays a decent, $3.24 dividend (3.00% yield). It also has the lowest forward P/E of the three; it is priced at just 8.26 times its future earnings. However, Chevron also has the lowest predicted earnings growth. Analysts anticipate the company’s earnings will grow by an average of just 4.35% a year for the next five years.
So, the question is whether Exxon is worth the premium pricing. I don’t think so, at least not for the shorter term investor. It may be a good play in the long term, as in over five years, but I prefer to put my money in stocks that have plenty of upside and stable growth, like Chevron. Exxon could be the big winner once natural gas goes up, but I say that investors would do better to bet on Chevron, realize the short-term gain, then sell and invest in Exxon – there is time for both plays. Alternatively, conservative investors could hedge one against the other. As natural gas prices go up, so will Exxon; as oil prices go up, Chevron will be the winner. It’s a win-win.