Friday, December 6, 2013

Should you buy Exxon Mobil?

Rising prices will likely result in higher profits over time, which would surely result in higher stock prices and higher dividends per share. The company has proven that it is a steward of shareholder capital, as it has managed to increase dividends for 31 years in a row. Over the past decade, Exxon Mobil has managed to also raise dividends at a rate of 9%/year, while also repurchased one third of outstanding shares. As I have mentioned before, Charlie Munger likes carnivores, which are companies that consistently repurchase their shares. IBM and Exxon Mobil are companies with some of the most consistent share repurchases, which didn't stop even during the financial crisis.

If you compare Exxon to the other major energy companies in the world, it is not the cheapest one on the list.

Currently, Exxon Mobil is trading at 12.40 times earnings and yields 2.60%. It is not the best value, based on this table. However, it is the company with the longest streak of consecutive dividend increases. You can probably look equally as well with any of the companies listed above. I am going to speculate why he didn't buy each company, based on information I have gathered from Buffett over the past decade. The likes of Total have withholding taxes, and some uncertainty over increasing taxes for French companies. BP was probably excluded, because of the negative environmental effects of the 2010 oil spill. Buffett probably doesn't want to be associated with this. I am not sure why Royal Dutch was excluded, although it could be due to a scandal a few years ago that had to do with the company overstating reserves. We all know that Buffett wants to deal with able and honest management, and therefore a history of mismanagement of such proportions could be a red flag. This could be a red flag, even if the company has gotten rid of all the people responsible for inflating the company's oil and gas reserves. I would say that Lukoil looks the cheapest, and probably has more room to grow. However, Russia has an image of a very corrupt country, with memories of the government expropriation and bankrupting of Yukos in the mid 2000's still fresh in many investor's memories. For example, during the 2004 Berkshire meeting, Buffett discussed that he had to decide between buying shares of Yukos or Petrochina (PTR). Ultimately, he purchased shares of Petrochina, because he thought that the risk there was lower. I didn't list Petrochina in the table, but with a P/E of 10.37 and yield of 3.90%, although I would not be surprised if Buffett revisits this trade as well.

Interestingly enough, I sold Exxon in late 2012 and replaced it with ConocoPhillips (COP). I guess COP does not have the scale of Exxon, and does not have any Refining & Marketing operations, which were spun-off in 2012. However, it seems to have a very shareholder friendly management, despite the fact that it doesn't have a lengthy history of dividend increases like Exxon.

As for Chevron, it is one of my largest portfolio positions ( top 3), and I am not sure why Buffett would pick Exxon over it. However, I realize that I am biased on that issue. It could be due to the trial in Ecuador, where Chevron has been ordered to pay billions of dollars in fines for damages. However, I have some doubts about the integrity of the trial against Chevron. Check my analysis of Chevron.

I think Buffett likes the valuation, the economics of the business, and the massive scale of the company. In addition, he likes the high amount of cash flows generated, which allow it to return so much in the form of dividends and share buybacks to shareholders. Furthermore, the company is one of the largest in the world, and therefore, further buying by the Oracle of Omaha is not going to materially impact the stock price. The company is also US based, and therefore all earnings and dividends are not going to be subject to foreign withholding taxes, or add increased uncertainty over foreign governments. Last but not least, the company has proven that it can boost dividends to shareholders, consistently buy back stock, and also effectively deploy cash to replace reserves used. With a shareholder friendly management culture like that, it is no wonder the Oracle of Omaha chose the stock.

Full Disclosure: Long XOM, IBM, WFC, CVX, BP, RDS.B, COP

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Charles Munger: A Lesson on Elementary, Worldly Wisdom as it Relates to Investment Management and Business
How to Generate Energy Dividends Despite the Peak Oil Non Sense

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