ExxonMobil: A Big Opportunity in Big Oil

Prospects for continued growth in production volumes—and strength in oil and gas prices—prompt S&P to rate the energy giant a strong buy

by Tina Vital From Standard & Poor's Equity Research

We think energy giant ExxonMobil's (XOM; recent price, 85) size gives it advantageous economies of scale, and its strong earnings have enabled it to build a cash balance of $34 billion, exceeding its total debt of $17 billion (including our estimate of $7.3 billion for the present value of its operating leases), as of Dec. 31, 2007.

We estimate ExxonMobil's returns are the best in its peer group with a return on capital of 32% (as of Dec. 31, 2007), reflecting very high returns from its exploration and production operations—which, on the scale of its business (some $129 billion of capital employed) is remarkable. For the past 19 years, we estimate ExxonMobil's shares have outperformed the S&P 500 on a total return basis, yielding 15% annually, compared to 11% for the broader market.

While the company's exploration and production earnings benefited from a sharp increase in crude oil prices in 2007, these prices outran refined product prices and cut into its downstream margins. However, ExxonMobil has partially mitigated this negative impact through its substantial capacity to refine cost-advantaged crudes. As a result, its refining and marketing earnings declined from the first to the second half of 2007, but beat our expectations.

Over the past five years (2003-07), we estimate ExxonMobil's after-tax operating earnings expanded by about 19% per annum. While after-tax operating earnings rose 1.6% in 2007 to $40 billion, or $7.20 per share, we see full-year 2008 operating earnings rising 16% to $46.6 billion, or $8.55 per share, before moderating to a 1% increase in 2009 to $8.63 per share. We view this as pretty good compared to its "supermajor" peers, which our earnings projections indicate, on average, will rise only about 8% in 2008 before declining 5% in 2009.

ExxonMobil is expected to report 2008 first-quarter earnings in late April. We project first-quarter operating earnings will increase 24% to $11.5 billion, or $2.11 per share.

With our forecast for solid volume growth over the next five years and continued strong oil and gas price realizations, and based on our intrinsic and relative valuations, our recommendation for ExxonMobil shares is 5 STARS (strong buy).

Industry Outlook

Our fundamental outlook for the integrated oil subindustry is neutral, as S&P sees the upside potential from high oil prices offset by narrowed refining and marketing margins. While prices for the benchmark grade of crude oil, West Texas Intermediate (WTI), have topped $100 per barrel, we believe new oil supplies from both OPEC and non-OPEC producers and slowed global economic growth will ease oil prices later this year. Crude oil prices moved sharply higher in the 2008 first quarter, reflecting market speculation, geopolitical tensions, and continued strong global oil demand. Prices of refined petroleum products have failed to keep pace with the sharp rise in oil prices, and refining margins have narrowed. S&P projects 2008 U.S. refining margins will narrow almost 40% from 2007.

While the subprime mortgage crisis has reduced our forecast for U.S. gross domestic product growth, S&P and Global Insight believe a U.S. slowdown will have a limited impact on the global economy, with the bulk of the worldwide oil demand growth coming from emerging economies in countries that are not members of the Organisation for Economic Co-operation & Development (OECD). As of Feb. 25, we revised down our 2008 estimate of global oil demand growth by 0.3 million barrels per day (b/d), to 1 million b/d, about the same as last year. We also reduced our 2008 estimate of global oil supplies growth by 0.25 million b/d to 1.58 million b/d, reflecting lowered expectations for non-OPEC production growth due to continued project delays.