Markets & Finance

Looking for a Good Defensive Play? Ride the Tiger


By Tina Vital This week's S&P Focus Stock of the Week is Exxon Mobil (XOM), ranked 5 STARS (buy). Standard & Poor's recommends the stock as a safe haven, and as a solid investment with growing cash flows and an active share repurchase program. Exxon Mobil, the largest publicly-traded oil company in the world, trades at a premium to its as the market rewards the behemoth for its earnings stability.

In this year's first quarter, lofty oil and gas prices resulted in profits of $5.05 billion, somewhat shy of Exxon Mobil's record 2000 fourth quarter earnings of $5.12 billion, the best ever recorded by a U.S. corporation. Recently, overall savings from the integration of Mobil were upped to $7 billion by 2002, from prior estimates of $2.8 billion in 1998 to $4.6 billion last year.

GLOBAL GIANT. Operationally, the company did a nice job of integrating the two merged units. Combined assets include oil and gas fields in 200 countries on six continents, 46 refineries in 26 countries that sell about 200 million gallons of fuel per day in 118 countries through 45,000 service stations.

The company's substantial business and geographic diversification helps moderate its exposure to business risk and margin volatility. In addition to being one of the largest oil and natural gas producers (the "upstream", 70% of 2000 after-tax earnings) in the world, Exxon Mobil is also one of the largest refiners (19%) and producers of petrochemicals (7%) in the world - and its leverage to refining shields it from falling crude prices. For every barrel of crude oil that Exxon Mobil produces, it sells three barrels of refined products.

However, with oil and gas demand rising about 3% per year, and output from mature production fields declining over 8%, the company will need to invest heavily in exploration and production to keep pace. Capital and exploration spending for 2001 is slated to increase as much as 20%, from 2000 levels of $11.14 billion. In 2000, the company replaced 112% of its production, and barrel oil equivalent (BOE) production totaled 1.6 billion barrels, up only slightly from 1999.

SWIMMING UPSTREAM. Going forward, the company expects to grow its oil and natural gas production by 3% per year - with future upstream investments in almost every key area of the world, including the Gulf of Mexico, the North Sea, the Caspian region and West Africa. The company has 39 upstream projects underway to develop 5.1 billion BOE of reserves - and an additional 49 projects are in the early planning stages with the potential to develop another 9 billion BOE of reserves.

In May 2001, Exxon Mobil secured a coveted role as leader and operator in two (the South Ghawar and the Red Sea) of three core projects, and will be the lead investor, in Saudi Arabia's first extensive opening of the its upstream sector to foreign investors since the 1970s. Competition for participation awards was ferocious, but eight international oil companies were winners: Exxon Mobil, Royal Dutch/Shell, BP, TotalFinaElf, Conoco, Phillips, Occidental Petroleum and USX Marathon.

The venture, called the Saudi Gas Initiative, has been described as the world's largest oil and gas project -- and is designed to develop the natural gas infrastructure of the Kingdom, freeing up more oil for export. The South Ghawar and Red Sea projects are expected to require up to $20 billion in investment from the group, but returns are expected to exceed 15%. Exxon Mobil's participation gives it a prized foothold in the Kingdom for future projects.

BEST IN CLASS. S&P recommends Exxon Mobil, trading at 17 times the 2001 earnings per share (EPS) forecast of $5.33, for superior appreciation and rising dividend income. The dividend, at a current annual rate of $1.76, is up 9% since 1997. The company's balance sheet is strengthening, with debt to capitalization 15% as of March 31, 2001, down from 23% at year-end 1999. Its strong earnings and cash flow has enabled the company to build a cash balance of about $10.9 billion, driving net debt to capitalization to about 2.6% -- despite repurchasing more than $3.0 billion of stock over the past two years and increasing capital expenditures by 15% to 20% this year. On May 30, the company's directors announced an additional cash dividend of two cents per share on its common stock and a 2-for-1 stock split.

Due to its best-in-class performance in all facets of the oil and gas industry and conservative financial management, S&P looks for the share price to top $120 over the next 12 months, representing a multiple of 23 times S&P's 2002 EPS estimate (versus about 24 times for the S&P 500). Vital is an oil and gas industry analyst for Standard & Poor's


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