After reporting on the negative signals from Exxon Mobil (XOM) pulling back on capital returns, sending the net payout yield to the lowest levels in the decade, the decision of the energy giant to ramp capex is further indication that stock weakness will persist. The stock is likely stuck in the $70 to $80 range based on this news with increased production keeping a lid on energy commodity prices.
Bold Investor Day Projections
Exxon Mobil made some bold projections at their Investor Day on March 6 as the company plans to ramp capex in order to grow production. The energy giant appears to be ignoring that new drilling capital efficiency in shale areas has allowed the domestic industry to grow production without increasing capital spending. In order to generate solid returns, Exxon Mobil is making the case for around $60/bbl Brent through 2025.
The company made these projections:
- Grow annual earnings potential by more than 140% by 2025 from 2017 adjusted earnings.
- Cumulative earnings potential from 2019 to 2025 increased by $9 billion from the 2018 Investor Day.
- Annual cash flows of $60 billion in 2025 that includes operations and plans for $15 billion in asset sales from 2019 to 2021.
- Increase capital spending to $30 billion in 2019 and up to $35 billion starting in 2020.
- Permian Basin production expected to exceed 1 million boe/d by 2024, an increase of 80% from last year projections and 5x current production.
The biggest surprise is the combination of much higher capital spending in 2019 and 2020 and the desire to grow Permian Basin production five fold. Exxon Mobil plans to increase capital spending from $26 billion last year to $30 billion this year and up to $35 billion in 2020 for a very dramatic increase in drilling and production growth.
Source: Exxon Mobile 2019 Investor Day
One only needs to look at slumping oil prices from a huge domestic supply boost to question the desire of Exxon Mobil to ramp up spending. The industry already is able to squeeze out more production from flat capital spending pushing domestic production to a record 12.1 million bbl/d.
The energy giant has the goal of boosting Permian production from 200K boe/d in 2018 to >1,000K boe/d. The goal is to increase production from a previous target of an already aggressive goal of 600K boe/d from the 2018 Investor Day.
As the company mentions, the Permian generates solid returns at $35/bbl oil, but one has to question why Exxon Mobil wants to push prices back that low. A plan to ramp production just ensures that the company sells a resource at a lower price and generates substantially lower earnings. The difference between $60/bbl and $40/bbl is very stark.
Source: Exxon Mobile 2019 Investor Day
Don't Focus On Dividend Yield
One of the biggest mistakes investors make is focusing on dividend yields of companies with large capital spending requirements. Such companies try to serve two masters, requiring large capital allocations to keep them happy.
In the case of Exxon Mobil, the company already has a $30 billion-plus cash requirement for capital spending so the dividend is a secondary use of cash. The energy giant pays a $3.28 annual dividend on 4.24 billion shares for another annual cash outlay of $13.9 billion.
Exxon Mobil has an annual cash commitment of nearly $44 billion to fund capital spending and reward shareholders. As my previous research highlighted, the company has shifted capital returns from a combined stock buyback and a dividend to only a dividend.
The above dividend at over 4% is the largest in the last decade due in part to this shift ,so investors shouldn't over glamorize what amounts to a lower combined net payout yield (net stock buyback + dividend yield). Even worse, Exxon Mobil is now talking about $15 billion worth of asset sells in part to cover their cash outlays and the potential restart the stock buyback.
The company forecasts free cash flows through 2025 to cover the dividends with up to $90 billion to spare. The amount includes about $25 billion in asset sales, but the key here is the $60/bbl oil target when the energy giant is ramping up production that likely works to reduce energy prices during the period.
The key investor takeaway is that Exxon Mobil is becoming too aggressive with their drilling programs due to attractive returns at current oil prices. The problem with the scenario is that the company is likely to contribute to lower energy prices in the next six years causing cash flows to miss targets. In addition, the company is forcing asset sales into a period where the company will likely push down asset values due to higher production levels.
Avoid the energy giant until the industry looks at plans to generate maximum returns from existing production levels. The problem is that the sector constantly wants to flood the market with new production in order to project higher cash flows that won't ever be realized due to the higher production.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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