FISHER COLLEGE OF BUSINESS
EXXON MOBIL CORPORATION
Ticker:
XOM
Stock Price: $60.45 Target Price: $ 76.71 Upside Potential: 26.90%
Recommendation: BUY
ANALYST:
Lane Flood
CONTACT:
(614) 330-5022
flood.37@osu.edu
flood_37@cob.osu.edu
FUND MANAGER:
Royce West, CFA
Recommendation Summary
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COURSE:
Business Finance 824
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DATE:
May 30, 2006
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Historical EPS
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Strong financial performance over the last 3-5 years
1st quarter 2006: Revenues $90B ; Earnings: $9B
Cheap relative to sector and S&P 500
o Further evidenced by low PE Ratio (10.5)
Conservative Target Price of $76.71 – gives upside potential of 26.90%
Diversified within Oil Sector
o Upstream, Downstream, and Chemical business
Geographically diversified
Stock performance strongly correlated to rising crude oil prices
World demand for oil is at an all time high and growing
o China and India helping drive demand
o U.S. remains largest consumer of oil
Oil supply is believed to have “peaked”
o Scarce resource – price will continually be driven up as used
Political unrest may increase crude oil prices
o e.g. Further instability with Iran
2003: $3.15
2004: $3.91
2005: $5.35
Sales / Net Income by Line of Business
Consensus EPS Estimates
Sales
2006: $5.87
2007: $5.78
2008: $5.28
Net Income
83%
67%
High Estimates
2006: $6.51
2007: $7.42
2008: $7.71
22%
9%
8%
11%
Low Estimates
Upstream
Downstream
2006: $5.06
2007: $4.70
2008: $3.65
Line of Business
1
Chemical
Table of Contents
Company Overview………………………………………………………………. 3-4
Sector Analysis…………………………………………………………………… 4-7
Macroeconomic Drivers………………………………………………………….. 8-9
Risk Factors………………………………………………………………………. 10-11
Company Financial Analysis……………………………………………………. 11-14
Ratio Analysis…………………………………………………………………….. 14-15
Valuation Analysis
Assumptions……………………………………………………………….. 16
Terminal Growth Rate…………………………………………….. 16
Discount Rate……………….. …………………………………..... 16-17
Sales Growth Rate…………………………………………………. 17
Margins……………………………………………………………. 17
Other………………………………………………………………. 17-18
Implied Value……………………………………………………………… 18
Sensitivity Analysis………………………………………………………... 18-20
Exxon vs. Sector Performance……………………………………………. 21
Exxon vs. S&P Performance……………………………………………… 22-23
Summary & Recommendation…………………………………………………… 24
2
Company Overview1
Exxon Mobil is engaged in the exploration for and production of crude oil and
natural gas. It also manufactures petroleum products and transports and sells crude oil,
natural gas, and petroleum products; including petrochemicals. Exxon is currently
operating in the United States as well as over 200 more countries around the world. The
company operates in three different lines of business; upstream, downstream, and
chemical.
The upstream aspect of the business includes the exploration, production, and
transport of crude oil prior to refining. According the company’s 10-K, “Exxon
maintains the largest portfolio of development and exploration opportunities among the
international oil companies, which enables the selectivity required to optimize total
profitability and mitigate overall political and technical risks. Exxon is currently
operating in growth areas that are expected to double in output in the next 5 years. These
areas include West Africa, the Caspian, the Middle East, and Russia. Exxon also expects
growth in oil production and natural gas production with its use of arctic technology,
deepwater drilling and production systems, and heavy oil recovery processes over the
next 5 years. At the end of fiscal year 2005, the upstream line of business accounted for
only 8.4% of Exxon’s sales revenue, but 67.1% of its profits. The margins in the
upstream line of business are significantly higher than those of the other two, and this
trend is expected to continue well into the future.
The downstream business refers to the refining, and marketing and distribution of
oil products after refining. The downstream industry is very competitive, specifically in
retail fuels, which has put a strain on operating margins within this line of business. As
of fiscal 2005, the downstream business accounted for a staggering 82.9% of sales, but
only 22% of profits. Exxon has invested capital in the improvement of refining
technology in order to make current refineries more efficient and productive. It has been
able to significantly increase capacity at a fraction of the cost of building a new refinery.
Over the past 10 years, it estimates its capacity has grown at the equivalency rate of 3
new mid-sized refineries. Refining margins are driven by the difference between what
refineries pay for raw materials and the market prices for the products produced. Market
prices on oil commodities (i.e. crude oil) are established by trading on multiple
exchanges around the world. The New York Mercantile Exchange and the International
Petroleum Exchange are two of the largest global marketplaces for these commodities.
The global market is impacted by the following factors (as well as many others):
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1
Global and Regional supply/demand balances
Inventory levels
Refinery operations
Import/Export balances
Seasonality
Exxon Mobil Corporation 2005 10-K Report
3
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Weather
o For example, fuel prices increased 25% after Hurricane Katrina
Political Environment
Exxon Mobil operates in the downstream business with a strategy of being the best
supplier of oil in all aspects of the business. This includes investing in maintaining the
leading technology, capitalizing on integration opportunities with other businesses, and
providing high quality products and services to its customers. Its reputation of being an
industry leader enables Exxon to take advantage of emerging market growth
opportunities around the world. This is vital to the success of the business because the
emerging markets, along with the United States, are driving the demand for oil. As India
and China continue to develop and increasingly introduce motor vehicles as a means of
transportation for all citizens, the demand for oil will maintain tremendous growth. This
can lead to increased margins and growth opportunities for Exxon Mobil.
Finally, the company operates a chemical business that refers to the production or
petrochemicals; including olefins, aromatics, polyethylene, polypropylene plastics, and
other specialty products. Petrochemical demand has continued to be supported by a
strong global economy; specifically Asian demand has been strong due to industrial
production growth. Exxon has benefited from its portfolio of products that happens to
include the largest-volume and highest-growth petrochemicals in the global economy.
Accordingly, this line of business accounts for 8.7% of sales and 10.9% of profits. As the
global economy continues to growth, margins in the chemical business should continue to
improve in the short-term. However, with increased success in the chemical business,
competition is sure to increase and drive down margins; much like it has in the
downstream business.
Sector Analysis
The Energy Sector has been a top performer in 2006 as it is up 6.53% year to
date, and is outperforming the S&P as a whole by 5.71%. In the second quarter, as
interest rates have risen and crude oil prices have relaxed, the energy sector has lost some
of its steam. The energy sector, which comprises 9.55% of the S&P 500, has been
driving market returns, and the recent downturn can be attributed to market wide factors;
including the fall in commodity prices. Despite the recent reports claiming the
emergence of alternative fuel sources, the world is still very much dependent on oil and
will continue to be for some time.
The Energy sector is broken down into five different industries: Oil & Natural
Gas Production and Exploration, Oil & Natural Gas Equipment and Services, Oil &
Natural Gas Pipelines, Oil & Natural Gas Marketing and Refining, and Integrated Oil &
Natural Gas. Exxon Mobil is in the Integrated Oil & Natural Gas industry as it performs
a combination of all of the other activities. All of the largest players in the Energy sector
are considered to be the Integrated Oil and Natural Gas industry. The top 5 players in
order of Revenue are: Exxon Mobil, Royal Dutch Shell, British Petroleum, Chevron, and
ConocoPhillips.
4
As the supply of oil decreases and the demand increases, prices for oil will
continue to increase and the energy sector will perform well. Currently, the world
production of oil is increasing dramatically; however, the price of crude oil continues to
climb. Economically, this shows that demand is driving the price of crude oil (See
Exhibit 1). There is certainly evidence that demand is in fact driving the price of oil. In
the last year, China’s oil consumption increased 9%; while India’s oil consumption
increased 7%. The world’s top consumers are included in (Exhibit 2). The United States
is far and away the largest consumer of oil in the world, followed by China and Japan.
To update the numbers to today’s figures, conservatively China and India’s consumption
is now closer to 7.75M barrels/day for China and 2.65M barrels/day for India. As more
and more emerging countries prosper, the energy sector will continue to perform well as
oil prices will remain high with the heightened demand.
Exhibit 1
S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) Price 62.23
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
StockVal®
2006
2007
75
55
HI 73.73
LO 10.86
ME 27.12
CU 67.50
GR 11.7%
40
25
20
15
04-26-1996
04-28-2006
10
CRUDE OIL (WTI) SPOT
74800
72600
HI
LO
ME
CU
70400
68200
74411
63220
67589
73943
66000
63800
04-30-1996
Demand Driving Price
01-31-2006
61600
INTL CRUDE OIL PRODUCTION-WORLD TOTAL
65
55
HI
65
LO
21
ME
33
CU
62
GR 11.1%
45
35
30
25
04-26-1996
04-28-2006
20
PRICE
5
Exhibit 2
Top World Oil Consumers, 2004*
Total Oil Consumption
Country
(million barrels per day)
1
United States
20.7
2
China
6.5
3
Japan
5.4
4
Germany
2.6
5
Russia
2.6
6
India
2.3
7
Canada
2.3
8
Brazil
2.2
9
South Korea
2.1
10
France
2.0
11
Mexico
2.0
*Table includes all countries that consumed more than 2 million bbl/d in 2004.
Finally, in order to further evaluate whether an investment in the Energy sector is
“good bet”, it is important to look at its status relative to historical data, as well as, the
S&P 500 index. In order to evaluate whether the sector is cheap, inline, or expensive
relative to its benchmark, we will look at Price to Earnings, Sales, Cash Flows, and Book
value ratios. With the belief that the performance is always mean reverting, which is
usually the case, it is important to compare the current number with the mean. As you
can see in Exhibit 3 (next page), the Energy sector is cheap compared to historical data.
In every aspect, price to earnings, price to sales, price to cash flows, and price to book,
the Energy sector is below the mean. The anticipation is that the sector will move back
toward the mean indicating that the price of the Energy sector will increase in the future.
The Energy sector relative to the S&P 500 is not as clear of an indicator (See Exhibit 4).
As one can see, the sector appears to be cheap relative to the S&P on a price to earnings
and price to cash flows basis, but appears relatively expensive on a price to sales and
price to book basis. The difference between the relative value measures indicates that
there may be reason to look at financial margins. If price to sales appears to be
expensive, but price to earnings and cash flows appears cheap, this indicates that the
sector is not generating an enormous amount or sales, but is out earning the market.
Therefore, it is important to determine whether the operating and profit margins in the
energy sector are sustainable. Based on historical information, there is no reason to
believe that margins will decline drastically moving forward. Relative to the S&P 500,
the energy sector operates with higher margins. This is most likely attributed to the lack
of substitutes in the industry. This leads to higher prices compared to a relatively low
cost structure associated with the production, exploration, manufacturing and distribution
of oil.
6
Exhibit 3
S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) Price 62.23
1996
1996
1997
1997
1998
1998
1999
2000
2000
2002
2002
2001
2001
2006
2003 200420042005 2005
2003
StockVal®
2007
2006
2008
2007
40
HI
LO
ME
CU
32
24
41.9
8.0
15.4
10.0
16
04-26-1996
04-28-2006
8
PRICE / YEAR-FORWARD EARNINGS
1.8
HI
LO
ME
CU
1.5
1.2
1.77
0.83
1.12
1.03
0.9
04-26-1996
04-28-2006
0.6
PRICE / SALES
18
HI
LO
ME
CU
15
12
17.3
7.1
9.4
8.2
9
04-26-1996
04-28-2006
6
PRICE / CASH FLOW ADJUSTED
4.0
HI
LO
ME
CU
3.5
3.0
4.0
2.0
2.9
2.6
2.5
04-26-1996
04-28-2006
2.0
PRICE / BOOK VALUE
Exhibit 4
S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) Price 62.23
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
StockVal®
2006
2007
2.0
HI
LO
ME
CU
1.6
1.2
1.76
0.44
0.77
0.68
0.8
04-26-1996
04-28-2006
0.4
PRICE / YEAR-FORWARD EARNINGS RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
0.9
HI
LO
ME
CU
0.8
0.7
0.81
0.54
0.67
0.70
0.6
04-26-1996
04-28-2006
0.5
PRICE / SALES RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.2
HI
LO
ME
CU
1.0
0.8
1.02
0.56
0.77
0.72
0.6
04-26-1996
04-28-2006
0.4
PRICE / CASH FLOW ADJUSTED RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.2
HI
LO
ME
CU
1.0
0.8
1.13
0.58
0.79
0.88
0.6
04-26-1996
04-28-2006
0.4
PRICE / BOOK VALUE RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
7
Macroeconomic Factors
The price of crude oil is the one macroeconomic factor that drives the success of
the energy sector and Exxon Mobil. The stock performance of Exxon Mobil has been
almost perfectly correlated with the price of crude oil over the past 10 years (See Exhibit
5). As the price of oil increases, the oil that Exxon produced and is keeping in reserves
increases in value. Additionally, the price of crude oil is also almost perfectly correlated
to consumer gas prices (See Exhibit 6), so Exxon is able to charge customers more
money for gas. The downstream aspect of the oil business is still responsible for the
purchasing of oil (raw materials), and therefore, the increased prices not only lead to
increased sales revenue, but also stressed margins. The increase in sales revenue in the
downstream line of business is usually more than enough to make up for some decreased
margins, so profits usually increase with increased crude oil prices. Additionally, the
upstream business performs extremely well under these conditions. This explains why
the correlation exists between stock performance and crude oil prices.
It is important to note, Exxon Mobil or the Energy sector itself is not responsible
for setting the price of crude oil. Crude oil is a commodity that is traded on various
exchanges, and therefore, the price is set through a series of trading. Therefore, although
oil companies are often vilified when crude oil prices rise, consumers are often directing
their attention towards the wrong people. Investors and the consumers themselves are the
ones driving the price of gas. Additionally, Exxon makes on average $0.09 per gallon of
gas, which is very small when compared to the government’s take of between $0.50 and
$0.60 per gallon in taxes. Therefore, it should not be surprising that the government is a
fan of big oil companies because it generates lots of tax revenue. As some congressmen
are proposing, a temporary cut in the taxes collected on gasoline purchases would allow
for the consumer to spend less money per gallon of gas. However, the government would
have to make up for the lost revenue in other places and higher sales or income taxes
would probably be the result. Therefore, it is important to note that many
macroeconomic factors influence the energy sector, but overall the success of the sector
and Exxon Mobil is explained best by crude oil prices.
Finally, it is important to explain why the price of oil and gasoline cannot be
considered mean reverting. When looking at Exhibits 5 and 6, one may incorrectly
conclude that since the price of oil is currently high and much greater than the mean, it
must be expensive and thus it should become cheaper in the future. There has been a
trend in crude oil and gas prices which skews the mean. It is not realistic to believe that
crude oil prices will revert back to the mean of $24 per barrel because oil is a scarce
resource and the demand for oil is at an all time high. With demand at its current level
and rising, there is no reason to believe that the price of this vital, depleting commodity
should revert back to the mean. Essentially, a new mean is being established in the new
environment of emerging countries growing more and more dependent on oil. The global
economic situation in which the world is currently living is not support a crude oil price
of $24 per barrel, and crude oil appears to be supported at its current level of $70+ per
barrel.
8
Exhibit 5
S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) Price 62.23
1996
1996
1997
1997
1998
1998
1999
2000
2000
2001
2001
2002
2002
2006
2003 200420042005 2005
2003
StockVal®
2007
2006
2008
2007
65
55
HI
LO
ME
CU
GR
45
35
30
25
65
21
33
62
11.1%
04-26-1996
04-28-2006
20
PRICE
75
55
HI
LO
ME
CU
GR
40
25
20
15
73.73
10.86
27.12
67.50
11.7%
04-26-1996
04-28-2006
10
CRUDE OIL (WTI) SPOT
80
HI
LO
ME
CU
GR
55
40
30
76.65
13.22
24.22
74.49
15.1%
20
15
04-26-1996
04-21-2006
10
CRUDE OIL ($ PER BBL) 1 YR FUTURE
Exhibit 6
StockVal®
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
80
HI
LO
ME
CU
GR
50
30
20
75.17
10.79
27.06
71.88
12.4%
04-26-1996
04-21-2006
10
CRUDE OIL ($ PER BBL) NF
2.5
HI
LO
ME
CU
GR
1.5
1.0
0.5
2.24
0.33
0.80
2.09
11.3%
04-26-1996
04-21-2006
0.3
GASOLINE-UNLEADED ($ PER GAL) NF
80
HI
LO
ME
CU
GR
50
30
20
76.65
13.22
24.22
74.49
15.1%
04-26-1996
04-21-2006
10
CRUDE OIL ($ PER BBL) 1 YR FUTURE
2.2
HI
LO
ME
CU
GR
1.4
1.0
0.6
2.01
0.40
0.71
1.88
13.3%
04-26-1996
04-21-2006
0.4
GASOLINE-UNLEADED ($ PER GAL) 1 YR FUTURE
9
Risk Factors
One of the main risk factors for Exxon Mobil and the energy sector are
macroeconomic changes that are not within a company’s control. Aforementioned, a
change in the price of crude oil will greatly change the dynamic of the energy business,
and Exxon Mobil will be greatly impacted by a change in price or margin associated with
refined oil products. Any global event that impacted the supply and/or demand for oil
products would greatly impact Exxon Mobil. In order to lower its macroeconomic risk,
Exxon engages in both the upstream and downstream lines of the business in over 200
countries. This enables Exxon to lower its exposure to risk since it is not dependent on
any one single country for its business to operate successfully.
Exxon also faces tremendous competition within its three lines of business. This
exposes it to other risks associated with its products. Exxon must invest capital in the
development of new technologies that could make their current operations obsolete. If a
competitor were to develop better technology, Exxon would face a risk of lost revenues
and declining margins. For example, if a technology enables a competitor to produce and
refine oil at a must cheaper rate than what Exxon incurs, Exxon’s revenues and margins
will suffer as customers buy their gas from the competitor with the cheaper price. This
risk is not as substantial in the energy sector as in many other sectors because oil is a
commodity that is traded on exchanges. However, it is still true that being
technologically innovative gives a company an advantage.
Another potential risk that is often discussed in the media is the change from oil
to another energy source. If another energy source were developed that could be
distributed to consumers at a lower price than oil products, then the energy sector,
including Exxon, would certainly be at risk of becoming obsolescent. If ethanol, for
example, were to become the “next gasoline” and had the ability to be distributed around
the world, then oil companies not engaged in the production of ethanol would certainly
fail. Although this is a very serious risk for oil companies, it does not appear that the
world will stop its dependence on oil suddenly. As these new sources of energy continue
to evolve, oil may eventually begin to lose it appeal to the mass consumers, but this will
certainly not happen overnight. As this risk continues to grow, oil companies will almost
assuredly begin to try and merge with alternative energy companies in order to survive.
Finally, political risk is the most important risk that Exxon Mobil must deal with
in today’s world. Exxon Mobil operates in a commodity business, and therefore, it is
important for Exxon to operate all over the world in order to obtain the commodity. With
increased geographic exposure comes increased political risk. The possible negative
effects of operating in different political environments include; corruption, exchange rate
risk, political and social unrest, cultural effects, etc. Corruption is often associated with
many of the countries in which oil is the primary export, such as Venezuela. For
example, in early April 2006, Venezuelan president, Hugo Chavez, tried to force Exxon
to renegotiate its deal. Chavez required that Exxon agree to the following terms:
10
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PDVSA (the Venezuelan Petroleum Agency) will control the boards of the
new joint ventures
Income tax rates go from 34% to 50%
Royalties increase from 16.6% to 33.3%
Exxon did not agree to the terms, so it sold its 15,000 barrel a day field to a
Spanish/Argentinean company named Repsol. This type of corruption is a huge risk to
Exxon because it leaves the company little choice but to leave the environment or accept
a bad deal. However, corruption is certainly not the only political risk associated with the
energy sector. Foreign exchange rate risk can be substantial, so Exxon and many oil
companies hedge their risk in various derivatives. The company is still exposed to the
laws and regulations of the country in which it operates, so the tax rates and royalties in
certain countries could be a risk to Exxon. Ultimately, when a company operates in
many different countries it is going to be exposed to many risks that truly national firms
do not deal with, but the benefits of taking on this additional risk can lead to huge
rewards.
Company Financial Analysis
Exxon has been experiencing a period of tremendous sales growth which has led
to its recent success. In 2005, Exxon became the largest company in the world in terms
of revenues, profits, and market capitalization. The company’s sales have grown at a rate
of 23% or more over the last two years, leading to an overall increase of over $120B
during that span. This success should not come at a surprise, as the macroeconomic
factors, especially crude oil prices, have been driving the entire energy sector. However,
it is important to look at how Exxon Mobil is driving its success. Sales are not the only
factor driving Exxon’s success; it has also been turning over its assets at an enormous
rate. Specifically, inventory turnover has increased tremendously over the past 5 years
(See Exhibit 7). Exxon in fiscal year 2005, turned over its inventory every 9.18 days.
The success in these two areas explains the tremendous 32.5% return on equity in the last
year.
Exxon’s increased sales revenue and net income have led to large cash balances
over the last couple of years. As you can see from Exhibit 7, Exxon’s day’s payable ratio
has decreased over the last 3 years. This indicates that Exxon has been using excess cash
generated by the increased sales revenue to pay off its accounts sooner. Although the
Accounts Payable balance has increased over the last few years, it is not doing so at the
rate of sales and cost of goods sold. Therefore, Exxon is becoming more efficient at
paying off their accounts. However, this also may be an indication of too much financial
slack. At the end of 2005, Exxon had nearly $30B in cash and cash equivalents.
Maintaining such a large cash hoard may be an indication that Exxon does not have any
positive NPV projects in which to invest capital. Exxon did spend 3.73% of sales, or
$13,839B in capital expenditures in 2005; however, this number will not be sustainable
into the future when sales growth slows (See Exhibit 8). This should mean good things
for the stock performance as free cash flow will increase, and the company will pay
money to buyback shares.
11
Exxon has also become more efficient in collecting its accounts receivable. It has
lowered the amount of days it takes to collect receivables from 38 to 27 over the last 3
years. By operating more efficiently, Exxon is able to put the cash collected from
customers to use in operating its business. As you can see in Exhibit 7, despite an
increase in sales of nearly $72.5B from 2004 to 2005, Accounts Receivable only
increased $2B during the same year. This increased efficiency is contributing to the
aforementioned financial slack being generated by the company. However, this mass
accumulation of cash gives Exxon flexibility in operations and helps to minimize its
risks. In the future, Exxon may use this large cash hoard to start producing alternative
energy sources, or purchase other companies that could diversify their energy holdings.
This is not likely to occur in the near future as the world is still very much dependent
upon oil, so free cash flows will remain strong.
With the increased sales and efficiency, it is not surprising that Exxon’s liquidity
ratios have improved over the last couple of years. Exxon is currently maintaining a
current ratio of 1.58, meaning that it has more than enough liquidity to cover all of its
short-term liabilities (See Exhibit 7). For a company the size of Exxon, maintaining a
current ratio much larger than 1.5 could be considered inefficient. It is important to
maintain a balance between financial flexibility and financial slack. At its current level,
Exxon is maintaining enough flexibility to cover all short-term liabilities and the ability
to invest in positive NPV project should they arrive. So, Exxon has nearly $27B in shortterm assets in which it can use to finance project, buyback shares, etc. before it would
have to borrow money to meet its obligations.
Although Exxon has been growing at a rapid pace over the last few years, it is in
the mature phase of its life cycle. Therefore, it should not be surprising that it maintains
very healthy leverage ratios. In the latest fiscal year, Exxon maintained a debt-to-equity
ratio of 0.87 and a debt-to-assets ratio of 0.47 (See Exhibit 7). The debt-to-equity ratio
gives an indication of how much capital has been borrowed compared to the money spent
to purchase shares of the company. The lower the debt-to-equity ratio usually means the
better and more sustainable the company’s operations. Additionally, Exxon maintains a
very healthy debt-to-assets ratio, which tells us that Exxon finances its operations with
47% debt and 53% equity. For large corporations, it is not uncommon to see large
amounts of corporate debt, and Exxon Mobil is no different. Exxon maintains a very
healthy credit rating of AAA, the highest attainable, giving an investor an indication of
the positive financial position that Exxon maintains. Investors are usually very cognizant
of the leverage ratio because of their residual interest in the firm’s assets, so a good credit
rating is not only important to debt investors but also shareholders. Therefore, if you are
a creditor or investor in the company, you feel pretty secure about your position with the
firm. As Exxon continues to grow, one should expect for the amount of debt and
liabilities to decrease and the leverage ratios to continue to improve. Interest expense,
although relatively small already, will decrease, margins and profitability with increase,
and the stock performance should prosper under these conditions.
12
Exhibit 7
2005
370,680
9,321
39.77
9.18
$
$
2004
298,035
9,487
31.42
11.62
$
$
2003
246,738
8,957
27.55
13.25
$
$
2002
204,506
8,068
25.35
14.40
$
$
2001
212,785
7,904
26.92
13.56
Sales
Inventory
Inventory Turnover
Inventory Days
$
$
Accounts Payable
COGS
Days Payable
$
$
36,120
212,038
62.18
$
$
31,763
162,449
71.37
$
$
28,445
128,918
80.54
$
$
25,186
108,781
84.51
$
$
22,862
110,000
75.86
Accounts Receivable
Sales
Days Receivable
$
$
27,484
370,680
27.06
$
$
25,359
298,035
31.06
$
$
24,309
246,738
35.96
$
$
21,163
204,506
37.77
$
$
19,549
212,785
33.53
Current Assets
Current Liabilities
Current Ratio
$
$
73,342
46,307
1.58
$
$
60,377
42,981
1.40
$
$
45,960
38,386
1.20
$
$
38,291
33,175
1.15
$
$
35,681
30,114
1.18
Total Liabilities
Total Equity
Total Assets
Debt-to-Equity Ratio
Debt-to-Assets Ratio
$
$
$
97,149
111,186
208,335
0.87
0.47
$
$
$
93,500
101,756
195,256
0.92
0.48
$
$
$
84,363
89,915
174,278
0.94
0.48
$
$
$
78,047
74,597
152,644
1.05
0.51
$
$
$
70,013
73,161
143,174
0.96
0.49
Exhibit 8
2005
Capital Expenditures
Current Rate
Sustainable Rate
Sustainable Expenditure
$13,839
3.73%
2.5 - 3%
$ 9,000 - $ 10,000
As one may expect, with the increase in cash and cash equivalents over the last
couple of years, working capital has also been increasing dramatically (See Exhibit 9).
The change in cash and cash equivalents has increased nearly 1400% over the last 4
years. This is explained by the strong financial performance and rapid sales and profit
growth associated with the time period. Receivables have increased in every year in the
table, thus hurting working capital. However, the receivable growth has been greatly
exceeded by sales growth, and therefore, the company is managing receivables very
effectively. In the last year, inventories were down from the previous year, helping to
increase working capital. However, Exxon appears to manage inventory well and no big
movement in working capital should be expected due to inventory changes. Finally,
accounts payable have been increasing during the period. This is a positive cash flow
into working capital because this is money that the firm still has possession and which
13
can be invested into the company’s operations. This increase become problematic if the
company is failing to pay off its accounts, but as mentioned above, the company has been
very efficient in its management of accounts payable. Overall, working capital appears
strong as it continues to grow. The company will look to invest the capital in order to
improve operations and minimize risks.
Exhibit 9
Change In Cash Flow
Cash & Equivalents
Trade Receivables
Inventories
Accounts Payable
Change in Working Capital
$
$
$
$
$
2005-2004
10,140
2,125
(166)
4,357
12,538
$
$
$
$
$
2004-2003
7,905
1,050
530
3,318
9,643
$
$
$
$
$
2003-2002
3,397
3,146
889
3,259
2,621
$
$
$
$
$
2002-2001
682
1,614
164
2,324
1,228
Ratio Analysis
In order to determine a “ballpark” price for Exxon Mobil’s stock, an analyst can
perform a ratio analysis. It is important to understand the theory behind the method
before evaluating Exxon’s stock, in order to determine whether one believes that the
method holds any weight. In order to price the security, the analysts looks at various
ratios; price to forward earnings, price to sales, price to book, price to earnings before
interest, taxes, depreciation, and amortization, and price to cash flows. After evaluating
the ratios based on their current levels compared to the mean, high, and low, one can
determine a target multiple for the ratio. Additionally, the analysts can determine a target
price per share based on the current price and number of shares. After multiplying these
two multiples together, a target price is determined for the stock. One of the important
assumptions in determining most targets is that the ratio is mean reverting. Therefore, it
may be helpful to look at the ratio in a chart over time to determine if any trends or
phenomenon need to be evaluated and excluded from or included in the analysis. Any
trends or phenomenon will usually be apparent when comparing the current level of the
ratio to the high and low figures. If the current is equal to the high, it may be the case
that the process has changed, and the current level of the ratio may not revert back to the
“old” mean. This process of careful evaluation of the targets helps ensure that the analyst
will be in the “ballpark” of the proper valuation. Because of the imprecision of the ratio
analysis valuation method, it is important for the analyst to have a substantial
upside/downside in order to trade based on the results. In practice, most analysts will
perform and additional method, such as a dividend discount model or discounted cash
flows model, in order to confirm what the ratio analysis led the analyst to conclude. The
ratio analysis method is a good way for an analyst to narrow down his selection of
securities that he or she would like to further investigate. Therefore, this method is a very
useful tool for all analysts, and is often used by investors.
After performing a ratio analysis for Exxon Mobil, the average target price for all
five of the ratios was $72.90 (See Exhibit 10). At that target price, the stock has a 20.6%
14
upside potential, and is certainly worth evaluating further (a DCM model is provided
later). As the company has experienced a period of rapid growth over the last couple of
years, its price to x ratios have decreased and thus the stock looks cheap. For example,
the Price to Forward earnings ratio is currently at 10.6, which is historically very low for
Exxon. As the company’s growth slows over the next couple of years, the PE ratio
should revert back closer to the mean. The very large earnings should continue into the
future, so the target multiple will not reach the mean of 15.6, which was established
throughout its entire life cycle. With the PE targets determined, a target price of $82.27
is calculated. This should be no surprise given that the price increases to reflect the large
profits that Exxon has earned. The method was applied to all ratios in Exhibit 10, and
general rules were established for all ratios. In applying a target multiple, the mean
reverting assumption was applied. Additionally, the target multiple was established
closer to the low value than the high value because the growth phase of the life cycle is
where price to x ratios are at their highest and this data is included in the numbers. All
target per share numbers were based on current information, and thus, all predictions for
future performance are maintained mostly in the multiples. After computing the 5 target
prices, they were averaged in order to determine a final target price. The average was
computed to minimize the risk of any “wrong” assumptions contained in individual
components of the ratio analysis. Because the ratio analysis indicates that Exxon may
have a potential upside of 20.6%, with the lowest target price (Price to Book) indicating a
7.5% upside, further analysis is certainly warranted.
Exhibit 10
Absolute
Valuation
High
Low
Mean
Current
Target
Multiple
P/Forward E
34.80
9.20
15.60
10.60
13.10
6.28
82.27
P/S
1.93
0.72
1.34
1.25
1.32
52.00
68.64
P/B
4.90
2.40
3.60
3.60
3.60
18.06
65.02
P/EBITDA
15.70
5.20
7.80
5.80
6.80
11.21
76.23
P/CF
18.50
8.10
11.40
9.30
10.35
6.99
72.35
Average Target Price = 72.90
Upside Potential = 20.6%
15
Target Target Price
Per Share
DCM Valuation Analysis
Assumptions
In preparing a discounted cash flows model, a series of assumptions must be made
about the future operations of a company. The analyst will then use these assumptions to
predict different account values in the income statement in order to ultimately arrive at
free cash flows. When the free cash flows have been determined for a certain time
horizon, usually 10-15 years, the amounts are discounted at the company’s cost of capital.
Additionally, a terminal value growth rate is determined and used to arrive at the terminal
cash flows; it is then discounted back to arrive at its present value. The sum of all of the
discounted cash flows divided by the number of shares outstanding gives the analyst the
implied share price value. After comparing the implied value to the current value, the
analyst is able to determine the upside/downside potential of the stock. The analyst will
then recommend buying, holding, or selling the particular security. Therefore, as one can
imagine, the assumptions that are used in the model are very important and must be
logical in nature. Conservatism is often used in assess the value of a security in order to
refrain from any outlandish predictions. All assumptions and related values for Exxon
Mobil can be found in Exhibit 11.
Terminal Growth Rate
The terminal growth has an enormous impact on the implied value of the stock
when using the discounted cash flows model. When determining what terminal growth
rate to use, the major factor to consider was the already massive size of Exxon. With
Exxon already being so large and operating in many countries, it will be difficult for it to
grow at a rapid pace. I decided to use a terminal growth rate of 3% because Exxon is a
well-managed company that has the ability to maintain average growth in the long-term.
There figures to be both good and bad years as crude oil prices will certainly change in
the future. Overall, I believe that the average growth rate will be slightly lower than the
historical Gross Domestic Product (GDP) growth, which is around 4%.
Discount Rate
The discount rate in a DCM model is obviously very important since it will
determine how much the free cash flows are discounted to arrive at their present value.
Although I did not specifically use CAPM to directly determine the discount rate, I used
its framework to logically think out a proper rate. The CAPM model is as follows:
Discount Rate = Rf + Beta * (Rm – Rf)
Where:
Rf = Risk Free Rate
Rm = Market
Rm-Rf = Market Premium
16
Based on the CAPM model logic, I used a discount rate of 9% for Exxon because of its
low beta of around 0.6, and because of recent analysis that indicates that the current
market premium is much lower than what historical data suggests. Specifically, the study
believes that the market premium over the US 30-year bond is closer to 3.5%, and not the
6.2% that the last 100+ years suggests. Therefore, I believe that using a 9% discount rate
is a conservative estimate.
Sales Growth
Sales growth has a tremendous impact on the 10-year time horizon financials.
Over the last two years, Exxon has maintained sales growth of around 23%. Because of
the large size of Exxon, and the fact that it is in the mature phase of its life cycle, this rate
of growth is certainly not sustainable. In 2006, the projected sales growth number will be
10%, well below the 23.25% from 2005. Then in 2007 to 2010, the growth rate will
become negative as the company struggles to find additional sources of income in the
competitive industry in which it operates. However, in 2011 and beyond Exxon will be
able to maintain prior year’s sales revenue numbers and return to a period of small but
stable growth. Fueling this growth will be the continued increased demand from China
and India, the continued reliance upon oil in the United States, and the increasingly
limited supply of “easy” oil (the oil that is drilled and then taken to be refined).
Additional oil supplies will be more difficult to produce and will require extra processes
in the manufacturing of gasoline. For example, in the Canadian provinces that are rich in
oil, the oil is maintained in a soil like substance that will need to be strained in order to
produce and refine. These factors will all lead to continued sales growth for Exxon.
Margins
Gross, Operating, and Profit margins are very important in determining how
efficiently a company is operating. In the DCM, they also play a major role in how much
free cash flow is generated in a given year. As Exxon continues it growth in the shortterm, there are indications that margins will continue to struggle. From 2003, when gross
margin was 47.75% and operating margin was 38.25%, the margins have been on a
decline. In 2005, gross profit margin had fallen to 42.8% and operating margin came in
at 35.89%. This stress on the margins, including profit margin, is expected to continue in
the next couple of years. However, there is some theory that would lead an investor to
expect margins to settle after the period of extreme growth slows. Additionally, Exxon
management may make it a point to try and operate more efficiently when revenue
growth slows and turns negative. When this happens, margins will be expected to remain
constant and possibly increase slightly.
Other Assumptions
There are many other assumptions that go into making a discounted cash flows
model. However, these assumptions are not as pertinent to the accuracy of the model as
they are easier to predict due to their nature. These other assumptions include; capital
expenditures, depreciation and amortization, net interest income/(expense), and tax rates.
17
I expect that capital expenditures will decrease over the next 10 years due to the
expectation of lower profits. Additionally, as previously mentioned, Exxon should fall
back to its sustainable cap-ex rate and sustainable expenditures of around 2.5 – 3% of
sales, or between $9 and $10B. In the current year however, capital expenditures will
remain high, around 3.5%. Depreciation and Amortization figures should decrease to
meet the capital expenditure rate of 2.5% over the 10-year period. Finally, there is no
reason to expect any significant changes in net interest income/(expense) or tax rates over
the next 10 years. Exxon made a profit of around $36B last year, so there is no reason to
expect tax rates to increase above what it already being paid out. (See Exhibit 11 – next
page)
Implied Value (DCM Result)
After making the above assumptions about the future financial performance of
Exxon, they were input into the discounted cash flow model to arrive at the implied value
of the stock. The DCM indicated that a share of Exxon stock should be worth $80.52,
giving the security a 33.2% potential upside. Attaining such a large upside is exciting for
the analyst because it helps to minimize the risk associated with trading based on this
analysis. With such a large upside, even if some of the assumptions turn out to be slight
off, there is a margin of error built in to the potential upside. For example, if sales
growth slows even greater than anticipated, or margins decrease slightly more than
expected, the stock may only have an upside of 20%. This would still be a very good
investment, so the risk of making an error in the assumptions has been diminished.
Since the creation of this model, there has been some news to confirm some of the
assumptions. Exxon released its first quarter earnings, and sales revenue was just under
$90B and profits just under $9B. Exxon did not meet analyst expectations despite having
the 5th highest earning quarter in history. The company is expected to have a good
second quarter and rest of the year, and may be in line to earn the $37.68B predicted in
the model. The recent earnings release also confirmed the continued strain on Exxon’s
margins. After developing the DCM, the analyst has the ability to make continuous
updates as relevant news is released. This gives the analyst a better ability to accurately
predict the true value of a security.
Sensitivity Analysis
Another tool that is very useful to the analyst is a sensitivity analysis. A
sensitivity analysis gives the analyst the ability to minimize risk by tracking the effect on
a stock price given certain events. For Exxon, a sensitivity analysis was performed using
4 different discount rates and 5 different terminal values (See Exhibit 12). The result of
the above model, using a 9% discount rate and 3% terminal growth rate, is highlighted in
the exhibit and is noticeably present in the middle. As one can see, as the discount rate
decreases and the terminal growth rate increases, the implied value of the security
increases. In the exhibit, there are 18 gains (noted in green) associated with the various
combinations and only 2 losses (noted in red). The best scenario is a 5% terminal growth
(continued on page 20)
18
INSERT LANDSCAPE
PAGE HERE
19
rate and an 8% discount rate, which would result in an implied upside potential of
121.47%. The only 2 losses in the various combinations of discount and terminal growth
rates are associated with an 11% discount rate, and a 1 or 2% terminal growth rate. It is
important to note that one would be hard pressed to explain using an 11% discount rate
for Exxon when the company’s beta is around 0.6. Additionally, one can see that a
reduction in terminal growth rate given that the discount rate remains at 9%, still implies
strong performance for Exxon stock; 15-23% upside. It is very likely that the price will
end up somewhere in the middle 6 cells given that all assumptions are plausible. If this
theory holds, the likely gain from holding Exxon stock is between 8.09 and 47.34%,
giving investors a substantial gain on their investment. (See Exhibit 12)
Exhibit 12
Discount Rate
8.00%
9.00%
10.00%
11.00%
1.00%
$
79.85
$
69.84
$
62.12
$
56.00
Terminal
2.00%
$
86.61
$
74.42
$
65.34
$
58.33
Growth
3.00%
$
96.06
80.52
$
69.48
$
61.24
Rate
4.00%
$
110.24
$
89.07
$
75.00
$
64.99
5.00%
$
133.88
$
101.88
$
82.73
$
69.99
$
Discount Rate
8.00%
9.00%
10.00%
11.00%
1.00%
32.09%
15.53%
2.76%
-7.36%
Terminal
2.00%
43.28%
23.11%
8.09%
-3.51%
Growth
3.00%
58.91%
33.20%
14.94%
1.31%
Rate
4.00%
82.37%
47.34%
24.07%
7.51%
5.00%
121.47%
68.54%
36.86%
15.78%
20
Exxon vs. Sector Comparison
After obtaining the implied value and potential upside of Exxon, it is necessary to
compare the security against its sector. Aforementioned, the energy sector has performed
very well this year and has been driving returns on the S&P 500. Therefore, it is
important to compare Exxon to the sector in order to determine if there are potentially
better gains associated with other energy stocks. When looking at the ratio chart of
Exxon Mobil compared to the Energy Sector, one can see that it is cheap in most aspects
compared to the sector (See Exhibit 13). Assuming that the ratios are mean-reverting,
price to sales, cash flow, and EBITDA ratios all make Exxon appear cheap, while the
price to forward earnings ratio appears to be inline with the rest of the sector. Although
there is not great parity in the ratios when comparing Exxon and the Energy sector, this is
a credit more to the performance of the sector as a whole and not an indication of suspect
performance out of Exxon. These numbers make Exxon look like a good investment
within the Energy sector.
Exhibit 13
EXXON MOBIL CORPORATION (XOM) Price 60.45
1996
1996 1997
1997
1998
1998
1999
1999
2000
2000
2001
2001
StockVal®
2002
2002 2003
2003 20042004 2005 20052006 20062007 2007
2008
1.4
HI
LO
ME
CU
1.2
1.27
0.82
1.07
1.09
1.0
0.8
PRICE / YEAR-FORWARD EARNINGS RELATIVE TO S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) M-Wtd
1.4
05-17-1996
05-19-2006
HI
LO
ME
CU
1.2
1.38
0.87
1.15
1.10
1.0
05-17-1996
05-19-2006
0.8
PRICE / SALES RELATIVE TO S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) M-Wtd
1.6
HI
LO
ME
CU
1.4
1.2
1.53
0.89
1.17
1.09
1.0
05-17-1996
05-19-2006
0.8
PRICE / CASH FLOW ADJUSTED RELATIVE TO S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) M-Wtd
1.6
HI
LO
ME
CU
1.4
1.2
1.46
0.87
1.17
1.05
1.0
05-17-1996
05-19-2006
0.8
PRICE / EBITDA RELATIVE TO S&P ENERGY SECTOR COMPOSITE ADJ (SP-10) M-Wtd
21
Exxon vs. S&P Performance
Exxon stock appears to have a huge upside while remaining relatively cheap
compared to the great performing energy sector. It is now important to ensure that Exxon
is a good investment within the S&P 500. Exxon is a relatively cheap stock operating in
a relatively cheap sector; so therefore, it must be the case that Exxon is relatively cheap
compared to the S&P 500. This is in fact the case, and this is illustrated in Exhibit 14.
Again assuming that the ratios are mean-reverting, Exxon appears to be substantially
cheap from a price to forward earnings, price to cash flow, and price to EBITDA
perspective. This gives further evidence to the strength of Exxon Mobil stock as an
investment.
Exhibit 14
EXXON MOBIL CORPORATION (XOM) Price 60.45
1996
1996 1997
1997
1998
1998
1999
1999
2000
2000
2001
2001
StockVal®
2002
2002 2003
2003 20042004 200520052006 20062007 2007
2008
2.0
HI
LO
ME
CU
1.6
1.2
1.64
0.52
0.83
0.73
0.8
05-17-1996
05-19-2006
0.4
PRICE / YEAR-FORWARD EARNINGS RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.2
HI
LO
ME
CU
1.0
0.8
1.02
0.57
0.77
0.77
0.6
05-17-1996
05-19-2006
0.4
PRICE / SALES RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.4
HI
LO
ME
CU
1.2
1.0
1.35
0.74
0.89
0.77
0.8
05-17-1996
05-19-2006
0.6
PRICE / CASH FLOW ADJUSTED RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
1.6
HI
LO
ME
CU
1.2
1.0
1.43
0.66
1.01
0.67
0.8
05-17-1996
05-19-2006
0.6
PRICE / EBITDA RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
22
Exxon Mobil has outperformed the S&P 500 over the last 25 years. The stock
performance charts have been given for the last 6 months (Exhibit 15) and 2 years
(Exhibit 16). As one can see, during the period of rapid growth for Exxon, the stock was
rewarded with a 40% gain. For the current year, Exxon is continuing to outperform the
market as a whole and is up 7.2% over the last 6 months, and 10.7% on the year. This
performance should continue as Exxon moves toward its target price in the long-run.
Exhibit 15
Exhibit 16
23
Summary & Recommendation
The recommendation granted for Exxon Mobil is a strong BUY. The target price,
equated by taking the average of the ratio analysis target price and the DCM implied value, is
$76.71. This price indicates a potential upside of 26.90%. Fueling this stock performance is the
strong financial performance expected in the future for Exxon. The energy sector performance is
highly correlated with crude oil prices, and as the worldwide demand steadily increases and
supply decreases, the price of crude oil will continue to rise in the future. As China and India’s
economies continue to grow and the motor vehicle increasingly becomes available to its citizens,
these countries will become greatly dependent upon oil. Additionally, the US continues to be
very much oil dependent, and this promises to continue well into the future. To further minimize
its risks, Exxon has diversified its business ventures and operates in three different lines of
business; upstream, downstream, and chemical. Exxon is also diversified geographically and
does not depend on any one country to supply or consume its oil products. As the world
becomes increasingly dependent on a limited natural resource, crude oil, Exxon is assured of
tremendous performance.
24