If you want to make your fellow investors laugh, tell them that you own a big position in the major oil companies. For investors in companies such as Exxon Mobil (NYSE:XOM), it’s been another bad year. Nothing new there. Since 2015, energy stocks have drastically underperformed the market, and things have only gotten worse with the novel coronavirus. Exxon Mobil stock in particular is down 47% year-to-date, and nearly 70% since its 2014 peak.
The pandemic has added insult to injury. The latest blow came with the storied Dow Jones Industrial Average deciding to kick out Exxon Mobil and other underperforming stocks. In their place, new hotshots like software giant Salesforce (NYSE:CRM) are entering the index. It’s a sign of energy’s deep unpopularity that Exxon Mobil is out and a company with a 95x P/E ratio is replacing it.
However, investors often make their best returns buying stocks on bad news. And it’d be hard to think of any mega-cap company that has endured more rough breaks than Exxon Mobil over the past six years. Fortunately, it appears things are about set to finally turn upward for the beleaguered energy giant.
Priced For Depression
Prior to the oil crash in 2014 and on, Exxon Mobil earned around $8 of earnings per share per year. If you believe that oil will ever have another bull market and trade back toward $80+/barrel, then Exxon Mobil stock is trading at something like a 4-5x P/E ratio of those future earnings. Even if you don’t think oil ever rallies again, consider than Exxon Mobil earned nearly $5 per share in both 2017 and 2018 well into the oil bust. Now, the stock is trading for just 7x those earnings as well. The stock is simply priced for permanent depression at this point.
Morningstar’s analyst Allen Good laid out the bull case on XOM stock clearly. Assuming a 10x enterprise value/EBITDA ratio — fully in-line with normal levels for industrials or materials stocks — you get a fair value of $74 per share for Exxon. Even with the recent earnings report, Good noted that it didn’t change the math behind this price target one bit. And $74, you might notice, is precisely a double on the stock price from today’s level.
That’s just assuming a historically normal median valuation for Exxon, even with earnings currently in a trough. In oil markets recover and/or Exxon stock ever comes back into fashion, upside could be even higher. Shares did trade as high as $90 in 2016, long after the price of oil had already crashed, after all. And, fundamentally, nothing dramatic has changed with Exxon’s business. It hasn’t dumped assets in fire sales. Its debtload is manageable. There’s nothing here that a stronger economy and a more normal oil market won’t fix.
More Than Just Oil Production
With oil prices crashing to $0/barrel at one point this year, investors are understandably focused on low oil and gas prices. They’re certainly making the headlines lately.
However, it’s important to remember that Exxon Mobil is more than just a pure oil producer. The company also has huge market share in chemicals and refining. Normally, in fact, these serve as a balance to the extraction business. When oil prices soar, profits from refining and chemicals tends to dip. And vice versa. By owning the whole supply chain, Exxon Mobil gets profits from producing oil, selling gasoline, jet fuel, and asphalt, and also producing chemicals for a whole host of industries.
This year, however, that diversification hasn’t amounted to much. With the quarantines, demand for gasoline and jet fuel collapsed. And industrial chemical use is off sharply as well. The good news is that these changes are hardly permanent — in fact, we’re starting to see some healthy numbers for transportation again already.
XOM Stock Verdict
At some point, stocks reach a point of peak pessimism. Once everything that can go wrong has gone wrong, things tend to improve. And for Exxon, we’re at that point, or at least very near it. Oil has been in a crushing bear market since 2014. Exxon Mobil got kicked out of the Dow Jones Industrials Average after decades of membership. The media has already written the obituary for Big Oil, as green energy technology and socially conscious investors seem set to kick crude to the curb. And analysts assume that XOM stock’s dividend will be cut. What else is left to go wrong?
On the plus side, it’d take very little to turn the tide for Exxon Mobil stock. A recovery in economic activity, even if oil prices don’t bounce, would do wonders for Exxon’s chemicals and refining business. A move in oil prices even if only to $50 or $55 per barrel would safeguard the dividend and bring back income investors. And a potential rotation out of tech stocks — which may already be in progress — would cause energy names to catch some interest.
All that adds up to the balance of factors sharply favoring the bulls here. Admittedly, Exxon Mobil could continue to disappoint. A dividend cut, if it happens, could provide one final blow for suffering shareholders. So be aware of that. However, the overwhelming odds point upward for Exxon Mobil stock.
On the date of publication, Ian Bezek held a long position in Exxon Mobil stock.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.