Better positioned to handle stricter environmental regulations going forward Exxon is still the best investment play in the integrated oil and gas sector but dividend hunters should not give Chevron a pass
With the increased focus on shale reserves along with a stricter environmental regulatory regime, we foresee significant changes in the energy mix as well as the cost of reserve exploitation. Bidness Etc takes a look at investment opportunities in the ‘Big Four’ oil companies – ExxonMobil Corp (XOM), Chevron Corporation (CVX), Royal Dutch Shell plc (RDS.A) and BP plc (BP) – or the supermajors as they are also known. The US oil majors have fared better against European oil majors, as shown by their better three-year stock performance in our article “Integrated Oil and Gas – How the Oil Flows”. The energy landscape is expected to change after 2020 due to the expected rise in environmental regulation. However, both Chevron and ExxonMobil have operations, proven oil reserves, revenue growth potential and other financial metrics that are strong enough to withstand the impact of stricter environmental regulations.
The integrated oil and gas industry comprises companies that are involved in the entire value chain in the oil and gas production process. The industry is divided into the upstream and downstream segments, in which the upstream segment deals in the exploration and production (E&P) of fuel, while the downstream segment refines hydrocarbons and transports and sells the end product, including fuels and lubricants, to consumers. Since both segments have their own specific metrics, they have been evaluated separately.
Performance of Upstream Segments:
ExxonMobil is the market leader in the upstream segment in terms of output level and reserve life, a metric that indicates how long the company’s proven reserves are expected to last at current production levels. The company’s reserve replacement ratio (the rate at which it adds proven reserves compared to the consumption of existing reserves) is also the highest in the industry. Moreover, Exxon has the lowest finding and development expense per BOE at around $19.27 followed by Chevron with $21.48, BP at $22.66. Royal Dutch Shell has the highest finding and development cost per BOE at around $58.58. BP has low exploration and production spending and one of the reasons for this is their low spending on reserve development. As a result, the reserve replacement ratio is also low. Instead BP is focusing on extracting resources from developed reserves.
Performance of Downstream Segments:
ExxonMobil is also the market leader in the downstream segment; it refines 78% more volume than its closest competitor, Royal Dutch Shell.
With excess refining capacity, as reflected by the lowest refining capacity utilization rate among the supermajors, BP is positioned to increase output in the downstream segment more easily than its competitors.
Other Performance Indicators:
Dividends are an important factor when it comes to picking a company to invest in. This holds true for the integrated oil and gas sector like any other.
For the past three years, Chevron’s earnings and dividends have been impressive. Not only does Chevron have the highest earnings and dividends per share, it has been able to make them grow the most as well. Chevron’s payout ratio is around 26.2%, lower than that of Royal Dutch Shell’s at 40% and BP (55%). Only Exxon has a lower payout ratio of around 22.5%.
Exxon and Chevron have been facing negative free cash flow (FCF) growth because the increase in their cash flows from operations was off-set by a larger increase in their capital expenditures. Royal Dutch Shell, on the other hand, increased its cash flow from operations at a faster pace than its capital expenditure. BP has not been included because its five-year FCF CAGR dropped about 183%, too big a range to be shown graphically. This fall was due to the decrease in cash flow from operations due to divestments after their Gulf of Mexico oil spill. Plus, its capital expenditure has also increased.
When looking at the companies’ capital structures, ExxonMobil is the most attractive stock. In 2QFY13, Exxon purchased around $4.03bn worth of common shares and Chevron purchased $1.25bn worth of stock. Royal Dutch Shell and BP do not have a specific repurchase program and haven’t bought any shares for the past five years.
Shareholder return has been calculated based on total returns from dividends and capital gains divided by market capitalization. According to this metric, Exxon returned the most to shareholders from 2QFY12 to 2QFY13.
Not only does Chevron pay the highest dividends out of the four supermajors, it is also in a better position than any of its competitors to pay out future dividends. It has the second-lowest payout ratio and the highest cash dividend coverage ratio (the amount of cash made in the year over and above the amount of dividends paid) among competitors, which makes it the safest dividend stock among the four. Furthermore, its better free cash flow growth rate and lower debt to equity ratio indicates that it has the flexibility, both in terms of capital structure and cash capacity, to increase its dividends in the future.
The International Environmental Agency (IEA) forecasts that the operating environment for oil and gas companies will change considerably after 2020, following the implementation of much stricter environmental regulations. Standard & Poor’s and the Carbon Tracker Initiative have devised a stress test to gauge the impact of new environmental regulations on the creditworthiness of oil and gas companies. The judging criteria were based the following indicators:
- Production scale
- Product mix
- Reserve life, reserve replacement, future growth prospects, and mix of developed versus undeveloped reserves
- Geographical diversity and country risk
The additional metrics like debt to equity, used have been added by Bidness Etc to provide a more comprehensive picture.
*Greater exposure in the Middle East/North Africa (MENA) and Europe means greater risk. MENA is considered particularly risky because of ongoing sociopolitical unrest in the region, while Europe faces declining production from the North Sea oil fields as they reach depletion.
Oil and gas companies will need to increase capital expenditures to capture energy reserves in the future, which will result in free cash flows drying up. In such a scenario, ExxonMobil seems to be the safest bet among its competitors because it is well-positioned due to it’s the largest proven reserves that will be allow it to continue operations for at least another 15 years.
An investment decision between the Big Four oil stocks is essentially a choice between ExxonMobil and Chevron. Chevron stands out in terms of the stability of current and future dividend payments. ExxonMobil stands out even more though, because of the sheer magnitude of its current and future operations. It also has the highest rank in the environmental stress test and looks to be best-prepared going ahead in a stricter regulatory environment which reflects that it is better positioned than its competitors. Its future earnings growth potential is the highest at 5.4% followed by 4.6% for Chevron. RDS has an earnings potential of 4% followed by BP in last place with 1.5%.
Overall, ExxonMobil looks like the best buy for a long-term investment and will provide the greatest returns (at least in terms of capital appreciation) in the coming years.
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