A few years ago my view was very bearish on Exxon Mobil (NYSE: XOM) until the stock was so beaten into the $30s that the only logical path forward was up. My hint for getting really bullish on the energy giant was a policy shift toward less capital spending to drill oil with a focus on generating positive cash flow. Now, my investment thesis suggests that investors should start looking for an exit point with the stock rising to $100 after gains of 200% from late-2020 lows.
Do not follow Buffett
Oil is currently trading at high levels due to Russia’s invasion of Ukraine over 100 days ago, as well as some supply constraints due to supply changes due to covid . In addition, President Biden’s decision to restrict oil drilling and the construction of pipelines, including the Keystone pipeline, did not help energy prices.
As stated in the introduction, a few years ago it was time to buy energy stocks. Warren Buffett fills up Chevron Corp. (CVX) and Occidental Petroleum (OXY) following Russia’s outbreak of the first war in Europe since World War II are retrospective sparks.
Over the past month, Berkshire Hathaway (BRK.B) has been steadily buying shares of Occidental after adding 121 million shares of Chevron in Q1’22. In fact, Occidental’s last buy was at $57 per share and investors could have bought shares below $10 in 2020. The stock is actually trading near a 5-year high calling into question question the logic of now buying oil stocks during a war by one of the largest energy producers in the world.
So far, Buffett has done a solid job of buying Occidental shares in May at prices around $57, with the stock now over $70. No one can deny that these purchases of almost 7 million shares were solid purchases for the first month.
The big question is whether an investor should now follow Buffett into energy stocks after Occidental jumped more than 20% above the last buy price. Berkshire Hathaway already owns more than 143 million shares and technically the Buffett-led company didn’t buy shares aggressively in May. Even though Buffett is still bullish on oil stocks, the signal isn’t very strong.
Another reason for caution is that Buffett has sold airlines like Delta Air Lines (DAL) and Wells Fargo (WFC) virtually to covid-induced lows. The notorious contrarian investor now appears much more like a dynamic investor dumping airlines at covid lows and chasing oil at war-induced highs.
Delta was sold around $20 and quickly rebounded to nearly $50 the following year. Similarly, Wells Fargo was sold at $24 and hit $60 in just over a year. In both cases, Buffett missed 150% gains in short periods due to panic selling stocks. In my opinion, Buffett built Berkshire by investing in banks during the financial crisis and making long-term bets on profit machines shot and ignored in previous decades.
Buying an energy stock after a 500% gain over a 20-month period resembles the scenario where Buffett would have unloaded a stock in the past, not built the position.
Weak bull case
A possible sign that Exxon Mobil is overvalued occurs when an analyst writes a bullish research note on a stock, but the conclusion does not offer a price target much higher than the current price. JP Morgan analyst Phil Gresh presents us with this case with the price target of $108 on a bullish call. Any bullish case for a 4% rise speaks volumes.
In fact, the analyst community as a whole struggles to justify Exxon Mobil’s current price. According to TipRanks, the average price target of $97.22 is 2% lower than the current price.
Average analyst EPS estimates point to another bearish thesis for the stock. The energy giant is expected to see its profits plummet over the next 4-5 years, at least.
The stock is trading at 15x 2025 EPS targets. A big key is naturally where oil and natural gas prices will trade over the next few years. Hess (HES) explained how the Stabroek Block contains billions of additional barrels of oil on top of the 11 billion barrels already discovered. The market is not short of oil supply, the market is only short of the will to drill and produce those supplies and the incentive is there with oil well above $100/bbl.
Perhaps the best indication of why Exxon Mobil is not a buy now is the net payout performance. The energy giant shifted from capital expenditures to returning capital to shareholders, but the net payout yield fell to just 4.1%.
The net distribution yield combines the dividend yield with the net treasury yield to derive a stock valuation equation that provides a better valuation view. The current dividend yield is a solid 3.6%, but the net payout yield is only 4.1% as Exxon Mobil hasn’t repurchased many shares as the market capitalization has climbed to 400 billions of dollars.
Remember, the company only increased the stock buyback program to $30 billion through 2023. Exxon Mobil only spending $15 billion on buybacks a year doesn’t move the company much. needle with the stock at 100 dollars.
Furthermore, investors should wonder if the energy giant will even use this clearance to buy back shares here, knowing that oil prices can’t stay that high. It is highly unlikely that Russia will continue to fight this battle for Ukraine after the first 100 days have mostly failed to achieve any stated goals.
In Q1’22, Exxon Mobil only spent $2.1 billion to repurchase shares. The stock traded at just $60 at the start of the quarter and ended around $80. Exxon Mobil is no longer attractive to management at $100 now.
During the Q1’22 earnings call, CEO Darren Woods reinforced the plan to spend $10 billion to $15 billion on stock buybacks this year:
We returned $5.8 billion to shareholders, of which approximately 2/3 was in the form of dividends and the rest in the form of share buybacks, in line with our previous program. We said in our corporate plan update in December that we plan to buy back $10 billion of our stock. This morning we announced an increase in the program, up to $30 billion in total through 2023. This decision reflects the confidence we have in our strategy, the performance we are seeing across our businesses and the strength of our balance sheet.
Additionally, management has made it clear that the goal is to grow cash balances from $11 billion at the end of March to levels between $20 billion and $30 billion. The company is smart to focus on improving the balance sheet and not spend all the money available to buy back shares at what are likely high oil prices.
Worse still, if Exxon Mobil sticks to its $15 billion annual buyout plan, the energy giant would spend more than $4 billion per quarter for the rest of the year. The company would fall into the normal trap of spending more on buybacks as stock prices rise compared to charging over the past two years when stock prices were much, much lower.
The main takeaway from investors is that now is not the time to follow Buffett to stock up on energy stocks. First, Buffett mostly bought Chevron and Occidental stocks at lower prices. Second, Exxon Mobil itself has pointed out that the valuation is already stretched by only offering a plan to buy back up to 3.8% of outstanding shares.
Oil could certainly surge and push the stock much higher, but investors need to use further gains to offload Exxon Mobil. The stock is now trading at peak valuations.