Exxon Mobil (NYSE:XOM)
In 2022, Exxon Mobil (NYSE:XOM) was able to close the year on a high note thanks to the record high prices for fossil fuels brought about by the instability in the energy markets, which was principally driven by Russia’s invasion of Ukraine and led to the interruption of oil and gas supply. I have been optimistic about Exxon’s stock for much of this year, arguing that the business stands to gain from the many supply interruptions that will occur as a result of the decline in Russian oil supplies and output as a result of western sanctions and the flight of oil field servicing companies from Russia.
Yet, the most recent restriction on Russian oil products that the EU enforced at the beginning of February is likely to be the last big disruption event soon that would significantly influence the oil market. The oil market has steadied at a time when the key bullish trigger of 2022 is no longer relevant. Hence, although Exxon is still certain to earn fortunes at Russia’s cost in 2023 and beyond, its stock is less appealing at the current prices than it was.
All of This Concerns Supply Chain Disruptions
Two weeks ago, Exxon announced its financial results for the fourth quarter and fiscal year 2022). As was predicted, the corporation has delivered record profits owing to persistent global oil supply disruptions that benefited Exxon in 2022. The company’s net quarterly net income, at $12.75 billion, was up 44% year over year. Its sales of $95.43 billion were up 12% year over year, both of which were better than the market projections by $5.22 billion. Net income for the fiscal year ending in FY22 was $55.7 billion.
Although many oil bears were harping on the destruction of demand and macroeconomic worries in 2022, supply interruptions and geopolitical events helped make those gains feasible. Throughout the first half of 2022, high oil prices and volatile energy markets were mostly caused by Western countries’ attempts to diversify supply and cease over-relying on Russia. Nevertheless, the European Union’s imposition of sanctions against Russian oil in December and Russian oil products in February was largely responsible for additional disruptions. Diversifying Europe’s supply chains had a negative impact on the continent’s economy. Still, Russia was the one to take the worst damage as a result.
Additional windfall taxes on Russia’s oil and gas companies were the sole reason the country could avert its first budget deficit in November. Despite this, the most recent numbers reveal that the government had a $25 billion public deficit in January and that the central bank is likely to increase interest rates beyond the existing 7.5% rate to combat inflation, which was 11.8% in January. Russia’s inability to completely replace its European clients for its oil, petroleum, and natural gas has resulted in a 46% Y/Y decline in oil and gas tax income, which has led to a widening of the country’s budget deficit.
However, Europe has been able to considerably diversify its supply and no longer over-rely on Russia due to the Union’s increased clout. By 2023, the majority of EU member states are expected to demonstrate growth, making the argument that the EU will be able to escape recession.
As oil prices are expected to stay at present levels due to the rise in demand brought on by economic development, and Russian supplies are unlikely to make it to Europe any time soon, all of this bodes well for Exxon’s ability to create big profits in the coming quarters. But, given the oil market has steadied since the embargo on Russian oil products went into effect at the beginning of this month, an argument may be made that. The primary trigger that drove prices upward in 2022 is now moot.
What if the Growth Story Stops?
Now that the oil market has settled, there should be fewer supply interruptions in 2023, which might mean higher profits than in 2022. The market anticipates Exxon’s profits to rise year over year in Q1 but does not anticipate overall sales or earnings to rise year over year in FY23. Furthermore, the EIA predicts that the price of Brent crude oil will steadily decrease in 2023 and 2024, when US output is likely to grow, while the Russian central bank has recently decreased its estimate of the average Urals oil price for 2023 from $70.10 per barrel to $55 per barrel. So, it is reasonable to infer that Exxon will produce low profits soon.
Exxon’s current value should be revised in light of these developments. As early as June, when the stock was trading at roughly $90, I created a discounted cash flow model that established the company’s fair value to be close to $100. Although the model’s assumptions are close to street estimates, I argued at the time that they were overly cautious since they failed to account for the further supply disruptions I expected to see throughout the globe in the coming months. This is precisely what has occurred, as mentioned at the outset of this piece.
After including the additional information into the model in August, it predicted a fair value of $105 per share for Exxon while its stock was selling for $98. Some key assumptions about Exxon’s future performance were revised upward, leading to a higher value.
Exxon’s stock price might rise much higher if European sanctions on Russian oil and oil products went into effect in December 2022 and February 2023, as I’ve been predicting for the months leading up to that point. This is precisely what has occurred, and the interruptions are a major reason why the company’s stock is now trading at its all-time high of $117 per share.
But as I’ve previously said, there’s a risk that Exxon’s momentum is going to come to an end since, with the introduction of the current sanctions on Russian oil products, it’s probable that large disruptions would no longer be in play or have such major repercussions on the oil market.
This line of reasoning is reflected in the revised DCF model shown below, which has been updated to include Exxon’s most recent FY22 financial data. The top-line growth rate and earnings before interest and taxes projections for the next two years align with the market’s expectations. Since oil prices are expected to remain lower than their 2022 highs in 2023 and beyond, a fall in revenues and reduced margins may be expected year over year.
Future years of the model are projected to have a tax rate comparable to that of 2021 and 2022, a D&A percentage of sales equal to the three-year average (8%), and a change in net working capital equal to 0.5% of yearly revenues. Management’s forecasts for Capital Expenditure until 2023 are on target. After that, as high earnings begin to level off, CapEx will decline. The model assumes a terminal growth rate of 3% and a WACC of 9%, both increases over my prior models’ WACCs of 7.5% and 7.0%, respectively, to account for the higher interest rate environment.
The model predicts a $466 billion enterprise value for Exxon, with a fair value per share of $110.05, less than the current market price of $117 per share.
No fresh triggers are likely to materially affect oil markets soon. Thus, this valuation is the most accurate. In June 2022, the European Union, Russia’s largest client, voted to prohibit Russian oil and oil products. As a result, the EU began actively diversifying its suppliers, which caused price increases and disruptions in the lead-up to the bans’ first implementation in December and February.
The market’s volatility persisted after the most recent shocks. Still, the continent’s ability to reduce its reliance on Russia, thanks to its diversification efforts, paid off. Now that 2022’s greatest story—the disruption case—is no longer a factor, it stands to reason that Exxon’s upward trajectory will soon stop. Thus, I believe there is little room for the stock to grow at its current price.
Conclusion
Back in June, when I first covered Exxon here on Seeking Alpha, I received a lot of pushback from oil bears who disagreed with my bullish thesis and said that it was too late to buy Exxon stock at its then-current price of around $90 per share because they had already risen significantly since Russia’s invasion of Ukraine began in February. Yet, I anticipated that the supply interruptions would have a more profound impact on oil prices, allowing Exxon to maintain its high rate of return on investment. That’s precisely what’s occurred since then; owing to the disruptions caused by Russian oil leaving the market and the oil demand remaining robust despite all the macroeconomic worries, Exxon has beat all forecasts.
Exxon is not expected to create higher returns in 2023 than in 2022 since the market has steadied at a time when the key bullish driver of 2022 is no longer relevant. The company’s fast expansion looks to have come to a halt, while it is still expected to produce more money in the years following 2021. Thus, it is sensible to take gains and move on to other ideas since the potential for further growth in Exxon’s stock price at the present levels is much less than it was a few months ago.
Featured Image: Unsplash @ Raymond Kotewicz
