Petro

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Exxon Mobil Corporation NYSE:XOM

Valuation Analysis

Sanan Juneja, sjuneja@wustl.edu Gu Yuan, ygu23@wustl.edu Grandhis Harumansyah, g.harumansyah@wustl.edu Xinning Yang, xinning@wustl.edu Ahmad Aldarrak, aldarrak@go.wustl.edu

Investment Recommendation: BUY Dec, 3

rd, 2012

XOM – NYSE (12/2/12) $ 88.14

52 week range $77.13-$93.67

Avg Daily Trade Volume 12,803,000

Revenue (2012 Est.) $ 447,832,000,000

Market Capitalization $ 401,860,000,000

Share Outstanding 4734M

Book Val. per Share (12/12) $36.56

Ratios Firm Comp. Ave.

Dividend Yield 2.5% 3.2%

Return of Equity 27.5% 17%

Return on Assets 13.2% 8.02%

Return on Sales 9.6% 5.6%

Asset Turnover 1.4x 1.2x

Industry Oil and Gas Integrated

EPS Forecast

FYE 12/30 2010A 2011A 2012E 2013E

EPS $6.24 $8.42 $7.91 $8.24

Est. 5 Yr. EPS Grow. Rt. 3.2%

Ratios Firm Average of Competitors

Forward P/E 11.11 8.83

Forward PEG 3.7 2.94

M/B 2.41 1.4

Valuation Predictions

Actual Current Price $ 88.14

P/E Valuation $ 90.91

FCFE Valuation $ 97.60

EBITDA Valuation $ 71.00

Performance of KO

Trailing 6 mo 12 mo 24 mo

Return on Exxon 13.12% 9.56% 23.8%

Return on S&P 500 10.81% 13.82% 15.63%

Return on Competitors 10.76% -1.1% 11.29%

Assigning a rating of market outperform on Exxon Mobil at its current price of $88.14 and a 12-month target price of $97.6 (based on FCFE valuation)

Exxon Mobil continues to outperform the industry average operation margin with a 9.6% NOPAT margin.

After the recovery from the financial crisis, the sales growth is likely to slow down and remain in the 3%-5% range.

Exxon Mobil remains the leader in the amount of oil reserves, and has a healthy number of long-term upstream projects to replace the oil produced.

The focus on the natural gas by the acquisition of XTO is likely to low profitability, at least in the short-term, due to low prices.

Higher dependence on unconventional oil fields and the additional difficulty of discovery and exploration are likely to reduce profitability in the long-term.

Rating System:

BUY: A purchase recommendation with above average long-term growth potential.

MARKET PERFORMER (HOLD): A recommendation to maintain current positions with returns to match that of the market.

SELL: A recommendation to sell the security (or short the security) as it is expected to decrease in price in the medium term.

Industry Overview

Exxon Mobil is multinational Oil and Gas Corporation that emerged as the resulting company of

the 1999 merger between Exxon and Mobil. The company is one of a handful of firms, Big Oil,

that run operations encompassing the whole petroleum industry value chain. The main

component of the oil industry is the upstream sector, which includes the exploration of potential

oil and gas fields, in addition to drilling and extracting the crude oil and natural gas. The other

industry component is the downstream sector, in which the firms transfer and refine the extracted

oil and gas, in addition to the distribution of the by-products, such as gasoline, diesel and

lubricants, to the retail level. Some of the major oil firms also have a petrochemical component

that produces plastic bottle, rubber and various other consumer goods. The five big oil

companies, along with their revenues, are shown in the following table.

Table 1 – Total Revenue of the Five Major Oil Firms

Due to the commodity nature of oil and gas, the oil companies have very little differentiation

power in their strategy. For this reason, all the five major oil firms are price takers and their

revenues and earnings strongly follow and correlate with oil prices. The downstream segment of

the industry can suffer from high oil prices because it has to either transfer the cost to the

consumer, or absorb the cost through lower margins. The Upstream, on the other hand, has

relatively stable cost, and it profits the additional increases in oil prices.

One of the key metrics in analyzing the performance of an oil firm is the oil reserve measured in

BOE (Barrel of Oil Equivalent), as it allows the firm to enjoy economies of scales through larger

production volume. Another key metric is the production replacement rate, which is the amount

of oil reserve added over the amount of oil produced. The replacement rate is important because

it supports the long-term growth of the firm. In addition to the oil reserve, the type of the oil field

plays a role on efficiency of the production, because extracting crude oil from unconventional oil

fields is more difficult and risky, and less profitable, than conventional fields.

To maintain a healthy oil reserve, oil firms spend capital expenditure on finding new oil fields to

replace the oil produced. Over the years, CapEx spending has been relatively stable even when

the oil prices were very volatile. This is the case because it can take 5-10 years from the

discovery of the oil area, to the beginning of the production. This makes the CapEx spending

more tied with the long-term view and less tied with short-term price fluctuations.

2007 2008 2009 2010 2011

ExxonMobil 404.5 477.3 310.6 383.2 486.4

Chevron 220.9 273 171.6 204.9 244.4

BP 291.4 365.7 246.1 308.9 386.4

Royal Dutch Shell 355.8 458.4 285.1 378.1 470.2

ConocoPhillips 194.6 246.2 152.8 198.6 251.2

Strategy Analysis

Summary of global energy outlook (2010-2040):

As world’s population grows to nearly 9 billion people in 2040 compared to 7 billion in 2010,

global energy demand will be about 30 percent higher in 2040 compared to 2010. Energy

demand growth is predicted to be slowing down as economies mature, efficiency gains accelerate

and population growth moderates. In the developed countries belonging to the Organization for

Economic Cooperation and Development (OECD) – including countries in North America and

Europe – energy use is predicted to be remained essentially flat, even as these countries achieve

economic growth and even higher living standards. In contrast, Non OECD energy demand will

grow by close to 60%.

China’s energy demand will continue to increase over the next two decades then gradually flatten

as its economy and population mature. In the rest of the world, billions of people will be working

to advance their living standards, hence increasing the energy demand. Energy analysts also

predict that the need for energy to make electricity will remain the single biggest driver of

demand. By 2040, electricity generation is predicted to account for more than 40 percent of

global energy consumption.

Graph . Electricity Generation by Fuel

As can be seen in below graph, coal usage throughout the world will peak and begin a gradual

decline, partly because of emerging policies to control emissions by imposing a cost on higher-

carbon fuels. The use of renewable energies and nuclear power will grow significantly. Oil, gas

and coal are predicted to continue to be the most widely used fuels, and have the scale needed to

meet global demand, making up about 80 percent of total energy consumption in 2040.

Graph . Global energy demand by fuel type.

The consumption of natural gas will grow fast enough to overtake coal for the number-two

position behind oil. Demand for natural gas will rise by more than 60 percent through 2040. For

both oil and natural gas, an increasing share of global supply will come from unconventional

sources such as those produced from shale formations.

Gains in efficiency through energy-saving practices and technologies – such as hybrid vehicles

and new, high efficiency natural gas power plants – will temper demand growth for fossil fuel

product (mainly oil) and at the same time will most likely curb emissions. Eventually, the global

energy transition in from 2010 to 2040 is expected to be as follow:

Graph . Global Fuel Mix

Exxon’s Corporate Strategy in response to the fore-mentioned energy outlook:

Exxon’s growth mainly depends on their successes of finding new reserves to replace the used

reserves from their existing oil fields. The growth also mainly affected by the demand for

energy. Exxon’s internal projection forecast worldwide energy demand is rising by 20% from

2010 to 2025, but by only 10% from 2025 to 2040. Exxon also projects that energy demands will

grow more diverse and not only depends on the oil consumption as technologies advances. The

main candidate for replacing the current widely-used coal is gas because gas is less pollutive and

can be converted into liquid to substitute the oil.

In the past 15 years, Exxon have spent more than $10 billion to expand their refining and

petrochemical production in Singapore due to logical expectation that the economic growth

across the Asia Pacific region will continue to spur demand for transportation fuels and the

chemicals used for plastics and other manufacturing.

Exxon also invested in Qatar Petroleum to develop the natural gas reserves there and also

decision to acquire XTO Energy in 2010. At the same time, Exxon also continually invests in the

production facility to increase the clean diesel production capability in US and Europe.

To maintain growth in their proven oil reserves, Exxon also investing in oil sands, deep water

and Arctic production, and also exploring the oil and gas supplies found in shale rock formation.

To support the effort in finding new reserves both for oil and gas, Exxon spent a significant

amount of capital expenditure in research & development for new methods of drilling and the

new technology to revitalize old oil-fields. In essence, Exxon expanding its exploration process

to various places in every corner of the world, and also put a big interest in exploring the deep

sea reserves.

Financial Analysis

I. Financial Summary

To analyze Exxon’s efficiency as a good investment choice, we use following ratios in the chart

as benchmarks to understand its recent performance since 2008 crisis.

Table – ExxonMobil’s Financial Summary

Financial Summary - XOM

Fiscal year 2011 2010 2009 2008

Sales (MM) 433,526 341,578 275,564 425,071

Growth 1.27 1.24 0.65 1.19

NOPAT (MM) 86,751 71,709 54,912 95,993

NOPAT Margin 20% 21% 20% 23%

Net Income (MM) 41,060 30,460 19,280 45,220

NI Margin 9% 9% 7% 11%

EPS 8.42 6.22 3.98 8.69

Growth 1.35 1.56 0.46 1.19

Free Cash Flow to Equity 24,370 21,542 5,947 40,407

ROE 27% 26% 16% 35%

Graph – ExxonMobil’s Financials 2008-2011

Exxon’s NOPAT margin was steady compared to its revenue volatility. This is due primarily to o

il price growth and its management’s cost reduction initiatives. Both ROE and EPS indicate Exx

on was in recovery and its profitability is closing to its pre-crisis level. The increase of FCFE refl

ects Exxon’s value in in an upward trajectory, which will be positive sign to both current and pot

ential stockholders.

II. Decomposing ROE

Table – ExxonMobil’s ROE Decomposed

20%

9%

0%

5%

10%

15%

20%

25%

2011 2010 2009 2008

Margin

NOPAT Margin NI Margin

8.42

0

2

4

6

8

10

2011 2010 2009 2008

EPS

27%

0%

10%

20%

30%

40%

2011 2010 2009 2008

ROE

24,370

-

10,000

20,000

30,000

40,000

2011 2010 2009 2008

Free Cash Flow to Equity

XOM

2011 2010 2009 2008

ROE 27% 26% 16% 35%

OpROA 28% 29% 22% 47%

NOPAT/Sale 10% 9% 7% 11%

Sales/NOA 2.9 3.2 3.1 4.5

Fin. Lev. Gain -1% -3% -6% -12%

Spread 47% 33% 24% 47%

ND/E (0.01) (0.08) (0.26) (0.26)

Graph – Financial Performance Across Competitors

From the previous graph, it was clear that Exxon’s OpROA 28% was primarily driven by its relat

ive high NOPAT margin 10% and its faster net operating assets turnover ratio 2.9, which combin

ed to suggest it has a decent profitability and the management well managed its assets.

-20%

-10%

0%

10%

20%

30%

40%

2011 2010 2009 2008

ROE

XOM BP CVX COP

-15%

-5%

5%

15%

25%

35%

45%

55%

2011 2010 2009 2008

OpROA

XOM BP CVX COP

-15%

-10%

-5%

0%

5%

2011 2010 2009 2008

Fin. Lev. Gain

XOM BP CVX COP

-10%

-5%

0%

5%

10%

15%

2011 2010 2009 2008

NOPAT/Sales

XOM BP CVX COP

1.5

2.0

2.5

3.0

3.5

4.0

2011 2010 2009 2008

Sales/NOA

XOM BP CVX COP

-40%

-20%

0%

20%

40%

2011 2010 2009 2008

Spread

XOM BP CVX COP

(0.30)

(0.10)

0.10

0.30

0.50

2011 2010 2009 2008

ND/E

XOM BP CVX COP

The -1% financial leverage gain was somewhat complicated. On the one hand, Exxon’s 47% spre

ad was due to its higher ROA and lower cost of debt. On the other hand, the -1% net debt to equi

ty ratio suggests Exxon holds relative high level of cash. But it was the highest ratio since 2008,

which suggests the management was trying to optimize its capital structure.

III. Competitive position

Mapping PE and ROE ratio for Exxon and other three competitors in chart below, we found that

Exxon’s higher ROE demonstrated its completive advantage, and its value was recognized by the

market, giving the highest PE ratio among rivals. Meanwhile, Exxon’s size by revenue is the lar

gest in the oil and gas industry.

Graph 5 – Major Oils PE VS. ROE positions

5

6

7

8

9

10

11

12

0.15 0.17 0.19 0.21 0.23 0.25 0.27 0.29

P/E

ROE

XOM BP CVX COP

Accounting Analysis

1. We identify critical accounting assumptions based on the Exxon’s 10K (2012), and we think E

xxon has a conservative accounting policy. As the largest energy corporation, the key issue in the

accounting process in Exxon is the capital & operating asset evaluation and revenue records.

1) Oil and gas reserve -

Evaluations of oil and gas reserves will affect upstream business. It is important to making invest

ment decisions such as whether development should process or not. Also, it is used to calculate u

nit-of-

production depreciation rates and for evaluating impairment. In Exxon, reserves included 2 areas

: proved or unproved. Proved reserves can further divide into developed and undeveloped. Exxon

reports proved reserves on the basis of the average of the first-day-of-the-

month price for each month during the last 12-

month period. The estimation of proved reserves, which is based on the requirement of reasonabl

e certainty, is an ongoing process based on rigorous technical evaluations and several other techn

iques. Furthermore, the Corporation only records proved reserves for projects which have receive

d significant funding commitments by management made toward the development of the reserve

s.

An asset would be impaired if the undiscounted cash flows were less than the asset’s carrying val

ue. Significant unproved properties are assessed for impairment individually. The Corporation do

es not view temporarily low oil and gas prices as a trigger event for conducting the impairment te

sts.

2) PP&E -

Depreciation, depletion and amortization of asset are usually determined either under unit-of-

production method or straight-

line method, based on the cost minus estimated salvage value. Maintenance and repair cost are e

xpensed as incurred. Major renewals and improvements are capitalized and the assets replaced ar

e retired.

3) Revenue and inventory recognition –

The Corporation sells crude oil, natural gas and petroleum and chemical products under short-

term agreements at prevailing market prices. It also has long-

term contracts with periodical price adjustments. Revenue will be recorded when delivered.

2. Operating Cash Flow and Net Earnings

XOM-US's accruals over the past five years are positive suggesting a buildup of reserves.

However, this level of accruals is also around the peer median and suggests the corporation is

recording a proper level of reserves compared to its peers (Royal Dutch Shell PLC, Chevron

Corp, BP PLC, Total S.A, China Petroleum & Chemical Corp, Occidental Petroleum Corp and

Conoco Phillips).

Table Exxon’s CF from Operations & Net Earnings

Table Exxon’s Annual Accruals (% Revenue) and Peer Median

1

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

2007 2008 2009 2010 2011

Net Earnings

CF from Operations

3. Turnover analysis

Selected Financial Data

(USD $ in millions)

Dec 31,

2011

Dec 31,

2010

Dec 31,

2009

Sales and other operating revenue 467029 370125 301500

Inventories 15024 12976 11553

COGS 306802 233751 185833

Accounts Receivable 38642 32284 27645

Accounts Payable 69794 59846 49585

Inventory Turnover (a)

Exxon Mobil Corp. 31 28 26

Industry, Oil & Gas 16 14 13.19

Receivable Turnover (b)

Exxon Mobil Corp.1 15 14 13

Industry, Oil & Gas 11 10 9

Payble Turnover (c)

Exxon Mobil Corp.1 14 12 12

Industry, Oil & Gas 11 10 10

Table Turnover Analysis of Exxon and Oil&Gas Industry

(a) Inventory Turnover = Sales/Inventory

(b) Receivable Turnover = Sales/Accounts Receivable

(c) Payable Turnover = Sales/Account Payable

(Note: We did not use COGS as denominator due to lack of information about Industry’s

COGS, and we think replacing by sales number could also reflect the relative company’s

operating position.)

Compared to the OIL & Gas industry average ratio, EXXON has relative healthier turnover ratio

s. It has a shorter cash conversion cycle as below. We think this is because economics of scales.

2011 2010 2009

Exxon Mobil Corp 9 8 12

Industry, Oil & Gas 23 26 30

Table Cash Conversion Cycle

Based on the analysis above, we think Exxon has a conservative accounting policy, its financial

statements could reflect the underlying business and operation. But problems might happen

about the reserve prediction and it will cause a biased depreciation. Oil industry is a resource and

investment intensive area, thus this problem will lead the cash flow deviate from the earnings.

P/E, Forward P/E and PEG Analysis

Below is a summary of P/E (ttm = Trailing Twelve Months), Forward P/E (fye next closing date),

and PEG Ratio (5 yrs. expected).

Table 4 - P/E, Forward P/E & PEG ratio

Company Name Sales growth (yoy) P/E Ratio (ttm)

Forward P/E PEG Ratio

XOM Exxon 26.9% 9.32 11.11 1.78

CVX Chevron 24.6% 8.67 8.65 -4.34

RDS Shell 27.7% 6.76 N/A N/A

COP Conoco Philips 31.4% 6.99 9.80 -0.81

BP BP. 26.4% 7.56 8.05 4.30

Peers Avg.

27.4% 7.49 N/A N/A

Industry Major Integrated Oil and Gas 27.4% 4.2 N/A N/A

Source: Yahoo finance

We can safely assume that earnings of these companies are still in the recovery phase after being

hit by global financial crisis in 2008. Across industry, sales growth rate experiencing a high

positive percentage during 2009 and 2010, but started to level in 2011 and 2012. We think that

this might be one of the reasons why some of the companies experiencing some gaps between

ttm P/E ratios and expected forward P/E, which can also be assumed that there are mispricing

problems by due to the slowing down in market condition.

XOM’s PE which is 9.32, is the highest compared to its peers. We believe that this is as the result

of exceptional sales growth during 2009 and 2010, which on average reaching 25%. But we also

think that this high P/E might not be sustainable because XOM had stated previous couple of

years exceptional growth was because the market was catching up the lag that it experienced

during the recession.

Below is XOM’s 5 year P/E history. We believe its highest P/E had been reached in 2010. In the

future, we think that Exxon would not be able to reach that level again mainly due to the fact that

the competition is becoming more intense in securing new oil reserves. We also think that the

shift in energy consumption towards a less-carbon-print fuel (Gas and liquefied gas) would also

depress XOM earnings going forward.

Graph 6 - XOM’s 5 year P/E history

Source: http://ycharts.com/companies/XOM/pe_ratio

XOM’s PEG ratio

XOM’s PEG ratio is not the lowest amongst its competitors, but also not the highest as well. We

believe that XOM’s PEG ratio still represents its capability to grow amidst the fierce

competition. We can also see that some of its competitors actually have a negative PEG which

means that in the coming years they predict a shrinkage in their businesses.

Valuation Analysis

Multiples Valuation

PE Valuation

With a PE ratio of 9.6 for the industry, and an EPS of 9.47 for Exxon Mobil, we get a PE valuatio

n of $90.91 for Exxon Mobil’s stock price.

EBITDA Valuation

With a 4.04 EV/EBITDA multiple in the oil industry, and an EBITA of $89 billion for Exxon Mo

bil, we get an Enterprise Value of $359 billion, which means an equity value of $336 billion. The

resulting stock price is $71.

Cost of Equity

We used a 2-years beta of 0.7689 instead of the historical to reflect the recent risk of the industry.

With a free risk rate of 1.7% and a market risk premium of 7.5%, we get a cost of equity of

7.47%.

Sales Growth

Exxon’s growth rate has fluctuated a lot in the past few years, especially in 2009, primarily

because of the recent economic downturn. We believe that Exxon’s high growth in the past two

years is mainly a recovery from the 2009 dip, and is not sustainable. From 2012 earnings so far,

it we expect the growth to be at 3%. Beyond that, we expect 4.5% growth rate that will converge

to the worldwide economic growth rate (3%) over a time period of 10 years. Exxon’s

management also testifies this assumption by discussing their expectations of worldwide

economic growth rate in the most recent 10-K.

Graph - Exxon’s growth rates

NOPAT Margin

Over the past few years, ExxonMobil has been enjoying higher profit margins than the

competition due to economies of scale and efficient operations. Going forward, however, we

don’t expect this advantage to remain in the long-term. The dominance of the oil industry by the

national companies around the world makes the discovery of oil fields more difficult. In addition,

the unconventional oil fields represent a large portion of XOM’s oil reserve, making it more

costly to produce in the future.

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

2003 2004 2005 2006 2007 2008 2009 2010 2011

E

x

x

o

n

'

s

G

r

o

w

t

h

R

a

t

e

Year

For these reasons, we project a NOPAT margin of 9.1% in 2012 (which is the average of the

previous four years). And this margin decreases linearly until year 10 where it reaches 6.1%, a

slightly higher margin than the current industry average.

Net long-term assets to sales

With increasing difficulty to explore new oil producing sites, we believe that the log-term assets

to sales ratio would increase over the next 10 years. We believe that the past 4 years is not a good

approximation of this ratio because of extremely low sales during the economic downturn. We

decided that a 2% increase each year is a reasonable approximation.

Valuation

FCFE Approach

Based on our projections for sales growth, operating margins, and long-term assets to sales, the

free cash flows to equity are projected to remain stable for the next 5 years, and would gradually

decrease after that. Our estimates lead to a stock price of 97.6 using the free cash flow to equity

approach.

Table 5 – Exxon’s Valuation – FCFE Approach

Discounted Dividend and Residual Income Approach

Discounted dividend approach and residual income approach yield stock price of $43.60 and

$45.3 respectively. We believe that this gives a pessimistic view of the company because it uses

an average of dividend payout rates. Exxon’s dividend payout rates have had a huge amount of

variability, the effect of which cannot be replicated by a constant dividend payout calculation.

Table – Exxon’s Valuation - Dividend Discount Approach

Table – Exxon’s Valuation – Residual Income Approach

Sensitivity Analysis

We did a sensitivity analysis around the two main variables that affect the valuation of the

company: Sales Growth and NOPAT margin. In the FCFE analysis the sales growth ranges

between 3% and 5%, while the NOPAT margin ranges between 6% and 9%. This table includes

the stock price on various assumptions in these ranges.

Table - Growth Rate VS NOPAT Margin Sensitivity Analysis

Another crucial input to the valuation is the cost of equity. The following table shows the stock p

rice given ranges of cost of equity between 6% and 9%

Table 6 - Cost of Equity Sensitivity Analysis

3% 4.0% 5.0%

6% 79.70$ 76.40$ 71.80$

7% $100 99.40$ 97.00$

8% 121.90$ 122.50$ 122.10$

9% 143.00$ 145.50$ 147.20$

Growth Rate

NOPAT margin

Cost of Equity 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00%

Stock Price 140.10$ 121.71$ 107.86$ 97.04$ 88.35$ 81.20$ 75.22$