<THE DRIP PORTFOLIO>
The industry giant steps up to the plate
by Brian Graney (TMFPanic@aol.com)
ALEXANDRIA, VA (Feb. 10, 1999) -- Batting in the number four spot in our oil and gas line-up is the universally recognized power hitter of the industry, Exxon Mobil.
Description: If John D. Rockefeller were still alive today, he might have veered from his strict Baptist ways and broken out into a song and dance when Exxon (NYSE: XON) and Mobil (NYSE: MOB), two former members of his old Standard Oil trust, announced plans to reunite early last December. For much of this century, Exxon was known as Standard Oil Co. of New Jersey (or Jersey Standard) until it changed its name to Exxon in 1972. Mobil started life as the Standard Oil Co. of New York (or Socony) and became Socony-Vacuum following its merger with Vacuum Oil in 1934. In 1966, the Socony name was officially ditched for the Mobil corporate moniker.
Exxon and Mobil are old hands at the combination game and had an earlier partnership this century through the Standard-Vacuum Oil Co. (or Stanvac), which was formed in 1933 by both companies to serve the Far Eastern market. However, Stanvac ultimately was disassembled in 1962 under a consent decree related to a civil antitrust case against Jersey Standard. With "bigness" fears still alive in 1999, there is a possibility that those same antitrust laws may also thwart Exxon and Mobil's latest attempt to join forces.
Still, we are going to analyze these two companies under the assumption that they will merge in the not-so-distant future, possibly sometime later this year. Once combined, Exxon Mobil will become the giant of the industry in almost every measurable respect. Total oil and gas reserves will amount to about 20.7 billion barrels of oil equivalents (BOE). Daily oil and gas production will total 4.3 million BOE. Combined 1998 total revenues are estimated at $171 billion, with combined net income in the neighborhood of $8.14 billion (excluding charges). The list of mind-boggling numbers goes on and on.
Even though many have latched on to the thesis that rock-bottom oil and gas prices prompted the creation of Exxon Mobil, we think other factors came into play as well. Exxon and Mobil are two very healthy companies; neither one was going to fall off the face of the planet had the merger not come about. In a sense, we feel the hook-up was a natural for Exxon and Mobil due to their complementary strong histories of building value for shareholders through any means possible. We side with Merrill Lynch analyst Constantine Fliakos, who stated in a research note after the deal was announced that the merger is simply "an extension of the unrelenting effort to improve performance" on the parts of both firms. That's a good reason for a combination in our eyes.
Financials: Again, this is an overview. We will be focusing on only a few key elements: How does the market value the company? How profitable are its chosen operations? How does the company finance its operations? And what does management do with the money that it earns? Like yesterday's look at BP Amoco, this will require some projections on our part. A disclaimer: take the following with a grain of salt, perhaps even a whole salt dome.
Valuation: Exxon's current market capitalization is $178.3 billion, which can be found be multiplying its share price of $72 3/16 by the 2.47 billion average diluted shares outstanding at the end of 1998. For Mobil, this figure works out to $71.8 billion ($89 per share times 807.3 million shares at the end of 1998.)
We're going to skip our normal analysis of enterprise value and head straight toward predicting a future market capitalization for Exxon Mobil. This is where things get interesting.
Under the merger, Exxon agreed to issue 1.32 new shares for every Mobil share outstanding. Let's assume the merger will not take place until Jan. 1, 2000. If both companies discontinue their current share repurchase programs ahead of the merger (Exxon has already halted its buybacks) and both keep their sharecounts constant this year, Exxon Mobil will have an initial sharecount of 3.54 billion shares (807.3 million x 1.32 + 2.47 billion = 3.54 billion.)
Now for the fun part -- estimating Exxon Mobil's share price on Jan. 1, 2000. Normally, we don't like trying to predict where share prices will go over such a short time span, but today we're breaking our own rules. Exxon's share price has appreciated at an average 11.5% annual rate over the past 18 years, so we're going to assume 11.5% growth from the Dec. 31, 1998 closing price of $73 1/8. That gives us a share price of $81.53 on Dec. 31, 1999. Putting our estimated share price and sharecount numbers together gives us an estimated market cap for Exxon Mobil on Jan. 1, 2000 of $288.6 billion.
This figure is just an estimate, but it gives us a rough idea of the combined company's ultimate size. Based on this figure, Exxon Mobil's forecasted market capitalization is 1.69 times estimated 1998 sales of $171 billion.
Exxon currently trades at 25.5 times estimated 1999 earnings of $2.83 per share and 22.7 times 2000 earnings of $3.18 per share. For its part, Mobil trades at 27.9 times 1999 earnings of $3.19 per share and 23.7 times expected 2000 earnings of $3.75 per share. Assuming a 2% boost to Exxon's earnings thanks to merger synergies in 2000 (probably a fairly conservative estimate), Exxon is currently trading at an estimated 22.3 times post-merger 2000 earnings of $3.24 per share.
Profitability: Exxon's net profit margin (net income divided by revenues) was 5.5% in 1998, while Mobil's rolled in at 3.2%. For more context, we'll look at return on capital employed (ROCE), which we define as operating earnings divided by the sum of total debt plus shareholders' equity. Mobil estimated that its ROCE was 10.1% last year, down from the 14% it reported a year earlier. We estimate Exxon's 1998 ROCE at about 11%, down from the 15.6% figure we calculated for 1997. The ROCE figures for both companies have been rising steadily for much of this decade, but fell last year due to the drop in oil and gas prices.
Leverage: At the end of Q3, Exxon's debt-to-capitalization ratio (total debt divided by the sum of total debt plus shareholders' equity) was 17.9%. Mobil's ratio was 25.5% at the end of Q3. As fellow Fool Dale Wettlaufer would say, "Like it!"
Use of Cash Flow: Exxon currently has a dividend yield of 2.27% and Mobil has a yield of 2.56%. Both figures are a bit shy of the 2.77% average yield of the 24 members of the S&P Energy Composite index but well above the 1.30% average yield of the S&P 500. Last year, Exxon repurchased 44.6 million shares of its stock, representing about 1.8% of its 1997 diluted sharecount. Mobil's diluted sharecount decreased nearly 1% year-over-year in 1998 as well. Both companies deserve high marks in the dividend and buyback departments.
As an aside, cost savings from the merger are estimated at $2.8 billion and will be recognized gradually over a few years. Given the stellar fiscal management track records of the two firms' respective management teams over the years, we wouldn't be surprised to see even more costs savings wrung out of the combination than the companies currently anticipate.
The Snapshots for Exxon and Mobil: Click here for Exxon's snapshot and here for a look at Mobil.
Conclusion: Obviously, it's impossible to cover all of the elements of Exxon Mobil's businesses and prospects in such a small space. We didn't even get a chance to discuss the combined company's massive chemical operation, which by itself will be larger than many major U.S. industrial companies. But based on the few things we did look at, we like what we see. We'll look into this industry giant further in the second round of our analysis. In the meantime, more reading on Exxon (and Mobil) can be found in our recent Dueling Fools feature.
[To discuss these columns, please visit the Drip Companies message board on the Web.]
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