Is ExxonMobil Fully Valued?

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After a recent Citigroup downgrade, doubts have once again emerged about ExxonMobil (NYSE: XOM  ) . As reason for his downgrade, Citigroup analyst Faisel Khan said that there wasn't sufficient upside in the stock and that the oil giant was fully valued. For reference, ExxonMobil now trades at 12.6 times forward earnings versus 10.4 for Chevron (NYSE: CVX  ) and 9.4 for BP  (NYSE: BP  ) .

Some hedge fund managers are also shorting ExxonMobil. In November, Jim Chanos said that ExxonMobil looked like a value trap as the company's return on capital and cash flows decline. 

The bearish perspective
Extracting oil and natural gas is harder than ever before. Oil companies cannot just put a pipe down and expect oil to come gushing out. Most of the easy to drill oil is now controlled by national oil companies such as Saudi Aramco or National Iranian Oil company.

The majority of the available projects to super-majors are in hard to drill places such as deepwater or the Arctic. Because those projects are more difficult to develop, there is a higher probability of an oil spill or a major delay in project development. BP's Macondo oil spill in 2010 and the continued delays in the Kashagan oil project  illustrate the higher risk that oil super-majors now have to take.  

Even for those harder to drill places, oil super-majors face increasing competition from Chinese oil companies such as CNOOC and Sinopec which aggressively bid in oil exploration auctions. Those semi-national oil companies have lower costs of capital than Western countries due to their access to low-interest loans. 

Because of the increasing difficulty in drilling for oil and natural gas, ExxonMobil's return on capital employed for 2013 was only 18% versus 34% in 2008. 

The bottom line
ExxonMobil is still a great company. The oil giant has world-leading drilling technology, benefits from enormous economies of scale, and has very good political connections. ExxonMobil counts the world's most famous investor as a stakeholder after Warren Buffett bought 40.1 million shares of ExxonMobil late last year.  

ExxonMobil management is also known for being shareholder-friendly. The oil giant has paid a dividend every year since 1911 and has raised its dividend for 31 straight years. The company has also spent $207 billion in share repurchases over the past decade.

Despite the project development risks, ExxonMobil's large projects ensure investors will be richly rewarded, and the company is well positioned in many diverse geographies. ExxonMobil, along with its subsidiary Imperial Oil, is developing the Canadian Kearl Oil Sands project, which has an estimated 4.6 billion barrels of recoverable bitumen. The company is also working with Russia's Rosneft in developing the arctic's Kara sea, which might hold some 85 billion barrels of oil equivalent.   

ExxonMobil may be overvalued versus competitors, such as Chevron and BP, but stocks rarely fall based on valuation concerns alone. The best days for ExxonMobil are still ahead. Despite recent doubt, long-term ExxonMobil investors can rest easy. 

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Jay Yao

Jay is an energy and materials writer. He reports on oil and gas fundamentals and macro trends in the industry.

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