Which of These Oil Giants Is the Better Investment?

Everyone has heard of ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) . The two giants are some of the largest publicly traded oil companies, and many investors hold shares of these two behemoths in their portfolios.

However, there is another oil giant that deserves some attention: Hess (NYSE: HES  ) .

The best in class
As Hess is a fraction of the size of Chevron and ExxonMobil, the company is often overlooked by investors due to its size. But Hess is actually reporting sector-leading metrics.

One of the best ways to whittle down prospective investments, which look similar on the face of it, is to assess their return on invested capital.

Return on invested capital (ROIC) for short is a calculation used to assess a company's efficiency at allocating its capital to profitable investments, not wasting capital on fruitless projects. Total capital includes all capital invested in the business, including long-term debt, common stock, property, machinery and retained profit. The total amount of capital invested is compared to the company's net income.

Companies with high ROIC figures usually generate the most cash, achieving the strongest growth records and returns for shareholders.

The numbers
At the top of the scale, reporting at ROIC of 18.1% last year, is Hess. It's actually quite easy to pinpoint how Hess managed to drive this impressive return. To start with, the company has an industry-leading oil-linked asset base.

What many investors fail to realize is that many oil and gas companies, almost all of them in fact, don't exclusively produce oil. Instead, production is usually a mix of oil and gas. ExxonMobil's production during the first quarter, for example, was around 50/50 gas and oil.

As a result, Hess' leading oil-linked production base gives the company a significant advantage over its peers.

Specifically, with 80% of the company's assets being oil-based and 76% of its 2013 production being oil, the company can achieve higher margins than many of its peers. With an overweight oil portfolio, Hess reported a cash margin of $49 per barrel during 2013; once again, an industry-leading figure.

As the company concentrates on high-margin oil-based assets, this high return on investment should continue.

Biggest is not best
Coming in at second place is ExxonMobil, with an ROIC of 17% reported during the last 12 months. Exxon's position on this list is unsurprising given the company's position as the world's largest publicly traded oil company.

Unlike Hess, both ExxonMobil's and Chevron's margin per barrel of oil produced is in the $18 to $25 region, as they have to grapple with high levels of low-margin gas output. Still, Exxon has a best-in-class refining segment with more capacity on the Gulf Coast that any other refiner. This is where Exxon's downstream division makes its cash.

Due to ExxonMobil's global footprint and integration, it is able to push down refining and chemical production costs. As a result, the company has consistently reported the best downstream returns on capital employed within the integrated oil sector during every year for the past ten. In many years, Exxon's downstream returns have been almost double that of its integrated supermajor peers, such as Shell and Chevron.

Last place
Third and last place, both in this group of three and across the wider universe of integrated oil companies is held by Chevron, which is odd because the company has built up a reputation for reporting the highest per-barrel profit margins within the integrated oil sector. The company reported a ROIC of 14% for the last 12 months, compared to a high ROIC of closer to 20% during the past five years.

This falling return can be traced back to Chevron's high level of capital spending but falling income. For example, Chevron's net income has declined from $26.9 billion, reported for 2011, to $21.4 billion reported last year. However, over the same period, the company's invested capital has jumped around 25%. The company is spending and investing more, but for a lower return.

Foolish summary
In conclusion, using the return on invested capital metric gives us a benchmark with which to compare the profitability of companies. Surprisingly, of all the publicly traded oil companies in the US with a market capitalization of over $100 million Hess is reporting the highest ROIC figure. 

It seems that the company is able to do this thanks to its oil-linked asset base and high-margin production. Targeting oil production over gas has allowed Hess to outperform its larger peers and achieve better returns for investors. 

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