Exxon: Same Oil-ed, Same Oil-ed Brian Graney (TMF Panic)
October 25, 1999
Integrated oil and gas giant Exxon Corp. (NYSE: XON) posted its third quarter results this morning, beating the First Call mean earnings estimate by $0.02 with EPS of $0.61 versus $0.58 a year ago. Despite the slight surprise, Exxon's shares lost some ground as investors may have been relying on the tiger to turn in even higher figures for the period thanks to rising oil prices.
Overall, revenues jumped 16% from a year ago but net income increased by less than half that rate at 7%. Whenever investors see net income growth not keeping up with revenue growth from one reporting period to another, that's a good sign that margins are coming under pressure, regardless of the industry or the specific business model of the enterprise in question.
In Exxon's case, a 27% rise in benchmark crude oil prices during the quarter helped boost earnings from the company's "upstream" exploration and production operations but took their toll on margins for "downstream" refining and marketing activities, where oil prices represent the most important variable cost. Upstream functional earnings were up a strong 114% in the U.S. and 105% internationally. However, those gains weren't adequate enough to offset a slide in downstream earnings, which fell 17% in the U.S. and a startling 96% internationally.
This may sound bad, but it's pretty consistent with what many of the other integrated oil and gas firms also reported today. In fact, investors wanting to know what business was generally like for Mobil (NYSE: MOB), Chevron (NYSE: CHV), Texaco (NYSE: TX), and ARCO (NYSE: ARC) over the past three months need only to refer to the major themes in Exxon's earnings report and plug in smaller numbers. The big difference is that Exxon's larger exposure to downstream activities prevented it from putting up the kind of double-digit earnings growth seen by its more upstream- and oil-centric peers during the period. Then again, that's pretty much the way Exxon's business is supposed to react under today's prevalent conditions.
With an immense $55 billion of employable capital around the world, Exxon is anything but a nimble enterprise. All three of the company's main operations -- upstream, downstream, and chemicals -- are set up to leverage the advantages of size and scale, not react quickly to fluctuating prices in commodity prices. The company's focus on size as a competitive advantage is evident by the business moves Exxon did, or perhaps even more importantly, didn't make recently. Capital and exploration expenditures during the period fell 22% -- the reverse of what one would expect in a quarter when oil prices are strengthening. Meanwhile, worldwide refinery throughput was essentially unchanged.
Investors approaching Exxon from the angle of a potential long-term investment are better off ignoring how the business reacts quarter to quarter compared to smaller publicly traded integrated firms and focus on how the company stacks up against its real peers -- the world's major state-run oil and gas concerns. Exxon will always be at a cost disadvantage to these mammoth companies, even after wringing out billions of dollar of cost savings through its proposed merger with Mobil. But that reality alone does not mean that the soon-to-be-formed Exxon Mobil will be unable to produce market-beating returns over the long pull.
It's important to realize that those returns in the short-run will likely be generated in a very different manner compared to other publicly traded integrated firms. Much like the stated goals of Warren Buffett's initial Buffett Partnership in the 1950s and 1960s, Exxon's main thrust will be to perform relatively well in periods of declining or level commodity prices while producing potentially unimpressive relative results in rapidly rising markets. Over time, this strategy worked wonders for Buffett and his original limited partners; it remains to be seen if Exxon can make it work in the oil and gas business.
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