A price war between Russia and Saudi Arabia. The biggest drop in crude oil prices since the Gulf War in 1991. A lot of bad news hit the energy markets on Monday and paired with coronavirus fears to create a broad market sell-off of more than 7% in the S&P 500, Nasdaq, and Dow Jones Industrial Average. The market's rebound on Tuesday was erased on Wednesday and then was followed by the worst crash in the Dow since 1987, bringing the S&P 500 with it into bear market territory.
Commodity-dependent businesses and companies with global supply chains have seen their stock prices plummet. Oil and gas companies will feel even more pain as they face shrinking and, in the vast majority of cases, negative margins. The more important task is determining which company, ExxonMobil (NYSE:XOM) or BP (NYSE:BP), is better positioned to endure short-term falls in commodity prices so it can potentially benefit from a rebound.
Navigating the current price environment
Despite major divestments, ExxonMobil and BP are not positioned to perform in a $30 oil market. No supermajor is. Both firms have done a good job reallocating their portfolios toward projects that break-even in the mid $40s and low $50s, but even these projects can't compete at today's prices.
ExxonMobil and BP are two of the most capital-intensive supermajors. BP's debt-heavy and spending-heavy strategy has positioned it to return some serious cash flow in a $55 oil market, but that same positioning leaves it more vulnerable than other majors when prices are lower. Unlike Chevron, which is banking on the long-term payoff of shale while remaining financially conservative, Exxon reaffirmed its annual investment program of $30 billion to $35 billion a year between 2020 and 2025. BP, which is about half the size of Exxon, is planning a similar amount of spending, specifically on the lower end of its guidance of $15 billion to $17 billion in 2020.
During Exxon's 2020 investor day on March 5, CEO Darren Woods noted the "advantages of leaning into this market while others have pulled back, and while saying that, remain very mindful of the challenges of the current market." Woods is basically saying that Exxon's investments in Guyana, Brazil, and other projects represent a long-term commitment to oil and gas. That being said, Exxon's heavy investment in the Permian on top of these other investments may be a bit too cavalier.
To some extent, oil and gas companies have to invest to avoid depletion in their assets, so spending on new projects is a must. But BP and especially Exxon are justifying their spending based on perceived fundamentals that fossil fuels will be:
- Instrumental in meeting the growing energy needs of the industrialized world.
- The potential energy choice of the 800 million people in the world without electricity.
- Competitive with renewables as the population continues to grow, mostly in developing countries.
Exxon expects its "earnings potential to double by 2025 in a flat real price and constant margin environment," but that assumption is based on 2017 actual earnings and $60 Brent prices, adjusted for inflation, over the next five years.
Dependence on oil and gas
In terms of dependence on oil and gas, Exxon and BP are behind other companies like Royal Dutch Shell. Exxon prides itself on innovating to be the best oil and gas company in the world, whereas Shell sees a future in renewables and, according to Bloomberg, led supermajors in clean energy investments last year. Shell's focus is mainly on electric power generation through solar and further "electrification" efforts like charging stations for electric vehicles.
In early February, BP announced its plans to be carbon neutral by 2050 but offered little details on how it will get there, leaving too many holes and too much time to make its pledge carry any weight.
Balance sheet comparison
Lower total long-term debt, less leverage thanks to lower financial debt to equity, and a lower debt-to-capital ratio all signal that Exxon is less dependent on debt than BP is. The debt-to-capital ratio is particularly important among oil and gas companies as a means to judge capital structure, solvency, and leverage by dividing total debt by debt plus stockholders' equity.
Exxon's superior balance sheet could take it far in a scenario in which small independents fall by the wayside, supply falls, prices rise, and assets are available for purchase on the cheap. That scenario remains highly unlikely anytime soon, but it's basically what a multiyear turnaround would look like.
According to the EIA, "The price of Brent crude oil, the international benchmark, averaged $64 per barrel (b) in 2019, $7/b lower than its 2018 average. The price of West Texas Intermediate (WTI) crude oil, the U.S. benchmark, averaged $57/b in 2019, $7/b lower than in 2018."
In this 2019 price environment, Exxon earned $14.34 billion in net income and $5.35 billion in free cash flow (FCF) and paid $14.65 billion in dividends. BP earned $4.026 in net income and $10.35 billion in FCF and paid $6.95 billion in dividends.
Based on 2019 numbers, Exxon's dividend payments were just a smidge higher than its total annual net income but nearly 3 times FCF, whereas BP's dividend payments were 70% more than its net income but less than its FCF. Both performances are bad, and with oil now around half of that 2019 average, they're going to look a lot worse.
The better buy
Considering Exxon's massive capital expenditure budget and the dependability of $55 Brent oil prices for BP's portfolio to really thrive, both of these companies have shaky dividends that, in the near term, will need to be paid using debt. That means that despite BP's nearly 10.2% yield and Exxon's 8.2% yield, neither company is a reliable dividend stock in a sub-$45 oil market. That being said, it's worth noting that Exxon is a dividend aristocrat, having raised its dividend for 37 consecutive years and hasn't cut its payout since 1948 (split-adjusted). However, if Exxon simply accumulates more debt to avoid losing this precious accolade it could appease investor sentiment in the short-term but damage Exxon's balance sheet over the next few years.
Since Exxon has a stronger balance sheet, it's the better stock to buy of the two. BP's gamble for strong cash flow at $55 oil combined with its massive debt and dividend obligation makes it a poor candidate to play a rebound in energy stocks. Exxon has a nice investment portfolio that gives it comparatively favorable positioning in the present market.