The U.S. oil and gas sector has been languishing ever since crude oil prices fell steeply in 2014. Investors who entered the sector just before that oil price crash have been left holding the bag. Energy investors have been hoping for a recovery for a long time, but it doesn't seem to be anywhere in sight. It's not surprising that some of those investors don't want to touch energy stocks again.
However, the steep fall in energy stocks due to the effects of the coronavirus presents an extremely attractive opportunity for long-term investors. Undoubtedly, the recovery timeframe is uncertain, especially if the fallout from the coronavirus lasts longer than expected, or if there is a second wave of infections. This uncertainty has impacted all energy companies, including giants like ExxonMobil (XOM -3.42%). The company is facing a challenging time even though the longer-term growth drivers remain in place. Are those long-term prospects good enough to make this company a buy? Let's look at what Exxon is up against today and where it plans to go from here.
ExxonMobil's total returns in the long term
ExxonMobil's total returns over the last 10 years severely underperformed the broader markets, infuriating many investors.
XOM Total Return Level data by YCharts
However, if we go a little further back, the picture looks different. ExxonMobil's 20-year total returns at this time last year well exceeded that of the S&P 500 index.
XOM Total Return Level data by YCharts
Concerns regarding global oil oversupply, combined with ExxonMobil's ambitious capital plans, were already pressuring the stock, which finally nosedived after the coronavirus pandemic destroyed demand for energy products. The stock is currently trading at extremely attractive levels compared to just a few months ago.
Will ExxonMobil cut it's dividend?
In its latest earnings call, ExxonMobil reiterated its commitment to keeping its dividend, which it has raised consecutively for 36 years, as intact as possible. The company projects a reduction of 400,000 oil equivalent barrels per day of production in the second quarter. Even considering that, it doesn't foresee a need for a dividend cut based on the current situation, which, of course, may change.
XOM Dividend data by YCharts
It's difficult to predict where oil prices are headed. However, with OPEC production cuts, oil demand may well exceed supply once the global economies reopen. This could provide a boost to energy stocks in the second half of 2020. At the same time, longer-term drivers for ExxonMobil's growth also remain in place, including global population growth, rising income levels, and energy demand, especially in developing economies.
Nevertheless, the risk of a longer-than-expected period of low demand remains. If ExxonMobil decides to cut dividends, say even to one-third of the current amount, its yield will still offer an attractive spread over the current 10-year Treasury yield. There are several other factors that make the stock a long-term buy.
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Focus on costs
ExxonMobil is laser-focused on bringing down its cost of production. The company understands that the pre-2014 oil prices may no longer return sustainably. Its production costs in the Permian Basin and Guyana are globally competitive. ExxonMobil has the size and scale to optimize its production costs. In fact, the company had been making huge investments to achieve that.
However, the unprecedented COVID-19 crisis forced the company to temporarily shelve those plans. While the company has reduced its 2020 capital expenditure plan by 30%, it has tried to do so with minimal impact on project returns. Short-cycle investments in the Permian Basin account for the largest chunk of capital reduction. However, ExxonMobil is continuing with its three-dimensional section development approach -- called cube development -- in the Permian to optimize output. The reduced capital spend will impact Exxon's Permian volumes in 2021. It's volume reductions in 2020 will largely come from well shut-ins, which can be adjusted quickly based on market conditions.
The other major impact of deferred capital expenditure would be a delay of around one year for roughly 750,000 barrels per day of Guyana production to 2026. Overall, ExxonMobil has tried to strike a balance between reducing capital expenditures while maintaining project advantages. While reduced investments will modestly hinder the company's profit growth, it looks well-placed to resume it as the markets improve.
Balance sheet strength
The key factor that allowed ExxonMobil to make huge investment plans for 2020 in the first place is its strong balance sheet position. ExxonMobil's debt-to-capital ratio is better than most of its peers.
XOM Debt to Capital (Annual) data by YCharts
If things remain bad, quite a few energy companies may go bankrupt. However, ExxonMobil looks much better poised to survive. On the other hand, an early return of demand for oil and gas products may boost the stock's price. Combined with an attractive yield, the total return prospects for ExxonMobil's stock look bright.
