The silver shimmer of Silicon Valley is replacing the oil slicks that once gilded the Dow Jones Industrial Average (DJIA) in black gold. That silver shimmer is, and it's replacing the longest-tenured DJIA component: ExxonMobil (XOM -0.57%), effective Aug. 31. 

Exxon's removal adds another red flag to a series of headwinds that have pushed its shares down over 40% for the year. Is there more pain ahead, or is there reason to believe Exxon can turn it around? 

Silver renders of a bull and a bear in the sun.

Image source: Getty Images.

The fall of ExxonMobil

Going back a few years further to 2007, Exxon was the largest company by market capitalization. Limited supply and rising demand led to high oil prices that pole-vaulted revenues and profits to new heights. As the oil industry's leader, Exxon became a staple in market indexes and a key holding for investors young and old.

During the height of the Great Recession, oil endured immense volatility, with the monthly average for WTI crude reaching as high as $133.88 per barrel in June 2008 and then as low as $41.12 that December. After a brief setback, oil prices took to the skies, averaging over $90 a barrel for the five year period between 2010 to 2014.

After the oil crash of 2015, prices never recovered, and neither have Exxon's earnings.

XOM Revenue (Annual) Chart

XOM Revenue (Annual) data by YCharts

Its stock has lost value over the past 20 years compared to an increase of over 130% for the S&P 500.

Where Exxon stands today

Exxon's stock has fallen for more than the simple fact that oil is out of favor. In cold hard numbers, Exxon simply isn't making as much as it was in the golden period between 2005 and the beginning of 2015. On top of that, its debt burden is ballooning and its free cash flow (FCF) has gone negative as a result of the COVID-19 pandemic's impact on oil and gas demand and prices.

XOM Free Cash Flow (Quarterly) Chart

XOM Free Cash Flow (Quarterly) data by YCharts

Lower FCF means Exxon is now supporting its dividend with debt, which is unsustainable over the long term.

Where Exxon is going

Exxon would argue that its investment thesis remains strong. Oil still dominates the transportation industry and natural gas is the United States' leading fuel source for power generation.

Exxon points to developing countries as a primary growth market for oil and gas, pointing to fossil fuels' competitiveness with renewables in emerging markets. Before the onset of the pandemic, Exxon expected its earnings could double by 2025 in a moderate pricing environment.

What Exxon needs is a stable oil price where it can reach the margins needed to pay a growing dividend and achieve its long term production goals. For that to happen, Exxon would like for oil demand to start outpacing supply. However, that's partially dependent on the energy mix of developed and developing economies as well as the investment appetite of its key competitors. Given recent decisions by rival majors Royal Dutch Shell, BP, and Equinor, there's reason to believe that Exxon's competitors would rather be renewable energy stocks than compete in oil and gas over the long term. 

Can Exxon reenter the DJIA?

Removal from the DJIA isn't necessarily a perpetual banishment. On August 31, Honeywell International (HON -1.08%), the third-largest U.S. industrial stock by market capitalization, will re-enter the Dow after a 12-year hiatus.

In Honeywell's case, the reentry is well deserved. The company has one of the best balance sheets in the industry and has outperformed the broader markets since its departure. Its future looks bright as it grows market share in its core business and expands further into operational technology (OT) and the industrial internet of things (IIoT). 

In Exxon's case, S&P Global made it clear that it was reducing redundancies in the index and adding new companies to better reflect the economy. That came in the form of removing Exxon but keeping Chevron. Therefore, a comeback for Exxon could mean that it either has to outright outperform Chevron, post years of stable earnings growth and reduce its debt, oil and gas as a whole regains favor, or some combination of the three.

Cause for concern

Given the leaps and bounds that it took for Honeywell to get back in the index, the road to reentry won't be easy for Exxon. For now, the stock's dividend obligation is drowning it in even more debt. The upside for Exxon doesn't look great, but given that its stock has fallen substantially, it looks like a reasonable hold at this time.