U.S. energy giant ExxonMobil (NYSE:XOM) has fallen on hard times, with its stock down roughly 50% so far in 2020. It's certainly not the only international oil major that is struggling, but investors need to step back and consider a number of key factors before deciding to buy this stock. Third-quarter earnings will be released Friday, Oct. 30. Here's a quick look at some of the key factors to consider.
1. The end is not near
Environmentalists would have you believe that the demise of carbon fuels like oil and natural gas is fast approaching. That's not likely to be the case, given that oil and gas are so integral to the global energy picture. Yes, clean energy is growing rapidly and displacing carbon fuels. But that's mostly coming at the expense of coal, while oil and natural gas are set to remain key energy sources for decades under even aggressive clean-energy scenarios.
In fact, it takes a long time to transition from one energy source to another. Oil, for example, took 100 years to displace coal as the largest global energy source. Sure, things may move more quickly this time around, but the need for Exxon's energy business isn't going away overnight.
2. Exxon is a survivor
While some once very prominent energy companies, like Chesapeake Energy, have filed for bankruptcy, Exxon is nowhere near that point. For starters, Exxon has a long history of running its business conservatively. That hasn't materially changed, with financial debt to equity at a reasonable 0.35 times. That's notable, as Exxon has taken on debt so it can continue to invest in its business and pay its dividend, but it's still toward the low end of its peer group. In fact, only peer Chevron has a lower ratio, at 0.20 times. Based on these first two points, the "worst-case" scenario for investors is unlikely to be a total loss of capital. And, assuming that the current industry disruptions prove temporary, there could be material recovery potential after such a large price decline. Energy is, historically speaking, a cyclical industry.
3. What about the dividend?
Now for a tougher call. Exxon has increased its dividend consecutively for 37 years. That's an incredible streak, particularly when you consider that oil is a highly volatile commodity. The deep price declines in the face of lax demand because of COVID-19 is just the most recent example of that, though a particularly troubling one. There are two problems here for Exxon, both of which tie back into the company's decision to increase its leverage.
First, in recent years Exxon has embarked on a massive capital spending program as it looks to get its production growing again. It has pulled back on the spending front, as have its peers, but it really can't give up on the plan because it needs to make these investments if it wants to grow.
Second, Exxon's long-term commitment to the dividend could be wavering. Management basically announced that it was reluctant to take on more debt when Exxon held its second-quarter 2020 earnings conference call. Although it remained committed to the dividend, if oil prices don't mount a sustained recovery, it may not be able to support both the dividend and its capital spending plans without taking on more debt.
If push came to shove, and management chose to avoid additional debt, the dividend would likely lose out to capital spending. This is, simplifying things a bit, basically what happened at BP and Royal Dutch Shell, both of which trimmed their payments in 2020.
The big takeaway
For investors looking to invest in the out-of-favor energy sector, and who don't care too much about dividends, Exxon remains a solid option. There's material turnaround potential if energy prices start to pick up again. However, dividend-focused investors should tread with a bit more caution. Yes the 10% dividend yield is enticing, but the risks of a dividend cut have materially increased. In fact, while a dividend was once virtually unthinkable, so far the company has only really stated that it will maintain the dividend through 2020. If you are an income investor, other oil and gas options like Chevron may be a better call right now.