Oil is enjoying its best year since prices topped out at more than $100 per barrel a decade ago. Oil and gas behemoth ExxonMobil (XOM 0.39%) has rallied with it, hitting pre-COVID share prices.
Investors could be wondering if it's too late to buy the stock after it's already hit its highest price in over a year. But fear not: Here are three reasons ExxonMobil is my favorite oil stock right now.
1. The most substantial cash flow in years
ExxonMobil's an integrated oil stock, which means it participates in multiple aspects of the oil and gas industry, including the exploration and extraction of fossil fuels (upstream) and the refining and distribution of fossil fuel products (downstream).
Image source: Getty Images.
You can reasonably simplify the company's business by looking at its financials over time and how several factors have affected them. The price of oil plays a significant role in how profitable oil companies like ExxonMobil are. It cannot control the price of oil, but it can control how much it spends to develop its assets for oil extraction, shown as the company's capital expenditures.
Its free cash flow comes from the combination of how much oil it can produce and the price it sells it at (cash from operations), minus the portion of those profits ExxonMobil invests into the business (capital expenditures) for developing these future assets for oil production or into the maintenance of its refineries, and the like.
XOM free cash flow. Data by YCharts. TTM = trailing 12 months.
Low commodity prices pushed ExxonMobil to change its investment strategy about a year ago. The company wrote off almost $20 billion in non-strategic natural gas assets, and cut spending to focus on its most important development projects, like Guyana and the Permian Basin. You can see this "belt-tightening" starting in 2020 in the above chart, and it's helped the company's free cash flow reach its highest amount in a decade as commodity prices rose throughout 2021. Again, free cash flow is left over after the company has invested in its business, so management can use this cash to either pay dividends, buy back shares, or horde cash on the balance sheet/pay down debt.
2. The dividend is still awesome
The up-and-down nature of the oil industry makes it hard for many oil and gas companies to pay a dividend over the long term reliably. But ExxonMobil is a $300 billion oil company and has the massive size and resources to be flexible when needed.
It's a Dividend Aristocrat that has paid and raised its dividend annually for the past 38 years, spanning multiple market cycles. Oil stocks tend to be high-yield dividend stocks, and ExxonMobil's dividend yield is currently 4.9% despite the stock's recent high share price.
The company showed how important the dividend is during the pandemic by issuing debt and selling assets to fund the dividend when cash flow dried up.
XOM cash and equivalents (quarterly). Data by YCharts.
It's not something you want to see all the time because the balance sheet can take on too much debt, but with ExxonMobil's financial rebound, it should be in a position to pay down what it borrowed. Total debt surpassed $80 billion in 2020, but that has already been paid down to under $60 billion in short order, while the company's debt-to-capital ratio is just 26%, signaling that the company doesn't rely on debt to operate. As long as things stay the way they are for a while, its financial healing will make it a blue chip dividend stock that investors can count on once again.
3. Production prospects look strong
ExxonMobil is emphasizing efficiency after a near decade-long bear market in oil prices. Of course, it also helps to get a little luck. Its Guyana exploration has been a smashing success over the past few years. It has repeatedly found high-yielding areas to drill, and production in the Guyana region could grow to more than a million barrels of oil per day over the next five years.
The crucial part in this is that these assets have cost the company far less to develop, helping maintain oil output but lowering overall spending and increasing cash flow. Oil and gas assets have a long tail, meaning that good news today doesn't hit the company's financials until later, sometimes years down the road.
Along with ExxonMobil's work in the Permian Basin, the Guyana discoveries could maintain its current total oil output but get 40% of volume from these low-cost sources by 2025. Oil from Guyana and the Permian Basin has more than 10% returns at just $35 per barrel, making them profitable in all but the worst environments for oil prices. In other words, ExxonMobil should handle the next downturn in oil far better than it did a decade ago when it was spending on expensive oil projects.
Ready for new highs?
ExxonMobil's become more careful with how it spends money and with recovering oil prices, free cash flow is its highest in a decade. Shares could still have near-term upside if oil continues rallying, but what I like is that the challenges of the past decade have pushed the company to become more careful with its capital instead of spending like a drunken sailor.
As a long-term investor, I look for companies built for sustained success. ExxonMobil is a massive business with resources and assets that make it a force in the energy industry. The past decade has shown how volatile oil prices can be, and it seems that ExxonMobil is now built for success in just about any market environment.
