Integrated energy giant ExxonMobil (XOM -2.78%) is in a tough industry. Not only are its competitors fierce, but its top line is reliant on highly volatile energy prices.
And yet, Exxon has managed to maintain a leading position in the energy space -- or at least most of the time, anyway. Notably, it is back on top when it comes to return on invested capital (ROIC). Here's why you should care.
A dynamic industry
There are a lot of players in the energy sector, from companies that focus on drilling for oil and natural gas (upstream), to those that move these commodities (midstream), all the way to the companies that refine and process these key energy sources (downstream). Exxon is among a small collection of companies that span all three segments, known as integrated energy majors. This group, which includes Chevron (CVX 0.37%), Shell (SHEL), BP (BP -0.38%), and TotalEnergies (TTE 1.10%), also share another trait: They aren't controlled or beholden to a government and are mostly publicly owned.
Image source: Getty Images.
The competition in this quintet can be pretty intense. That's notable because oil and natural gas are depleting assets. The first step is to find a good place to drill for the commodities, and then develop it into a functioning asset.
But there's only so much oil and natural gas in each discovery, so every barrel pulled from the ground is one less barrel available from the project. When a well runs dry, a new well has to be found to replace it. This is why oil reserves are such an important number for energy companies. It basically gives investors an idea of future production capacity.
But the bigger number is probably capital spending. That's the cash that energy companies put toward things like finding and developing new oil and natural gas wells. If a company doesn't spend enough, its future won't be as bright as peers that spend more.
Only that's too simple a view of things.
Investing success
Basically, the absolute dollar figure attached to capital spending isn't enough to understand how well a company is using its cash on behalf of shareholders. There needs to be some objective sign of success. Increasing reserves is one way to see this, but Wall Street tends to favor return on invested capital when it comes to energy companies like Exxon.
Strictly speaking, to calculate ROIC, you take net operating profit after taxes and divide it by invested capital. From a big-picture view, it basically tells you how good a job the company is doing with its capital investments. The higher the number, the better a company is doing for investors, who have entrusted management with their hard-earned savings. Exxon has a long history of sitting at or near the top of its peer group with regard to ROIC.
But not every year. In fact, in 2020 and 2021 it stumbled pretty notably, falling toward the bottom of the pack. Those were volatile years for the industry, which faced a huge downturn in the early days of the pandemic, when economies around the world were essentially shut down to slow the spread of the illness. That was quickly followed by a huge rebound as economies started to reopen. Unfortunately, Exxon entered this period with big spending plans, and it was clearly caught on its back foot.
XOM Return on Invested Capital data by YCharts
However, Exxon invests through the cycle, using its balance sheet to support capital spending needs during hard times so it can come out the other side in a stronger position. To put a number on that, its debt-to-equity ratio doubled during the pandemic downturn. Like its peers, it trimmed its spending plans, but what it did spend is paying off well today, as the company's production is heading higher despite asset divestitures. On top of that, costs are heading lower and, as the chart shows, its ROIC has once again risen to the top of its closest peer group.
Rewarded for patience
It isn't easy to stick with a company -- even one known for being an industry leader -- when times get tough. Businesses move along sine curves, not straight lines.
That said, investors that have stuck by Exxon have long been rewarded for their commitment, with the company's return to an industry-leading ROIC level being the latest sign of its success. All in, it looks like Exxon has returned to classic form.
