Integrated energy behemoth ExxonMobil (XOM 3.61%) has long used share buybacks as its primary vehicle to return cash to shareholders. Whereas some other members of Big Oil, including rival super-majors Total (TOT +0.00%) and Chevron (CVX 2.21%) choose to reward investors with hefty dividend yields, ExxonMobil uses a different tactic.
ExxonMobil has spent tens of billions of dollars every year to repurchase its own shares, which reduces the amount of its shares outstanding. However, ExxonMobil's levels of quarterly share repurchases are declining sequentially. This could be an indication of a nervous management team, since share buybacks are often viewed as a signal of overall management confidence in future results. Therefore, investors may have reason for concern over the state of ExxonMobil's buybacks.
Is ExxonMobil's capital allocation strategy backfiring?
Over the past several quarters, ExxonMobil's pattern of share repurchases has steadily trended down. As previously mentioned, ExxonMobil chooses to send cash to shareholders in the form of buybacks rather than hefty dividend yields. This is often a beneficial decision for investors, since buybacks are a tax-advantaged distribution versus dividend payments, which are taxed as income to the shareholder.
That's why ExxonMobil has chosen to keep a relatively lower dividend, at roughly 2.5%, than many of its integrated peers. By comparison, Total and Chevron pay much higher dividend yields than ExxonMobil. In turn, Total and Chevron spend a relatively paltry amount on share buybacks. Total pays a nearly 5% dividend yield, but barely buys back any of its own shares at all, having repurchased just $179 million through the first nine months of 2013. For its part, Chevron spent a total of $5 billion on share repurchases in 2013. Rather than buy back huge sums of its own stock like ExxonMobil, Chevron uses some of that cash for a higher dividend, which stands at 3.6%.
ExxonMobil had maintained a streak of ten consecutive quarters in which it spent at least $5 billion on share repurchases, which lasted through the first quarter of 2013. Since then, its repurchases have steadily declined. Exxon bought back $4 billion worth of its shares in the second quarter, and just $3 billion in the third and fourth quarters. Going back even further, the numbers are truly staggering. ExxonMobil has spent more than $200 billion on share buybacks over the past decade.
Buybacks, when utilized to reduce shares outstanding, help to lift corporate earnings on a per share basis. Since there are fewer shares outstanding, there are more profits to go around for the remaining shares. This reduces the denominator in the earnings per share equation, which theoretically should result in a higher stock price.
Unfortunately, during periods of fundamental business under-performance, hefty share buybacks become less beneficial to shareholders. ExxonMobil's earnings per share fell 24% last year, despite spending billions on share repurchases. It's clear that ExxonMobil is forced to make difficult decisions with its capital allocation in light of its operating struggles over the past year.
Should ExxonMobil change its capital allocation strategy?
Despite spending tens of billions of dollars on share repurchases every year, ExxonMobil's underlying performance still struggles. Its earnings per share dropped significantly last year, even though there are far fewer slices of the corporate pie out there. With its underlying business seeing deterioration across the upstream and downstream segments, it may be wise for ExxonMobil to allocate more money for dividends to provide a guaranteed return, and thereby protect investors against downside risk.
Another possible strategy could be for ExxonMobil to use its cash flow to reinvest in promising growth opportunities to get its production and profits going in the right direction again, instead of cutting capital expenditures. ExxonMobil's capital and exploration expenditures fell 20% in the fourth quarter. Perhaps it's time for ExxonMobil to review its capital priorities.
Share buybacks aren't the only way to add value for shareholders
