(Unfortunately I did not have the time to fully research this.)
Improvements in shale extraction technology and a glut of capital have basically destroyed oil and natural gas prices. While Exxon’s management is ok, the company cannot defy commodity prices. Its upstream assets aren’t worth that much anymore because they’re inherently leveraged to oil prices. But despite the dramatic decline in oil prices, Exxon’s share price remains high.
The put options are interesting to me since implied volatility is low (20-30%+) and the company is overvalued. The options are barely more expensive than SPY puts (in terms of implied volatility), except that oil prices fell by half and America’s GDP did not.
A back of the envelope calculation puts Exxon’s private market value at <$129B versus a market cap of $359B.
Back of the envelope calculation
My post “Quickly estimating the DCF of oil and gas reserves” notes that 3X cash flow is a good approximation of the DCF of an oil & gas asset. For Exxon I will use 6X cash flow just to be safe and to handle Exxon’s downstream assets, where a higher number is needed to estimate DCF.
- According to the latest 10-K, net cash provided by operating activities was $30.344B.
- Changes in working capital were 4.692 – 0.379 + 0.045 – 7.471 – 0.226 – 0.166 or -$3.505B.
- Adjusted for changes in working capital, cash flow was $33.849B.
- I ignored maintenance capex (several billion / year?), capitalized interest (Exxon capitalizes very little), stock-based compensation, and pension costs.
- 6 times cash flow is $203.094B. I want to replace the balance sheet entry for PP&E with that number.
- PP&E less depreciation and depletion is $251.6B.
- The difference between #5 and #6 is -$48.511B.
- I adjust the book value of $176.810B by that number, which gives and adjusted book value of $128.299B.
- I did not make an adjustment for tax because I am lazy. (Not doing this unfairly favours the argument for a short position, so perhaps I should have done that.) Exxon has deferred tax liabilities of $36.818B.
The point is that the run-off value of Exxon is around a third of the current market cap. Now one could make the argument that Exxon’s ability to generate high returns on capital is worth something. However, as Jim Chanos points out, Exxon’s ability to generate high returns on its investments has been going down. The historical trend has been that Exxon has spent increasing amounts of capex to generate the same amount of cash flow. So I think that Exxon has lost its way and hasn’t been investing smartly in the past several years under Rex Tillerson. e.g. Capex has consistently outpaced D&A, yet cash flow has not grown.
How to value Exxon… the right way
Use cash flow figures that reflect more realistic market prices
Cash flow adjusted for changes in working capital for the six months ended June 30, 2016 was $11.056. Annualized, that’s $22.112B versus the $33.849B I used in the back of the envelope calculation above.
A further adjustment can be made for the slight contango in the futures market (around $4 for oil).
Value assets separately
Exxon’s downstream assets have been great assets because the price of oil went up a lot since 2000 along with the price of the raw materials needed to build downstream assets. Very few new refineries have been built in North America over the past few decades. Refineries’ prices went up and there was no competition to bring prices back down to historical levels. These assets throw off a lot of cash and cause my calculations to be off.
Exxon also has cash flows from oil sands. Those cash flows tend to last much longer than traditional oil and gas wells because they “decline” much slower. However, due to the massive drop in oil prices, oil sands are close to breakeven (if not below breakeven) so that makes the analysis easier. They are highly leveraged to oil and aren’t worth a lot given current oil prices. (They’re also why Exxon has made so much money in the past several years… the high leverage to commodity prices was a boon with $80-100+ oil)
Oil projects with long lead times (e.g. deepwater) should also be valued separately. However, Exxon got unlucky because it seems like its Russian operations are a lost cause. Russia’s economy tanked (due to low oil prices) and the country has begun to steal from foreigners. The political issues and low oil prices mean that its deepwater assets are not very good assets (deepwater is somewhat higher on the cost curve).
Exxon does have shale assets since it purchased XTO Energy. Those cash flows are weird… declines are extremely high initially (often 30-70% compared to 15% for a traditional oil and gas well) and then drop dramatically. Modelling those cash flows take some guesswork since the terminal decline is unclear and it takes a lot of work to figure out what wells are in what stage of decline (this is possible if you go through state production data).
Some areas of the chemicals business are great since the glut of natural gas liquids in the US means low raw material costs. Not all chemicals have hydrocarbon inputs.
The maintenance capex on the downstream and chemical segments are likely four to five billion a year (capex is stated as Exxon breaks out the upstream, downstream, and chemicals segments). I did not model that.
Oil sands have high maintenance capex costs because a lot of the machinery needs to be constantly replaced. I did not model that.
The bottom line
I think that valuing Exxon at $129B is being generous. However, I think that it is highly unlikely that Exxon will go bankrupt given low amounts of debt and good assets in downstream, chemical, and existing upstream assets. The company should have ample coverage of its debt. It’s overvalued but not outrageously so.
While I don’t like shorting good companies based solely on valuation, I’m willing to speculate on the put options. I only need a small chance of things going my way to have a positive expected return on the puts.
*Disclosure: I am shorting XOM via put options (Jan 2018 LEAPs, somewhat out of the money).
Other oil supermajors
*I know very, very little about oil supermajors. Don’t take my comments too seriously.
Royal Dutch Shell (RDS.A): Seems overvalued like Exxon. However, there is close to no liquidity in out-of-the-money January 2018 options.
Chevron Corporation (CVX): Mkt cap of $190B versus adjusted book of maybe ??$107B??.
ConocoPhilips (COP): Could potentially be even more overvalued than Exxon. However, implied volatility is in the mid 30s. I’d rather buy lower-cost options on XOM (?).
Suncor: Implied volatility on the puts is in the thirties. The company has a lot of refining assets, which aren’t affected as much by the crash in oil prices.
Total SA: While I think management at Total is much worse than Exxon’s, Total does have a lot of good assets. It may even be less overvalued than Exxon.
Petrobras (PBR): It seems fairly valued?
BP: It seems fairly valued?
Eni: Did not research. Apparently there are no options available.