Exxon Mobil – Priced to Buy for Dividend Growth Portfolio

Exxon Mobil Corporation engages in the exploration, production, transportation, and sale of crude oil and natural gas. It also involves in the manufacture, transportation, and sale of petroleum products. The company manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics, and other specialty products. XOM pretty much operates in all parts of the world such as United States, Canada, Europe, Africa, the Asia Pacific, the Middle East, Russia/Caspian region, and South America. Exxon Mobil Corporation was founded in 1870 and is based in Irving, Texas.

XOM is a part of the dividend aristocrats, S&P500 index, and DJIA index. It has been raising its dividend for last 28 years. The latest increase in dividend was 4.8% in April 2010. My objective here is to analyze XOM to determine fair price range for buying and how will it rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: Overall had a growing trend, but dropped significantly in 2009.
• Cash Flows: In general, a slow growing trend, but dropped significantly in 2009. The free cash flow is generally close to net income. Operating cash flow is always higher.
• EPS from continuing operation: In general, growing trend, but dropped in 2009.
• Dividends per share: Consistently growing dividends.
  

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.86. This is a medium risk category (relatively closer low risk) as per my 3-point risk scale. The sudden drop in 2009 (EPS and gross margins) makes it a medium risk-to-dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past ten years.

• Dividend growth rate: The average dividend growth of 7% (stdev. 3.6%) is almost same as average EPS growth rate of 7.6%. Dividends have grown inline with earnings per share.
• Duration of dividend growth: 28 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10% for past 10 years.
• Payout factor: It has been in the less than 30%. It was at 42% (at the end of 2009).
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.9%; and (b) MMA yield is 1.75%. Last 10 years average dividend growth rate has been 7.1%, and I expect XOM dividend growth rate to be 7.1%. With my projected dividend growth of 7.1%, the dividend cash flow is twice the MMA income at the price of $77.0.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $37
• Average high yield price calculated based on past 10 years: $63
• Pricing based on past 8 year relative price-to-earnings ratio. $87
• Pricing based on price-to-earnings ratio of 12: $72
• Graham number: $56

The range of fair value is calculated as $53 to $63.

Qualitative Analysis
XOM is one of the largest vertically integrated oil and natural gas company. It has exploration and production operations in more than 180 countries, full-to-partial ownership in 37 refineries, and high oil and gas reserves.

• The revenue distribution shows that US contributes approximately 30% of the revenue. The rest 70% comes from foreign markets and emerging markets.
• Investing in XOM can be considered as a good proxy for foreign/emerging markets
• It has taken initiatives to expand its capabilities and capacity in natural gas by proposing to acquire XTO.
• The company seems to spend more on share buybacks than on dividends. This is a drawback. The fact that it has cash for share buyback, I would argue why not increase dividends (and reduce the share buybacks). Higher dividend payout could support its prices. But for a large organization like XOM, there could be large number of options exercised that require buybacks, otherwise EPS starts getting affected.
• Contrarily, when we look at dividend growth, it has kept pace with earnings growth.

Conclusion
I like XOM’s large size, worldwide operation, presence in every international market. It has built a global operation with integrated exploration, productions, and refining. This gives it moat for economies of scale. The dividend growth seems to follow the growth in EPS. The stock’s current risk-to-dividend rating is 1.86 (medium risk). This is much closer to being a low risk. I recently added a new starter position in XOM. I will continue to build my position as per my allocation level if the stock stays within my buy price range.

Full Disclosure: Long on XOM.

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