Upstream Segment Will Continue to Drive Growth for XOM Stock

Faisal Humayun

Mon, Sep 23, 2019, 9:05 AM

Exxon Mobil (NYSE:XOM) stock has been an underperformer for the last year. XOM stock has declined by 15.4% during this period. I further believe that XOM stock will remain weak in the next few quarters as recession fears dominate headlines. Geo-political tensions have supported oil price, but I do expect oil to trend lower as demand declines on sluggish economic growth.

Bullish on Exxon Mobil for long-term upside

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However, amidst these concerns, I believe that Exxon stock is worth accumulating on every correction. This thesis will focus on the upstream segment to elaborate on factors that will take XOM stock higher in the medium to long-term.

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My focus is on the upstream segment as the division remain the main earnings driver for the company as compared to the downstream or chemicals segment.

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Why I Am Bullish on Oil

Oil has been sideways to lower as trade tensions have impacted global economic growth. However, I believe that the best part of the demand for oil is still impending.

To put things into perspective, global energy demand is expected to rise by 20% by 2040. Further, India and China will account for 50% of the energy growth.

Both these countries are home to 2.5 billion people and per capita oil consumption still remains low as compared to the U.S. With both economies likely to grow above 5%, the demand for oil is likely to witness sustained growth.

In addition, I believe that geo-political tensions in the Middle East will continue to escalate with Iran remaining in focus. This should also support oil prices in the medium to long term.

Another factor that is worth mentioning is renewed expansionary monetary policies by the Federal Reserve. In general, it translates into a weaker dollar, which is bullish for commodities and oil.

Overall, oil will trend higher in the long term and higher price realization will imply higher EBITDA margin and cash flows for upstream segment.

Exxon Mobil Has Quality Upstream Assets

Exxon Mobil has quality assets that will ensure steady production growth and cash flow upside.

The company’s Permian asset has delivered 274 koebd production in 2Q19. It is worth noting that the company production increased by 90% between 2Q18 and 2Q19. Further, the company expects Permian production to continue accelerating until 2025. Rystad Energy expects U.S. shale production to peak in 2030 and this implies significant impending production growth.

In addition, the company’s asset in Guyana is likely to be another cash flow game changer. Liza Phase 1 is expected to commence in early 2020 with production estimate of 120,000 boepd. Liza Phase 2 will commence production in 2022 with production of 220,000 boepd. Overall, the company expects production of 750,000 boepd from the Stabroek block by 2025. With the asset having resources of 6 billion barrels of oil equivalent, long-term production growth will be supported.

With production growth, the company is also looking at divesting non-core assets. The company is targeting asset sale of $15 billion by 2021. This will allow the company to accelerate investments in high potential assets.

At the same time, as oil trends higher in the next 3-5 years, the company’s free cash flow will increase. As a consolidated entity, Exxon Mobil reported operating cash flow of $14.4 billion and free cash flow of $1.6 billion for 1H19. Therefore, investments have been significant and this will translate into higher cash flows.

In 2Q19, Exxon Mobil reported dividend growth of 6%, making it the 37^th consecutive year of dividend increase. I believe that dividend growth will sustain in the coming years. This makes XOM stock a high quality dividend stock for the portfolio.

The Bottom Line on XOM Stock

XOM stock has been lower in the last one year, but I see the downside as an opportunity to gradually accumulate. Economic headwinds will dominate the oil price trend in the coming quarters and that might keep Exxon stock depressed.

However, I believe it provides long-term investors will a good investment opportunity. In the coming years, Permian asset and the asset in Guyana will drive production growth. Further, as oil trends higher, free cash flow will swell and translate into incremental value creation.

It is worth mentioning here that in 2Q19, the company’s liquid production was the highest since 2016. With higher focus on liquids, EBITDA margin expansion will value creation as well.

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Overall, XOM stock is a buy on declines and I expect the upstream sector drive free cash flow growth in the coming years. With visibility of steady dividend growth, Exxon Mobil is worth considering for dividend investors as well.

As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.