The investment research firm, Cowen, downgraded the stock of oil giant Exxon Mobil Corporation (NYSE: XOM) to ‘market perform’ from ‘outperform’ rating on Friday after the company divulged to analysts that its capital expenditure would remain more or less unchanged from the past level. Exxon shares have gained 8.2% in the last 12 months, while the Dow Jones Industrial Average (DJIA) has gained 2.3% and the S&P 500 (SPX) has gained 0.4%. The stock closed at $79.01, down $1.15 or 1.43% from the prior close.
Exxon Mobil’s capital spending plans are not taken well by investors
Exxon Mobil’s stock has made impressive gains in the past year, led by a recovery in oil in early 2019 and better-than-expected earnings. The appreciation in the stock price has managed to erase a portion of the sharp drop in 2018. However, Cowen analyst, Jason Gabelman, questions the company’s production outlook on the basis of volatile energy prices.
In a recent investor event, Exxon argued the need for investing in hydrocarbons on a continuous basis, saying that they are innately diminishing commodity that requires investment, and market demands for goods extracted from those hydrocarbons change against a landscape of overall growth.
Exxon Mobil, therefore, does not want to trim its expenditure on natural gas anytime soon. The company has stated that its capital spending will be to the tune of between $30 billion to $35 billion this year, which implies a substantially lower cash flow and minimal upside potential to the stock in the next year, as per Cowen.
Thus, analyst Jason Gabelman downwardly revised the energy behemoth’s stock from ‘outperform’ to’ market performance,’ and explained that while the company’s capital spending may result in the generation of more cash in the foreseeable future, existing shareholders are likely going to see a slowdown in dividend growth.
Specifically, in his research note, Gabelman points out that the company’s counter-cyclical investment plans may look smart in the years to come, but it may endanger the ability of the company to achieve its dividend multiple. The analyst further points out that “investors are likely more willing to pay for excess free cash flow today than count on future free cash flow.”
That may look like a silly claim. For several years Exxon has been an energy giant, and with a market cap of roughly $340 million, when fuel prices decline, it is not in the same tight spot as smaller firms. However, the sharp decline in oil prices is justifiably fresh in the mind of investors. Since mid-2014, Crude has not surpassed $100 a barrel, and the commodity remains volatile.
Crude is currently trading at around $55 a barrel, a little higher than 50% of what it was five years before, and the stock price of Exxon hasn’t bounced back to 2014 levels either (Exxon was trading above $100 before the crash).
While there is little doubt that investors who remain patient may be rewarded financially, it is unsurprising that perseverance among Exxon shareholders at this point is somewhat scarce.
In a research note, analysts wrote: “XOM’s counter-cyclical investment decision may look prescient in future years, but we do not believe the investor community is willing to place that same bet today and are downgrading the stock as a result.”
On the basis of the arguments provided above, analysts headed by Jason Gabelman slashed their stock price target by 25% to $75 from $100.
The downward revision to the Dow component arrives two days after the oil and gas Major issued new financial guidance, which indicates that the company is on course to record an improvement in profit and cash flow in the current fiscal year.
But the share price fell after investors were cautioned about an increase in capital expenditure in the coming years. Exxon anticipates boosting capital expenditure by $4 billion to $30 billion in 2019. Exxon forecasts spending between $33 billion and $35 billion in 2020 and $30 to $35 billion in subsequent years through 2025.
Regarding dividend yield, Gabelman said: “Exxon Mobil should continue to grow its dividend, though potentially by a lower rate than the greater than 5 percent compounded annual growth rate over the past five years. Its dividend yield has increased 10 of the past 12 years and averaged the highest level of the 2000s in 2018.”
There is also pessimism in the options markets. At the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), “Exxon’s 10-day put/call volume ratio of 1.97 ranks in the 99th annual percentile.”
Therefore, keeping capital spending unchanged from last year, the possibility of a decline in dividend growth and analysts downgrade is expected to keep the stock weak in the near-term.
Technically, the stock is facing resistance at 80. The stochastic oscillator is also in the overbought zone. As a result, we can anticipate the stock to undergo a correction in the short-term.
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