The prolonged softness in commodity prices has deteriorated the profitability of oil and gas companies worldwide, forcing them to raise additional debt in order to sustain their operations. This, coupled with the significant drop in the shareholders' equity, has severely weakened the capital structure of these companies. However, large integrated companies, such as Exxon Mobil ( XOM ) and Chevron ( CVX ), who have the advantage to mitigate their weaker upstream operations with their downstream performance, have managed to have a relatively stable capital structure. In this note, we aim to discuss and analyze the financial position of Exxon Mobil and Chevron to determine which of the two has a more optimal capital structure.
See Our Complete Analysis For Exxon Mobil Here
Source: Exxon Mobil's Analyst Meeting Presentation 2017
To begin with, we discuss the debt-to-capital ratio of the two companies. This ratio indicates the proportion of long-term debt in a company's capital structure. Despite being the world's largest integrated energy company, Exxon has held a fairly low amount of debt on its books historically. Consequently, the company had a debt-to-capital ratio of merely 6% in 2014, when the commodity downturn began. However, due to the distress caused by the oil slump, the company had to raise additional debt over the last two years, increasing its long-term obligations to almost $29 billion in 2016 from only $12 billion in 2014. Accordingly, Exxon's debt-to-capital ratio jumped to around 15% in 2016, bringing its three-year average to 10.5%.
On the other hand, Chevron had about $24 billion of debt on its balance sheet in 2014, translating into a debt-to-capital ratio of around 13%. However, just like Exxon, Chevron, too, had to increase its long-term obligations over the last two years in order to fund its capital expenditure and day-to-day operations. At the end of 2016, the company's long-term debt rose to roughly $35 billion, and its leverage grew to nearly 20%, increasing the three-year average to 17%.
On comparing the leverage of the two companies, we believe that Exxon continues to hold much lower amount of debt than Chevron, and thus, has less pressure of repayment of debt in the current low price environment.
Secondly, we analyze the debt-to-EBITDA ratio. This metric shows the number of years that a company would require to repay its long term debt at the current rate of profits. EBITDA is the operating profit of a company before interest, taxes, depreciation, and amortization.
As mentioned earlier, Exxon and Chevron had to raise additional debt over the last couple of years to meet their operational needs. While the long-term debt of the two companies has increased notably since 2014, Chevron's adjusted profits have declined much faster than that of Exxon's. As a result, Chevron's average debt-to-EBITDA ratio is more than double that of Exxon's. This indicates that the company's ability to meet its debt obligations has deteriorated over time, and is much lower than Exxon's ability to repay its debt.
Interest Coverage Ratio
Lastly, we talk about the interest coverage ratio, which shows a company's ability to fulfill its interest obligations. A higher interest coverage ratio implies a higher ability to meet the interest payments. Since the long-term debt of both the companies has gone up sizeably in the last two years, their interest payments has also increased significantly. For instance, Exxon Mobil's interest expense has increased from around $300 million to about $500 million in a span of two years, while Chevron, which did not have any interest obligations until 2015, paid an interest expense of nearly $200 million in 2016.
To add to this, the profitability of the two firms has suffered drastically due to the commodity downturn. In fact, Chevron made an operating loss of around $100 million in 2016, as opposed to a profit of $33 billion in 2014. Similarly, Exxon's recorded adjusted operating profits of $12.6 billion in 2016, almost 80% lower compared to the profits generated in 2014. The reduction in their profitability implies that their ability to service the interest obligations has come down notably, which is evident from their interest coverage ratio. While the interest coverage of both the companies has dropped drastically, Exxon still continues to make operating profits, and thus, has a higher ability to meet its interest obligations. In contrast, Chevron may not be able to meet its interest expenses from its operational profits, which poses a risk to its debt-holders, if the commodity prices do not recover soon.
Based on the discussion above, we believe that despite rising debt and declining profitability, Exxon continues to hold a stable capital structure and is operationally sound to repay its long-term obligations. In comparison, Chevron has a levered balance sheet, and could run into the risk of defaulting on its debt repayments, if the commodity slowdown persists longer-than-expected.
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