Shares of integrated energy giant ExxonMobil (NYSE: XOM) have nosedived in 2020 as oil prices have plunged to historic lows. With the stock set to be booted from the Dow 30, is this the end of an era, or an investing opportunity for those willing to step in while others are fearful? Here's a look at some of the key risks to understand before making a final call on this oil company.
Let's get the biggest potential risk out of the way up front: An Exxon bankruptcy is highly unlikely in the near term. As it stands, the company has one of the strongest balance sheets of its integrated peers. Exxon's debt-to-equity ratio is roughly 0.38 times. Although Chevron's (NYSE: CVX) 0.25 times is lower, all of the European players have much higher debt-to-equity ratios. At the top end is BP at around 1.1 times. The truth is that 0.38 times is actually a fairly reasonable number, leaving Exxon with ample room on its balance sheet to handle more adversity.
Bankruptcy, however, is the worst-case scenario. There are a lot of things besides Exxon going belly up that can go wrong for investors.
2. A dividend cut?
Exxon has increased its dividend for over three decades. During Exxon's second-quarter earnings conference call management again reiterated the importance of returning value to shareholders via a stable and growing dividend. However, major energy industry peers like BP and Royal Dutch Shell have both slashed their dividends at this point, and it's hardly unreasonable for investors to think Exxon could end up following that trend. In fact, at this point, the company's commitment to the dividend is really the only thing keeping it at its current level. Exxon's cash flow isn't sufficient to cover its dividend payments right now.
Which brings the balance sheet back into play. Exxon's debt-to-equity ratio started the year at around 0.24 times. As oil prices and demand fell in the face of COVID-19-related economic shut downs, the company added debt to cover its material capital investment plans and the dividend. This is par for the course -- the oil space is highly cyclical and Exxon has used this tactic before. But there's a fly in the ointment. During the second-quarter conference call, management also hinted that it was unlikely to issue more debt. That limits the places where Exxon can find additional cash if it needs it. One easy way to free up capital is to cut the dividend, which costs Exxon around $3.7 billion a quarter and nearly $15 billion a year.
The dividend is likely safe for at least the rest of 2020. But after that point there's materially more uncertainty. If oil prices remain moribund, a dividend cut is not out of the question.
3. Is oil dead?
As noted, Exxon is currently in the middle of a large capital investment program driven by weak production numbers in the past few years. There's a bigger takeaway here, in that Exxon is basically doubling down on oil at a time when peers, like Shell and France's Total (NYSE: TOT) have been pivoting toward electricity. The logic of that shift is pretty simple: Carbon-based fuels are being replaced by cleaner options, impacting everything from transportation to utility-level electricity generation. Exxon, however, has stressed that energy transitions have historically taken a long time and that oil will remain an important energy source for decades to come. This take is backed up by the International Energy Agency's long-term outlook -- even in a scenario where carbon emission reductions are a global focus.
And yet oil prices literally fell to zero in the early part of 2020, hinting that things aren't right in the energy space. The fact that oil drillers, for a brief moment, were paying customers to take their oil is frightening. However, prices are back up to the $40 per barrel space, suggesting that the near-term demise of oil is greatly exaggerated. As a commodity, oil is subject to supply and demand, with the current low prices (driven by COVID-19 demand dislocations) causing a material shakeout in the industry. Many exploration and production companies, especially in the U.S. onshore space, have filed for bankruptcy. Eventually, though it might be painful, supply and demand are likely to balance out again. Financially strong Exxon will be positioned to benefit when that happens. For investors who are bearish on oil, however, Exxon's decision to redouble its efforts on black gold should be very worrisome.
The risks are increasing
There are some very material risks to consider when looking at Exxon and they are hard to quantify. While it is unlikely that Exxon is going to go out of business anytime soon, lingering low energy prices could lead to a dividend cut. And the oil space, which is what drives the company's top and bottom lines, is clearly in flux today. Exxon, once a stock appropriate for conservative investors, doesn't have quite the same risk profile as it did just a few years ago. If you are looking at the company's hefty 8% yield, you will want to think carefully before jumping aboard this name today. You might be better off with Chevron, which is on stronger financial footing, or Total, which is diversifying its business by adding electricity assets to its portfolio.
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