Petro Research

Exxon Mobil Corporation NYSE:XOM Valuation Analysis

Sanan Juneja, sjuneja@wustl.edu Grandhis Harumansyah, g.harumansyah@wustl.edu Ahmad Aldarrak, aldarrak@go.wustl.edu Investment Recommendation: BUY XOM NYSE (12/2/12) 52 week range Avg Daily Trade Volume Revenue (2012 Est.) Market Capitalization Share Outstanding Book Val. per Share (12/12) Ratios Dividend Yield Return of Equity Return on Assets Return on Sales Asset Turnover Industry $ 88.14 $77.13-$93.67 12,803,000 $ 447,832,000,000 $ 401,860,000,000 4734M $36.56 Firm 2.5% 27.5% 13.2% 9.6% 1.4x Comp. Ave. 3.2% 17% 8.02% 5.6% 1.2x

Gu Yuan, ygu23@wustl.edu Xinning Yang, xinning@wustl.edu Dec, 3 , 2012 EPS Forecast FYE 12/30 2010A 2011A 2012E 2013E EPS $6.24 $8.42 $7.91 $8.24 Est. 5 Yr. EPS Grow. Rt. 3.2% Ratios Forward P/E Forward PEG M/B Firm 11.11 3.7 2.41 Average of Competitors 8.83 2.94 1.4
rd

Valuation Predictions Actual Current Price P/E Valuation FCFE Valuation EBITDA Valuation Performance of KO Trailing Return on Exxon Return on S&P 500 Return on Competitors

$ 88.14 $ 90.91 $ 97.60 $ 71.00

Oil and Gas Integrated

6 mo 13.12% 10.81% 10.76%

12 mo 24 mo 9.56% 23.8% 13.82% 15.63% -1.1% 11.29%

Assigning a rating of market outperform on Exxon Mobil at its current price of $88.14 and a 12-month target price of $97.6 (based on FCFE valuation) Exxon Mobil continues to outperform the industry average operation margin with a 9.6% NOPAT margin. After the recovery from the financial crisis, the sales growth is likely to slow down and remain in the 3%-5% range. Exxon Mobil remains the leader in the amount of oil reserves, and has a healthy number of long-term upstream projects to replace the oil produced. The focus on the natural gas by the acquisition of XTO is likely to low profitability, at least in the short-term, due to low prices. Higher dependence on unconventional oil fields and the additional difficulty of discovery and exploration are likely to reduce profitability in the long-term.

Rating System: BUY: A purchase recommendation with above average long-term growth potential. MARKET PERFORMER (HOLD): A recommendation to maintain current positions with returns to match that of the market. SELL: A recommendation to sell the security (or short the security) as it is expected to decrease in price in the medium term.

Industry Overview Exxon Mobil is multinational Oil and Gas Corporation that emerged as the resulting company of the 1999 merger between Exxon and Mobil. The company is one of a handful of firms, Big Oil, that run operations encompassing the whole petroleum industry value chain. The main component of the oil industry is the upstream sector, which includes the exploration of potential oil and gas fields, in addition to drilling and extracting the crude oil and natural gas. The other industry component is the downstream sector, in which the firms transfer and refine the extracted oil and gas, in addition to the distribution of the by-products, such as gasoline, diesel and lubricants, to the retail level. Some of the major oil firms also have a petrochemical component that produces plastic bottle, rubber and various other consumer goods. The five big oil companies, along with their revenues, are shown in the following table. Table 1 Total Revenue of the Five Major Oil Firms
ExxonMobil Chevron BP Royal Dutch Shell ConocoPhillips 2007 404.5 220.9 291.4 355.8 194.6 2008 477.3 273 365.7 458.4 246.2 2009 310.6 171.6 246.1 285.1 152.8 2010 383.2 204.9 308.9 378.1 198.6 2011 486.4 244.4 386.4 470.2 251.2

Due to the commodity nature of oil and gas, the oil companies have very little differentiation power in their strategy. For this reason, all the five major oil firms are price takers and their revenues and earnings strongly follow and correlate with oil prices. The downstream segment of the industry can suffer from high oil prices because it has to either transfer the cost to the consumer, or absorb the cost through lower margins. The Upstream, on the other hand, has relatively stable cost, and it profits the additional increases in oil prices. One of the key metrics in analyzing the performance of an oil firm is the oil reserve measured in BOE (Barrel of Oil Equivalent), as it allows the firm to enjoy economies of scales through larger production volume. Another key metric is the production replacement rate, which is the amount of oil reserve added over the amount of oil produced. The replacement rate is important because it supports the long-term growth of the firm. In addition to the oil reserve, the type of the oil field plays a role on efficiency of the production, because extracting crude oil from unconventional oil fields is more difficult and risky, and less profitable, than conventional fields. To maintain a healthy oil reserve, oil firms spend capital expenditure on finding new oil fields to replace the oil produced. Over the years, CapEx spending has been relatively stable even when the oil prices were very volatile. This is the case because it can take 5-10 years from the discovery of the oil area, to the beginning of the production. This makes the CapEx spending more tied with the long-term view and less tied with short-term price fluctuations.

Strategy Analysis Summary of global energy outlook (2010-2040): As worlds population grows to nearly 9 billion people in 2040 compared to 7 billion in 2010, global energy demand will be about 30 percent higher in 2040 compared to 2010. Energy demand growth is predicted to be slowing down as economies mature, efficiency gains accelerate and population growth moderates. In the developed countries belonging to the Organization for Economic Cooperation and Development (OECD) including countries in North America and Europe energy use is predicted to be remained essentially flat, even as these countries achieve economic growth and even higher living standards. In contrast, Non OECD energy demand will grow by close to 60%. Chinas energy demand will continue to increase over the next two decades then gradually flatten as its economy and population mature. In the rest of the world, billions of people will be working to advance their living standards, hence increasing the energy demand. Energy analysts also predict that the need for energy to make electricity will remain the single biggest driver of demand. By 2040, electricity generation is predicted to account for more than 40 percent of global energy consumption.
Graph . Electricity Generation by Fuel

As can be seen in below graph, coal usage throughout the world will peak and begin a gradual decline, partly because of emerging policies to control emissions by imposing a cost on highercarbon fuels. The use of renewable energies and nuclear power will grow significantly. Oil, gas and coal are predicted to continue to be the most widely used fuels, and have the scale needed to meet global demand, making up about 80 percent of total energy consumption in 2040.
Graph . Global energy demand by fuel type.

The consumption of natural gas will grow fast enough to overtake coal for the number-two position behind oil. Demand for natural gas will rise by more than 60 percent through 2040. For both oil and natural gas, an increasing share of global supply will come from unconventional sources such as those produced from shale formations. Gains in efficiency through energy-saving practices and technologies such as hybrid vehicles and new, high efficiency natural gas power plants will temper demand growth for fossil fuel product (mainly oil) and at the same time will most likely curb emissions. Eventually, the global energy transition in from 2010 to 2040 is expected to be as follow:

Graph . Global Fuel Mix

Exxons Corporate Strategy in response to the fore-mentioned energy outlook: Exxons growth mainly depends on their successes of finding new reserves to replace the used reserves from their existing oil fields. The growth also mainly affected by the demand for energy. Exxons internal projection forecast worldwide energy demand is rising by 20% from 2010 to 2025, but by only 10% from 2025 to 2040. Exxon also projects that energy demands will grow more diverse and not only depends on the oil consumption as technologies advances. The main candidate for replacing the current widely-used coal is gas because gas is less pollutive and can be converted into liquid to substitute the oil.

In the past 15 years, Exxon have spent more than $10 billion to expand their refining and petrochemical production in Singapore due to logical expectation that the economic growth across the Asia Pacific region will continue to spur demand for transportation fuels and the chemicals used for plastics and other manufacturing.

Exxon also invested in Qatar Petroleum to develop the natural gas reserves there and also decision to acquire XTO Energy in 2010. At the same time, Exxon also continually invests in the production facility to increase the clean diesel production capability in US and Europe.

To maintain growth in their proven oil reserves, Exxon also investing in oil sands, deep water and Arctic production, and also exploring the oil and gas supplies found in shale rock formation. To support the effort in finding new reserves both for oil and gas, Exxon spent a significant amount of capital expenditure in research & development for new methods of drilling and the new technology to revitalize old oil-fields. In essence, Exxon expanding its exploration process to various places in every corner of the world, and also put a big interest in exploring the deep sea reserves. Financial Analysis I. Financial Summary To analyze Exxons efficiency as a good investment choice, we use following ratios in the chart as benchmarks to understand its recent performance since 2008 crisis. Table ExxonMobils Financial Summary

Financial Summary - XOM

Fiscal year Sales (MM) Growth NOPAT (MM) NOPAT Margin Net Income (MM) NI Margin EPS Growth Free Cash Flow to Equity ROE 2011 433,526 1.27 86,751 20% 41,060 9% 8.42 1.35 24,370 27% 2010 341,578 1.24 71,709 21% 30,460 9% 6.22 1.56 21,542 26% 2009 275,564 0.65 54,912 20% 19,280 7% 3.98 0.46 5,947 16% 2008 425,071 1.19 95,993 23% 45,220 11% 8.69 1.19 40,407 35%

Graph ExxonMobils Financials 2008-2011

Margin
25% 20% 40%

ROE
30% 27%

20%
15%

10% 5% 0%

9%

20%

10% 2011 2010

NOPAT Margin

2009
NI Margin

2008

0% 2011 2010 2009 2008

EPS
10
8 8.42

Free Cash Flow to Equity

40,000 30,000 24,370

6 4 2
0 2011 2010 2009 2008 20,000 10,000 -

2011

2010

2009

2008

Exxons NOPAT margin was steady compared to its revenue volatility. This is due primarily to o il price growth and its managements cost reduction initiatives. Both ROE and EPS indicate Exx on was in recovery and its profitability is closing to its pre-crisis level. The increase of FCFE refl ects Exxons value in in an upward trajectory, which will be positive sign to both current and pot ential stockholders. II. Decomposing ROE

Table ExxonMobils ROE Decomposed

XOM ROE OpROA
NOPAT/Sale Sales/NOA

2011 27% 28% 10% 2.9 -1% 47% (0.01)

2010 26% 29% 9% 3.2 -3% 33% (0.08)

2009 16% 22% 7% 3.1 -6% 24% (0.26)

2008 35% 47% 11% 4.5 -12% 47% (0.26)

Fin. Lev. Gain

Spread ND/E

Graph Financial Performance Across Competitors

ROE
40% 30% 20% 10% 0% -10% -20%
XOM BP CVX COP

OpROA
55% 45% 35% 25% 15%

2011

2010

2009

2008

5% -5%
-15%
XOM BP CVX COP

2011

2010

2009

2008

NOPAT/Sales
15%
10%

Sales/NOA
4.0
3.5 3.0 2.5

5%
0% 2011 -5% 2010 2009 2008

2.0
1.5

-10%
XOM BP CVX COP

2011
XOM

2010
BP

2009
CVX COP

2008

Fin. Lev. Gain

5% 0% 2011 -5% -10% -15%
XOM BP CVX COP

Spread
40% 20%

2010

2009

2008 0% 2011 -20% -40%

XOM BP CVX COP

2010

2009

2008

ND/E
0.50 0.30
0.10 (0.10) (0.30)
XOM BP CVX COP

2011

2010

2009

2008

From the previous graph, it was clear that Exxons OpROA 28% was primarily driven by its relat ive high NOPAT margin 10% and its faster net operating assets turnover ratio 2.9, which combin ed to suggest it has a decent profitability and the management well managed its assets.

The -1% financial leverage gain was somewhat complicated. On the one hand, Exxon s 47% spre ad was due to its higher ROA and lower cost of debt. On the other hand, the -1% net debt to equi ty ratio suggests Exxon holds relative high level of cash. But it was the highest ratio since 2008, which suggests the management was trying to optimize its capital structure. III. Competitive position

Mapping PE and ROE ratio for Exxon and other three competitors in chart below, we found that Exxons higher ROE demonstrated its completive advantage, and its value was recognized by the market, giving the highest PE ratio among rivals. Meanwhile, Exxons size by revenue is the lar gest in the oil and gas industry. Graph 5 Major Oils PE VS. ROE positions
12 11 10
P/E

9 8

7 6
5

0.15

0.17

0.19 ROE
XOM BP

0.21

0.23

0.25

0.27

0.29

CVX

COP

Accounting Analysis 1. We identify critical accounting assumptions based on the Exxons 10K (2012), and we think E xxon has a conservative accounting policy. As the largest energy corporation, the key issue in the accounting process in Exxon is the capital & operating asset evaluation and revenue records. 1) Oil and gas reserve Evaluations of oil and gas reserves will affect upstream business. It is important to making invest ment decisions such as whether development should process or not. Also, it is used to calculate u nit-ofproduction depreciation rates and for evaluating impairment. In Exxon, reserves included 2 areas : proved or unproved. Proved reserves can further divide into developed and undeveloped. Exxon reports proved reserves on the basis of the average of the first-day-of-themonth price for each month during the last 12month period. The estimation of proved reserves, which is based on the requirement of reasonabl e certainty, is an ongoing process based on rigorous technical evaluations and several other techn iques. Furthermore, the Corporation only records proved reserves for projects which have receive d significant funding commitments by management made toward the development of the reserve s. An asset would be impaired if the undiscounted cash flows were less than the assets carrying val ue. Significant unproved properties are assessed for impairment individually. The Corporation do es not view temporarily low oil and gas prices as a trigger event for conducting the impairment te sts. 2) PP&E Depreciation, depletion and amortization of asset are usually determined either under unit-ofproduction method or straightline method, based on the cost minus estimated salvage value. Maintenance and repair cost are e xpensed as incurred. Major renewals and improvements are capitalized and the assets replaced ar e retired. 3) Revenue and inventory recognition The Corporation sells crude oil, natural gas and petroleum and chemical products under shortterm agreements at prevailing market prices. It also has longterm contracts with periodical price adjustments. Revenue will be recorded when delivered. 2. Operating Cash Flow and Net Earnings XOM-US's accruals over the past five years are positive suggesting a buildup of reserves. However, this level of accruals is also around the peer median and suggests the corporation is recording a proper level of reserves compared to its peers (Royal Dutch Shell PLC, Chevron

Corp, BP PLC, Total S.A, China Petroleum & Chemical Corp, Occidental Petroleum Corp and Conoco Phillips).
70,000 60,000 50,000 40,000 30,000 Net Earnings CF from Operations

20,000
10,000 2007 2008 2009 2010 2011

Table Exxons CF from Operations & Net Earnings

Table Exxons Annual Accruals (% Revenue) and Peer Median 1

3. Turnover analysis Selected Financial Data (USD $ in millions) Dec 31, 2011 467029 15024 306802 38642 69794 Dec 31, 2010 370125 12976 233751 32284 59846 Dec 31, 2009 301500 11553 185833 27645 49585

Sales and other operating revenue Inventories COGS Accounts Receivable Accounts Payable

Inventory Turnover (a) Exxon Mobil Corp. 31 28 26 Industry, Oil & Gas 16 14 13.19 Receivable Turnover (b) Exxon Mobil Corp.1 15 14 13 Industry, Oil & Gas 11 10 9 Payble Turnover (c) Exxon Mobil Corp.1 14 12 12 Industry, Oil & Gas 11 10 10 Table Turnover Analysis of Exxon and Oil&Gas Industry (a) Inventory Turnover = Sales/Inventory (b) Receivable Turnover = Sales/Accounts Receivable (c) Payable Turnover = Sales/Account Payable (Note: We did not use COGS as denominator due to lack of information about Industrys COGS, and we think replacing by sales number could also reflect the relative companys operating position.) Compared to the OIL & Gas industry average ratio, EXXON has relative healthier turnover ratio s. It has a shorter cash conversion cycle as below. We think this is because economics of scales. 2011 2010 2009 Exxon Mobil Corp 9 8 12 Industry, Oil & Gas 23 26 30 Table Cash Conversion Cycle Based on the analysis above, we think Exxon has a conservative accounting policy, its financial statements could reflect the underlying business and operation. But problems might happen about the reserve prediction and it will cause a biased depreciation. Oil industry is a resource and investment intensive area, thus this problem will lead the cash flow deviate from the earnings.

P/E, Forward P/E and PEG Analysis Below is a summary of P/E (ttm = Trailing Twelve Months), Forward P/E (fye next closing date), and PEG Ratio (5 yrs. expected). Table 4 - P/E, Forward P/E & PEG ratio
XOM CVX RDS COP BP Peers Avg. Industry
Major Integrated Oil and Gas

Company Name Exxon Chevron Shell Conoco Philips BP.

Sales growth (yoy)

P/E Ratio (ttm)

Forward P/E

PEG Ratio

26.9% 24.6% 27.7% 31.4% 26.4% 27.4% 27.4%

9.32 8.67 6.76 6.99 7.56 7.49 4.2

11.11 8.65 N/A 9.80 8.05 N/A N/A

1.78 -4.34 N/A -0.81 4.30 N/A N/A

Source: Yahoo finance

We can safely assume that earnings of these companies are still in the recovery phase after being hit by global financial crisis in 2008. Across industry, sales growth rate experiencing a high positive percentage during 2009 and 2010, but started to level in 2011 and 2012. We think that this might be one of the reasons why some of the companies experiencing some gaps between ttm P/E ratios and expected forward P/E, which can also be assumed that there are mispricing problems by due to the slowing down in market condition. XOMs PE which is 9.32, is the highest compared to its peers. We believe that this is as the result of exceptional sales growth during 2009 and 2010, which on average reaching 25%. But we also think that this high P/E might not be sustainable because XOM had stated previous couple of years exceptional growth was because the market was catching up the lag that it experienced during the recession. Below is XOMs 5 year P/E history. We believe its highest P/E had been reached in 2010. In the future, we think that Exxon would not be able to reach that level again mainly due to the fact that the competition is becoming more intense in securing new oil reserves. We also think that the shift in energy consumption towards a less -carbon-print fuel (Gas and liquefied gas) would also depress XOM earnings going forward.

Graph 6 - XOMs 5 year P/E history

Source: http://ycharts.com/companies/XOM/pe_ratio

XOMs PEG ratio XOMs PEG ratio is not the lowest amongst its competitors, but also not the highest as well. We believe that XOMs PEG ratio still represents its capability to grow amidst the fierce competition. We can also see that some of its competitors actually have a negative PEG which means that in the coming years they predict a shrinkage in their businesses. Valuation Analysis Multiples Valuation PE Valuation With a PE ratio of 9.6 for the industry, and an EPS of 9.47 for Exxon Mobil, we get a PE valuatio n of $90.91 for Exxon Mobils stock price. EBITDA Valuation With a 4.04 EV/EBITDA multiple in the oil industry, and an EBITA of $89 billion for Exxon Mo bil, we get an Enterprise Value of $359 billion, which means an equity value of $336 billion. The resulting stock price is $71.

Cost of Equity We used a 2-years beta of 0.7689 instead of the historical to reflect the recent risk of the industry. With a free risk rate of 1.7% and a market risk premium of 7.5%, we get a cost of equity of 7.47%. Sales Growth Exxons growth rate has fluctuated a lot in the past few years, especially in 2009, primarily because of the recent economic downturn. We believe that Exxons high growth in the past two years is mainly a recovery from the 2009 dip, and is not sustainable. From 2012 earnings so far, it we expect the growth to be at 3%. Beyond that, we expect 4.5% growth rate that will converge to the worldwide economic growth rate (3%) over a time period of 10 years. Exxons management also testifies this assumption by discussing their expectations of worldwide economic growth rate in the most recent 10-K. Graph - Exxons growth rates
30.0% E x x o n ' s 20.0% G r o w t h

10.0% R 0.0% a t -10.0% e -20.0%

-30.0%

2003

2004

2005

2006

2007

2008

2009

2010

2011

-40.0%

Year

NOPAT Margin Over the past few years, ExxonMobil has been enjoying higher profit margins than the competition due to economies of scale and efficient operations. Going forward, however, we dont expect this advantage to remain in the long -term. The dominance of the oil industry by the national companies around the world makes the discovery of oil fields more difficult. In addition, the unconventional oil fields represent a large portion of XOMs oil reserve, making it more costly to produce in the future.

For these reasons, we project a NOPAT margin of 9.1% in 2012 (which is the average of the previous four years). And this margin decreases linearly until year 10 where it reaches 6.1%, a slightly higher margin than the current industry average. Net long-term assets to sales With increasing difficulty to explore new oil producing sites, we believe that the log -term assets to sales ratio would increase over the next 10 years. We believe that the past 4 years is not a good approximation of this ratio because of extremely low sales during the economic downturn. We decided that a 2% increase each year is a reasonable approximation. Valuation FCFE Approach Based on our projections for sales growth, operating margins, and long -term assets to sales, the free cash flows to equity are projected to remain stable for the next 5 years, and would gradually decrease after that. Our estimates lead to a stock price of 97.6 using the free cash flow to equity approach. Table 5 Exxons Valuation FCFE Approach

Discounted Dividend and Residual Income Approach Discounted dividend approach and residual income approach yield stock price of $43.60 and $45.3 respectively. We believe that this gives a pessimistic view of the company because it uses an average of dividend payout rates. Exxons dividend payout rates have had a huge amount of variability, the effect of which cannot be replicated by a constant dividend payout calculation.

Table Exxons Valuation - Dividend Discount Approach

Table Exxons Valuation Residual Income Approach

Sensitivity Analysis We did a sensitivity analysis around the two main variables that affect the valuation of the company: Sales Growth and NOPAT margin. In the FCFE analysis the sales growth ranges between 3% and 5%, while the NOPAT margin ranges between 6% and 9%. This table includes the stock price on various assumptions in these ranges. Table - Growth Rate VS NOPAT Margin Sensitivity Analysis
Growth Rate 3% 4.0% 5.0% $ 79.70 $ 76.40 $ 71.80 $100 $ 99.40 $ 97.00 $ 121.90 $ 122.50 $ 122.10 $ 143.00 $ 145.50 $ 147.20

NOPAT margin

6% 7% 8% 9%

Another crucial input to the valuation is the cost of equity. The following table shows the stock p rice given ranges of cost of equity between 6% and 9% Table 6 - Cost of Equity Sensitivity Analysis
Cost of Equity 6.00% 6.50% 7.00% 7.50% 8.00% 8.50% 9.00% Stock Price $ 140.10 $ 121.71 $ 107.86 $ 97.04 $ 88.35 $ 81.20 $ 75.22