Tuesday, March 4, 2014

Dividend Growth Investment ExxonMobil

My first investment in this journey is the integrated oil major Exxon Mobil (XOM) - When I first made the decision to start investing, the first thing I did was get my hands on as many economic, political e sociological studies and forecasts. Among several analysis and conflicting predictions, there were two trends that emerged: The world population is forecast to increase and the demand for energy will increase significantly in the future (also a consequence of the first trend). Surprisingly, contrary to popular belief, this additional demand for energy is going to be supplied on its largest part by oil (providing a subtle growth in oil consumption compared to the present) followed by natural gas, which will experience the largest demand growth of all energy sources.

With this in mind I started by looking at the energy sector and noticing how beat up oil stocks are, mostly due to a combination of bad reputation and a falling profitability on exploring and extracting oil and gas. Seeing how many of the oil majors are dividend aristocrats that have been increasing their dividend uninterruptedly for 25 years or more and seeing how strong their balance sheets are: Negligible debt, high cash flows and low payout ratios, I definitely felt this was a good place to start.

If we look at oil majors short-term I would say they are not a very good investment as they are currently facing many headwinds and uncertainty with low oil prices, very weak refining margins, demand increasing extremely slowly and mostly very high exploration and extraction costs just to keep their reserves. 

However, in the long term, as energy demand increases and companies struggle with the costs of finding and extracting oil and gas, only two things can happen: Either the Upstream cost efficiency improves or the price of oil and gas rises. So, I think a long-term decision boils down to one question: Can oil companies survive the short-term massive amount of capital expenditure required for sustainable upstream operations? In my opinion, the answer would be yes, as these companies have great track records of capital management and capital allocation and with their low levels of debt, they could borrow to withstand the storm. 

Based on my analysis, I am looking for the following key aspects:

At least 2.5% dividend yield (roughly 150% of S&P500 average yield)
Dividend Growth of at least 25 years (considering maturity of companies operating in the oil industry)

Balance Sheet
Low debt
High Free Cash Flow (To support both CAPEX and dividend)
Fairly low payout ratio

Good return on equity over the last few years
Upwards trend on EPS (Earnings per share) over the last few years

Industry Specific
Strong balance sheet to be able to invest massively for long-term sustainable oil and gas reserves
Strong long-term natural gas position
International Presence
Stability (The lower the number of lawsuits and their respective risk, the better)
Integrated oil-major
Stable management

Looking at the biggest oil majors listed on the London Stock Exchange (LSE), there is Royal Dutch Shell (RDS.B) and BP (BP). Shell has shown managerial instability and terrible performance in 2013 seeing EPS drop massively. BP is still suffering aggressively from their latest oil spill, having to sell assets to stay afloat instead of investing in future oil and gas reserves.

This left the two biggest majors listed in the US: Chevron (CVX) and Exxon (XOM). On all the above criteria, I liked them both. What tipped the scales for me at the time was that Exxon is almost twice the size but has the same CAPEX as Chevron. Furthermore, Chevron had the Equador lawsuit which included the payment of big sums. 

So, Exxon seemed like the safest choice in this space and I went for it. Even though it's a very conservative play, it was the first stock investment of my life, the first baby step in the marathon, so I it was really quite thrilling. What about you, do you still remember the first stock you bought? 

Price per share: 100$
Dividend Yield: 2.6%

Note: Chevron's Equador lawsuit seemed more threatening in January when I made the purchase than it is now. At this point, I am more confident on Chevron's ability to either win or defer this indefinitely. In fact, I even acquired Chevron, which I will talk about in a future post.

1 comment:

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