There’s Big Value in Big Oil: Exxon, Chevron, BP
Investors have been rather optimistic on the prospect of American companies going forward. This is evidenced by the historically lofty valuations we see in the S&P 500. In the aggregate, the S&P 500 trades at over 20-times trailing earnings, over 4.5-times book value, and with a dividend yield of less than 1.9 percent. Historically, stocks have been strong buys when we reach a valuation about half of this level, or even lower.
However, there is one sector that does trade at a compelling valuation for long term investors — large integrated oil. The large integrated oil companies are Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), BP (NYSE:BP), and Royal Dutch Shell (NYSE:RDS.A). These companies trade with an average P/E ratio of about 10 and they have a dividend yield ranging from 2.6 percent at the low end (Exxon Mobile) to around 5 percent at the high end (Royal Dutch Shell.)
There is no doubt that these companies have problems, most notably a lack of near term growth and difficulty replacing reserves. Furthermore, BP has the added stigma of the Gulf oil spill. Nevertheless, for the most part, these companies have done a solid job of generating shareholder value for long-term investors.
Given their shareholder friendly policies and their relatively attractive valuations, I think that these companies make excellent long-term investments, especially for risk averse investors and for retirees. Let us take a look at each of them to highlight the advantages and disadvantages of holding them.
Exxon Mobil is the largest of these companies. It is also in many ways the most expensive, trading at over 2-times book value and at nearly 13-times earnings. This is still inexpensive when compared with the S&P 500. Exxon trades at a premium to its peers for several reasons. First, it buys back a lot of its own shares; $16 billion worth in the past year and $70 billion worth in the past 4 years. As investors value the company’s shares, they take into consideration that future earnings will be distributed among fewer shares and this makes future earnings more valuable on a share by share basis. While some investors complain that the company has too little growth relative to its peers, we need to keep in mind that on a share by share basis this isn’t the case, and this is due to the company’s large buyback.
Second, the company is the best allocator of capital in the industry, with a high double digit return on investment ratio. This makes Exxon the most conservative of these investments insofar as it will only make investments if it believes it can achieve a high return. Given these points, Exxon may be the best of the large oil companies.
Chevron, the other American oil giant, is often preferred by investors given its lower P/E ratio of around 10 – 11, and its larger dividend yield of 3.4 percent. It also trades at less than two times its book value. Finally, the company is growing its production slightly while its peers have stagnated for the time being. However, given Exxon’s large share buyback, I think in the long run that on a per-share basis Exxon will grow production more quickly. Chevron is a little bit more aggressive with its investment capital and so it returns less capital to shareholders than Exxon. Nevertheless, it still has a nice buy-back program that is growing, having reached $4.5 billion in 2013. Ultimately, on a quantitative basis, Chevron seems to be the less expensive investment of the two American oil companies. However, while I own both, I prefer Exxon given its history of generating shareholder value and given its prudent capital allocation strategy.
BP on a quantitative basis appears to be the cheapest stock I mention here. While its trailing earnings are skewed by asset sales and actually aren’t that great, its forward earnings are expected to reach around $15 billion giving it a forward P/E ratio of just 9. Furthermore, the company pays an enormous dividend of 4.75 percent, which is well more than twice that paid by the S&P 500. The company has plans to increase production with $25 billion budgeted for capital expenditures this year. Given these points, BP appears to be incredibly attractive.
However, there is still fallout from the Gulf of Mexico oil spill a few years back. There are numerous civil lawsuits that could end up costing the company billions. With this in mind, a lot of investors have stayed away from the stock, including myself. Nevertheless, this issue is quickly becoming a distant memory and the company has reinstated its dividend, and it has more recently instituted a share repurchase program. With this in mind, BP shares are certainly worth considering, although risk-averse investors should stick with BP’s American counterparts.
Royal Dutch Shell is arguably the least attractive of the major oil companies. The company has seen its margins shrink and it has not seen production growth. For this reason, the stock trades at 13-times trailing earnings, which is the highest of the companies I mention here. However, the company’s margins are expected to rise and it trades at 10.4 times 2014’s expected earnings. Furthermore, while it does pay a large dividend of 5 percent, it hasn’t been buying back stock, which is something I like about the company’s American and British counterparts. However, there are things to like about Shell. Given that the shares trade at 1.25-times book value, there is a lot of room for upside price action.
We also see that the company is heavily involved in ethanol, and it has a large deal in place with the Brazilian ethanol and sugar based fuel producer Cosan (NYSE:CZZ). With the price of sugar so low at just $0.17/lb., there is a lot of potential to generate an inexpensive fuel that can compete with gasoline, and Shell will be a major beneficiary of this. But despite what the company has going for it, investors need to keep in mind that Shell has been an underperformer, and this suggests to me that this might not be a management team worth betting on.
Ultimately, I think there is a lot of opportunity in the big integrated oil companies. These stocks are simply too cheap, and I struggle to understand why these stocks trade at such depressed valuations when we have other low-risk dividend paying companies trading at 20 – 25 times earnings such as, for instance, Procter & Gamble (NYSE:PG). Therefore, I think investors looking for low risk long-term opportunities with predictable, yet sizable returns should consider taking a position in one or more of the big integrated oil companies.
Disclosure: Ben Kramer-Miller is long Exxon Mobil and Chevron.