Monday, April 20, 2015

This Too Shall Pass: Investment in the Integrated Oil Majors

There's been plenty written already about the decline in oil prices over the last 9 months or so. The per barrel price of oil has declined from $98.70 in June 2014 to $51.77 as of Friday's close. That's a 47.5% decline from the peak last year. This has caused plenty of investors to worry about the viability of the oil and gas sector for investment. Exploration and production companies have announced declines in capital expenditures around 15% and there's a high likelihood of more to come.

We haven't begun to really see the effect on earnings for the integrated majors yet, but will start to see the results later this month when both ExxonMobil (XOM) and Chevron (CVX) report Q1 earnings. For the integrated oil and gas majors this isn't the first decline in oil prices that they've had to navigate through.

Oil, like most commodities, is a rather cyclical beast. In 2002 we saw a cyclical trough that brought the price of oil down to $15.89. The subsequent peak in 2008 saw the price of oil increase to $128.08. The Great Recession brought about another trough in 2009 which saw prices of $34.14 and the last peak was in 2011 at $108.80. Per barrel oil prices are sourced from the U.S. Energy Information Administration website which be found here.

Too often the recency bias takes hold and we project the current condition to continue on into the future. With cyclical commodity based companies it's important to look at the growth of companies across a wide range of scenarios. If you only compare a peak of a cycle to the next trough, then of course the numbers will look bad. So we must look at how both ExxonMobil and Chevron fared on a peak to peak and trough to trough basis to get a real feel for the power behind these companies.

First let's look at XOM. In 2002, cyclical trough, XOM earned $1.61 per share. By the peak in 2008, XOM's earnings had jumped to $8.69. There was another trough in 2009 which saw XOM's earnings decline to $3.98 per share and the subsequent peak in 2011 saw earnings rebound to $8.42 per share.

ExxonMobil's CAGR of EPS
Trough-Peak (2002-2008)32.44%
Trough-Trough (2002-2009)13.80%
Trough-Peak (2009-2011)45.45%
Peak-Peak (2008-2011)-1.05%

The only scenario that is bad out of that bunch is the peak-peak. Part of that is probably explained by the price of oil being higher at the peak in 2008 compared to the peak in 2011. All of the other scenarios look outright fantastic.

As a dividend growth investor, the dividend is also of utmost importance. The following table shows XOM's dividend payment for the years in question as well as for 2003 and 2010 which were the first year after the cyclical troughs were reached.

ExxonMobil's Historic Dividends
YearAnnual Dividends

The following table shows the compound annual growth rate of the dividend for each of the periods from above (trough-trough, trough-peak...) as well as the one year dividend growth following each trough.

ExxonMobil's CAGR of Dividends
CAGR of Dividends
Trough-Peak (2002-2008)9.08%
Trough-Trough (2002-2009)8.80%
Trough-Peak (2009-2011)5.57%
Peak-Peak (2008-2011)6.08%
Trough + 1 year (2002-2003)6.52%
Trough + 1 year (2009-2010)4.82%

You know what I see there? Dividends increasing across every scenario.

What about Chevron? In 2002, cyclical trough, Chevron had earnings per share of $0.54 and paid out $1.40 in dividends. In 2003, Chevron paid out $1.43 in dividends. By 2008, the next cyclical peak, earnings had recovered to $11.67 and Chevron paid out $2.53 in dividends. The Great Recession in 2009 brought another cyclical trough and Chevron's earnings dipped to $5.24 and they paid out $2.66 in dividends. In 2010, Chevron paid out $2.84 in dividends. The next peak came in 2011 with earnings rebounding to $13.44 and dividends were $3.09.

Chevron's CAGR of EPS
Trough-Peak (2002-2008)66.90%
Trough-Trough (2002-2009)38.35%
Trough-Peak (2009-2011)60.15%
Peak-Peak (2008-2011)4.82%

Chevron showed solid earnings growth across all the time periods including the peak-peak scenario that ExxonMobil saw a slight decline in.

Chevron's CAGR of Dividends
CAGR of Dividends
Trough-Peak (2002-2008)10.37%
Trough-Trough (2002-2009)9.60%
Trough-Peak (2009-2011)7.78%
Peak-Peak (2008-2011)6.89%
Trough + 1 year (2002-2003)2.14%
Trough + 1 year (2009-2010)6.77%

Once again we see that the dividend has continued to grow each and every year. The lowest increase was just 2.14% for the trough + 1 year scenario covering 2002-2003.


It's important to remember that this is just a historical look at the performance of two of the integrated oil majors. History is a guide, but by no means is it a path that's set in stone.

Chevron recently announced that the share buyback program would be suspended because the dividend is the top priority for them as a means to reward shareholders. Future share buybacks were not out of the question should conditions improve later this year.

Forecasts for a rebound in the price of oil are very uncertain. Some are expecting a "V"-shaped rebound with prices rising fast over the coming months. Others see the price of oil slowly climbing over the next 6-12 months. If you believe the long-term trend, as I do, is for the price of oil to trend higher then both ExxonMobil and Chevron are potentially attractive purchases. They both have global exploration and production operations as well as refining operations that help to diversify their income sources.

Both ExxonMobil and Chevron have kept their balance sheets clean, so if we see a prolonged slump in oil prices they have room to leverage up by taking on debt. ExxonMobil's debt to equity ratio sits at 0.07 as of the end of 2014 and Chevron's is at 0.16. Ideally the increase of debt would not be required, but both companies have kept themselves in excellent financial health if it's needed.

While I expect dividend growth for both ExxonMobil and Chevron to be relatively lackluster when they announce increases later this month, I do expect raises from both of these giants. The dividend increases will most likely be small when announced for this year, but with a long term investment horizon both companies have historically rewarded shareholders with high single digit growth as the next boom takes hold. As dividend growth investors that's all we are really concerned about.

Both ExxonMobil and Chevron will get through this low oil price environment just fine and most likely stronger on the other side and continue to pay increasing dividends. Last week, Shell (RDS.A) announced plans to acquire BG Group (BRGYY) for $70 Billion. I expect that Chevron and ExxonMobil are both on the lookout for potential acquisitions of their own of companies that aren't built to weather the current oil price environment as well as these two.

Eventually the tide will turn on oil prices and it may have already started as prices have stabilized and trended higher over the last three months. When investing in commodity based cyclical companies we must take a long term look at the investment prospects and avoid projecting the recent history out into the future forever. That goes for both the troughs and the peaks.

Both companies are strong enough to ride out the storm in the event that a prolonged slump in energy prices occurs. With the potential for acquisitions, oil prices normalizing over time, and most assuredly dividend increases coming later this month I feel that both ExxonMobil and Chevron are attractive long term investments at current prices.

Personally ExxonMobil is higher on my list of purchase due to my current portfolio construction, but I would have no qualms adding to my position in Chevron as well, as capital permits. I have no doubts that both ExxonMobil and Chevron will announce dividend increases this year.


  1. JC,
    Nice analysis. I'm long XOM and CVX since they are about as safe as you can get in the oil majors. I also have a more speculative position in BP which might prove to be a great investment or a poor investment; time will tell.
    Take care,

  2. From a qualitative side of analysis, I feel like the larger oil players are all down but ready to rebound once oil goes back up again. Same for any of the large companies that provide instrumentation or automation solutions to oilfields. Either way, I would buy energy stocks right now, but I just bought some PM the day before earnings were announced.


  3. Great analysis, JC. I love the comparisons between the two and the trough-peak, trough-trough and peak-peak comparisons. Really puts a great perspective on where things stand over the long term in the cycle.

    I should revisit and see if I want to add to my CVX position again. A bit heavy on energy, Ive been looking elsewhere for putting my capital to work.


  4. Thanks for taking the time for this analysis. Iike them both. Hope we'll see better pricing from both of them so we can add. Take care JC.

  5. JC,

    Excellent analysis, great job! And thank you for sharing it with us.

    Many people seem to think that businesses work on a year-to-year basis with only current cashflow and earnings determining the dividend payout ratio, but a good management maintains the dividend even through a downturn. If they manage to grow earnings during an entire economic cycle and not cut the dividend, you know they've succeeded.

    Chevron's growth rate is particularly impressive, I can imagine why you wouldn't mind a larger stake in that company! For now I'll remain with BP, RDS and Total as I'm already heavy on dividends from oil.

    Best wishes,