Dueling Fools
Exxon, Exxoff
February 3, 1999

Exxon Bull's Pen
by Yi-Hsin Chang ([email protected])

Anyone who drives a car or pays minimal attention to the sign when passing a gas station knows that these days gas is cheap. A gallon of gas, in this country at least, has long been less expensive than a bottle of Evian. But now you pay more for a gallon of distilled water than you would for a gallon of unleaded gasoline.

This is great for consumers, but not so great for oil companies like Exxon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XON)") else Response.Write("(NYSE: XON)") end if %>, which as a result of historically low oil prices, just turned in fourth quarter earnings per share that were about 30% lower than the year before and 1998 full-year earnings that were down 21% from 1997.

As illustrated by this chart, Exxon's stock price has suffered from the company's four straight quarters of earnings decline and lagged behind the S&P 500 performance for the overall period. Though it's a prettier picture than charts for such rivals as Texaco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TX)") else Response.Write("(NYSE: TX)") end if %> and Chevron <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CHV)") else Response.Write("(NYSE: CHV)") end if %>, Exxon's one-year chart shows tremendous volatility unlike the more or less steady upward price movement in pace with the S&P 500 seen on its five-year and 10-year charts.

Before you turn your back on Exxon, let me say that there's definitely a silver lining in this dark cloud. Exxon and the major international oil companies are currently trading at an average price-to-earnings multiple of roughly 25. That represents a nearly 10% discount to the multiple for the S&P 500, which is all the more significant because the shares of these companies have traded at multiples in line with the S&P 500 for the past decade.

In other words, this is a great buying opportunity for Foolish (i.e., long-term) investors. And out of the major oil companies, Exxon is clearly the strongest and most well-positioned in these uncertain times, especially considering its proposed acquisition of Mobil <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MOB)") else Response.Write("(NYSE: MOB)") end if %>.

The merger, the biggest ever, will create the world's largest oil company, bigger than Royal Dutch/Shell (NSYE: RD & SC). Exxon Mobil, as the new company will be called, will have oil and gas reserves totaling more than 20 billion barrels of oil equivalent (versus 19 billion for Shell), produce oil and gas at a rate of 4.3 million barrels a day (compared with 3.7 million for Shell), and sell 8.4 million barrels of refined products a day (to Shell's 6.6 million). It will produce more crude oil than the country of Kuwait.

The companies expect "significant near-term pre-tax synergies of about $2.8 billion." Exxon, which has displayed an impressive record of shareholder returns -- total returns prior to 1998 have averaged 19% per year over two decades and 31% over the three years preceding last year -- will be able to use the combined assets to deliver increasing returns and growth while cutting operating costs. It's reassuring to note that maximizing shareholder value is explicitly stated as the guiding principle at Exxon.

What's more, there is remarkably little overlap between the operations of Exxon and Mobil. In fact, they actually complement each other. For instance, Mobil is an active oil producer in several geographically diverse areas where Exxon has no presence, such as California and Nigeria. Mobil will also bring with it its liquefied natural gas (LNG) business, another new area for Exxon. In addition, Exxon's strength in Russia will be complemented by Mobil's solid presence in the Caspian region.

Although Exxon has achieved high rates of return on capital on its own, this mega-merger with Mobil will give it added momentum for growth. The two will be able to weed out their weakest investments and focus on the best projects for maximizing growth and return on investment. Plus, the combined company will be able to leverage off the global recognition of the Exxon and Mobil names by continuing to use both brands on its products and gas stations.

The fourth quarter earnings just reported by the major oil companies further demonstrate why Exxon is head and shoulders above its peers. Yes, Exxon announced a 30% drop in Q4 earnings, but that's almost cause for celebration compared with the 80% decline at Texaco, the 63% fall at Chevron, the 79% decrease at Atlantic Richfield <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ARC)") else Response.Write("(NYSE: ARC)") end if %>, and the 100% reduction at Phillips Petroleum <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: P)") else Response.Write("(NYSE: P)") end if %>.

Indeed, bucking the industry trend of disappointing results, Exxon turned in Q4 EPS that was a nickel ahead of the First Call analysts' mean estimate, prompting Deutsche Bank Securities to raise its price target to $80 from $76 a share. As a Merrill Lynch bulletin pointed out: "The results were quite good considering how difficult the industry environment has been. Exxon's earnings trend has been better than that of its peer group in the last two years, and the shares have outperformed the sector as a result."

There's no question that crude oil prices are dismally low as supply continues to outstrip demand in large part because of weakness in Asia. But there are signs that the fever may be breaking on the Asian Contagion, and demand there may soon pick up. Merrill Lynch expects oil inventories will be significantly lowered in the next several months with oil prices recovering to the high teens this year. It's also projecting that earnings among the major oil companies will increase some 15% this year.

I should note that when we interviewed Global Marine CEO Bob Rose for StockTalk in September, he predicted the price of oil in 1999 would be around $20 a barrel. He added that as long as the price fell in the "ideal" range of $19 to $21 a barrel, "you get a really healthy, prosperous offshore industry."

Exxon is the stock to own in this beleaguered sector on the verge of a turnaround. Put a tiger in your tank -- and in your Foolish portfolio.