Trends to watch:
•Oil, coal, natural gas and the companies that service them.
•Electric cars are inevitable as we have passed peak oil. BYD is the best play I know of there, but the shares are now overpriced.
•As oil rises AE will have a second wave in it's current growth path. Vestas wind and GE in turbines. STP is the lowest cost producer in solar. These are not recommendations, you should look and wait for good entry points if you are interested. Solar is the riskiest.
•The fall of the USD, especially against commodity based currencies like AUD.
•The final end of this commodity boom. Wealth is made the fastest on the way down.
I've reproduced the analysis that first was posted on the blog, as such, some of the prices obviously are a little out of date.
Certainly from the chart we can see that oil the commodity, fell to $20/barrel during the 2001-2002 recession. As this recession is likely to be both deeper and longer, holding off for the time being would be prudent. At some point however, a longer term investment within this sector is likely to pay off.
Year……………….%Capitalization…………S&P500……Compounded gain
1929…………………..8.48%………………..30.10
1932………………….10.86%………………..7.12
1949………………….16.0%………………..15.29
1982………………….12.6%……………….109.70
2008………………….8.53%……………….876.77
……………………………………………………………………4.36% [not including dividends]
The oil majors were always within the first three sectors and very often the largest sector within the S&P500; thus their growth has been consistent with both the market and the economy.
While by comparison other “major sectors” have faded through the years, automobile, aircraft, rails and a host of other sectors that have simply disappeared. While it is true that alternative energy must become a focal point, oil is critical to so many products that it’s ultimate demise will take time.
Inflation.
With the incredible monetary stimulus that is now worldwide, there will be inflation, and possibly a very serious out of control inflation. China, who has amassed some $2 Trillion in foreign reserves, predominantly denominated in USD, with a rapidly slowing economy, due to contraction in demand from both the US & Europe, will do what with them?
Looked at another way, China will not be amassing further reserves at the rate that they had been. Thus an immediate consequence will be a rise in interest rates across the part of the curve where China was accumulating US Treasury paper. Should they also start to sell reserves, to fund their economy in a Keyenesian manner, again, interest rates will rise across that part of the curve.
In an inflationary environment, the purchase a real assets and commodities can hedge the inflationary pressures providing real returns. Oil, although subject to any number of risks, political, war, terrorist, environmental and supply/demand shocks, still provides an attractive commodity to invest in.
Should the bear market deepen, where would the likely purchasers come from? For the actual commodity, oil itself, the buyers would have to be the economies themselves, in the form of products, be that energy generation or as a component in product manufacture. With a recession of potential depth forming, economies could well cut back for the indeterminate future.
With equity, the buyers might likely be corporations themselves. In an inflationary environment, rising prices of land, plant, reserves, and other input costs, rise with inflation. The price of equity however tends to fall, thus making it cheaper to consolidate, rather than expand.
Therefore, in an inflationary environment, it would be more rational to look to purchase equity that will appreciate in real terms in either scenario.
We would want in trying economic conditions one of the majors, who has the ability to withstand the economic downturn and capability to expand through consolidation, acquiring competitors at advantageous prices.
Exxon Mobil Corporation (Exxon Mobil) through its divisions and affiliates is engaged in exploration for, and production of, crude oil and natural gas, manufacture of petroleum products and transportation and sale of crude oil, natural gas and petroleum products. Exxon Mobil is a manufacturer and marketer of commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics and a range of specialty products. Exxon Mobil also has interests in electric power generation facilities. Affiliates of Exxon Mobil conduct research programs in support of these businesses. Exxon Mobil Corporation has several divisions and affiliates, many with names that include Exxon Mobil, Exxon, Esso or Mobil. The Company operates in three segments: Upstream, Downstream and Chemicals. In April 2008, Galp Energia SGPS S.A. has acquired Exxon Mobil Corporation’s businesses in Spain and Portugal.
First some of the problems.
It would seem that management are capitalising a portion of receivables onto the Balance Sheet. I would suspect that these are potential writedowns at some point in the future. Assume the worst and adjust for them as writedowns at $0.29/share
Management are also capitalising Operating expenses. This of course directly enhances the bottom line, and inflates Net Income. This is particularly obvious in the forthcoming 2008 financials, where I have adjusted for potential results [obviously they may be slightly better or worse] thus I have adjusted by $0.16/share
Total adjustments = $0.45/share
Positive adjustments.
Management have discretionary cashflows through squeezing suppliers of some $0.21/share that has offset the deductions.
Adjusted per share adjustments = $0.21 – $0.45 = [-$0.44/share]
Adjusted Net Income = $9.80 – $0.44 = $9.36/share
The margins, notwithstanding the adjustments are outstanding. With a six year aggregate of 16.5% on a primarily common stock capitalization, this represents an outstanding return.
The common stock capitalization at 90%+ shows very low leverage. This in the current climate in part accounts for the relative out performance of XOM to it’s peers.
Pension liabilities = $34.5 Bil
Pension Assets = $27.8 Bil
While underfunded, this is not at a point of danger with XOM’s earning power taken into consideration.
Reserves are at 21.5 Bil bbs [oil/gas] which represents circa 22.6 yrs based on the current 2.6 Mil daily production. Thus, there is a substantial timeframe of safety currently.
Reserves are being replaced at a 1.74% compounded rate. They are thus growing at 0.74% compounded. This represents value for common share holders.
Common shares are [and have been] the subject of repurchase. To date the ownership base has been reducing at a 2.8% compounded basis. Thus, holders are benefitting from this management policy.
That XOM is a resource company, oil & gas, thus the investor must account for the depletion of the assets, including plant. The amounts charged off by the company are quite likely to be irrelevant for the individual investor, thus, he should make his own.
If we place the reserves at a optimistic 20 yrs and a conservative 11 yrs, we can then amortize the value in the ground and ascertain whether we are buying value.
…………………………………………………6 yrs………………..Current
Paid for entire company……………….$363822……………$423958
Less Cash Assets……………………….$26051……………..$38434
Paid for company………………………$337771……………$385524
Earnings before amortization………..$60320………………$91406
Earnings required on cash @ 5%……$1302……………….$1921
Balance earned on drilling……………$59017……………..$89484
% earned before amortization……….17.4%………………..23%
Investors amortization
11 yrs [maximum]……………………$5311……………….$8053
20yrs [minimum]…………………….$3016………………..$4474
Earned after amortization
Minimum earnings…………………..$53705………………$81431
Maximum earnings………………….$57304………………$85010
% earned on investment
Minimum……………………………..15.9%…………………21%
Maximum…………………………….17.4%…………………22%
Valuation = $136.52/share
This is a conservative valuation, and thus trading at circa $77.00/share represents a 76% discount from fair value.
In summary, barring some management manipulation, Exxon represents a conservatively capitalised, highly profitable and massively undervalued investment common stock.
jog on
duc