NEW YORK – In investing, it can be wise to avoid absolutist statements. Conditions change, new data emerges, and stories evolve. However, back in 2017, this reporter felt confident asserting that ExxonMobil stock would never earn a spot in my portfolio. My reasoning? The oil titan’s financials were not as healthy as they appeared at first glance. But now, Exxon is making waves at the top of my stock screener lists – causing me to reevaluate my hardline stance.
Eating Humble Pie
Let’s rewind to 2017. After analyzing Exxon’s books, I noticed a discrepancy. While the company’s income statements touted hefty profits over the preceding years, the actual free cash flow generated from operations told a different story.
In essence, it cost Exxon loads of money to build and maintain the infrastructure required to extract oil. However, the company’s official profit calculations did not properly account for these major cash outflows.
By my math, Exxon’s free cash flow from 2000 to 2019 was about 30% less than the net income reported on its financial statements. This meant investors who purchased Exxon shares based on traditional valuation metrics like the P/E ratio were overpaying by around 44%.
Given this misalignment between profits on paper and cold hard cash, I publicly declared Exxon a value trap. An oil giant masquerading as a diamond in the rough. The implication was clear – ExxonMobil stock would never touch my portfolio.
How times have changed.
Just last month, I ran my proprietary value stock screener designed to uncover hidden gems trading at bargain prices. The software filters for stocks generating strong free cash flow yet sporting low valuations.
I about fell out of my chair when Exxon emerged atop the list of promising picks.
Could this oil behemoth actually shape up as a shrewd investment? Or was my screener glitching? Let’s investigate whether this leopard has changed its spots.
Follow the Free Cash Flow
During pre-pandemic times, Exxon routinely reported far higher net profits than free cash flow. But COVID shook up the global economy in unprecedented ways. And Exxon seems to have flipped the script when it comes to free cash flow alignment.
From 2020 to 2022, Exxon churned out $102.7 billion in free cash flow. Yet only $67.7 billion made it onto the net income statements. For once, real cash generation exceeded officially reported earnings.
The trend persists into 2023. For the first three quarters, free cash flow sits at $26 billion compared to net income of $28.4 billion. Exxon may close the year with a less than 10% difference between the two figures – a sea change from the 30%+ divergence seen prior to COVID.
The improved free cash flow alignment indicates Exxon’s dirt-cheap P/E ratio of 10.7x more accurately reflects today’s financial reality. In fact, projecting out 2023 numbers suggests a price-to-free cash flow ratio around 11.5x – right on par with the P/E.
This surprising development plants Exxon firmly on my value stock radar.
Oil Springs Eternal
Beyond the improved cash flow stats, several other factors make Exxon enticing:
- The company has utilized excess cash to pay down debt. Long-term obligations have decreased more than $10 billion over three years.
- Exxon maintains a mammoth dividend with a 3.8% yield – over twice the S&P 500 average. The payout has increased annually for 41 consecutive years.
- My analysis shows the dividend alone supports nearly one-third of Exxon’s share price.
- Earnings growth has averaged over 12% the past half-decade. 7%+ growth going forward could make today’s valuation a bargain.
- Exxon remains a cash flow machine, on pace for $35 billion in 2023 free cash flow.
For an industry leader of Exxon’s stature, a sub-12x price-to-free cash flow multiple seems like a discount. The company’s cash generation prowess, improving financial alignment, still-princely dividend, and moderate growth prospects make this oil giant my top dividend income play for 2024.
Caveats Apply
Before chasing yield with Exxon, some risks require acknowledgement:
- Oil and gas fundamentals remain historically volatile. Fossil fuel prices could crater if recession strikes or clean energy advances accelerate.
- Despite improved alignment, Exxon’s free cash flow still falls short of reported earnings. Lingering financial opacity remains.
- Exxon’s fundamentals weakened substantially during the 2014-2020 oil downturn. Pain could recur in the next slump.
- ESG concerns plague the oil industry. Exxon may face escalating environmental pressures.
- Renewable energy and electric vehicles threaten to disrupt Exxon’s long-term business model.
Of course, I could be suffering from recency bias here. Exxon flourished in 2022’s uniquely favorable macro environment. We must see whether the company maintains its newfound cash generation prowess in leaner times.
Moreover, Exxon realigning financials to better showcase free cash flow hardly transforms it into a pristine value investment. Caveat emptor remains the watchword when dealing with oil majors.
Even so, the improved profitability optics, fortress balance sheet, mouthwatering dividend, and discounted cash flow valuation make Exxon impossible to ignore. This oil giant seems poised to fuel income portfolios in 2024.
My mistake in the past was issuing blanket statements against Exxon based solely on historical data. But investing is never static. Prudent stewards stay open to new information changing old assumptions. Exxon’s revamped financials and rock-bottom valuation convince me to flip my script.
Sure, it may require dining on some crow. But abolishing anti-Exxon absolutism appears the wise move today. No investment thesis should be set in stone. Sometimes, you must admit mistakes to seize emerging opportunities. And right now, ExxonMobil checks all the boxes for a value dividend stock built to outperform in 2024.
