Exxon Mobil Near 20-yr Lows… Is it a Buy?

• JP Morgan handily beats expectations as profit margins fall
• Assessing a Trade on XOM for a 11.2% Annualized Return
• Gallup Poll finds 56% of Americans feel they are better off today than 2016

Q3 earnings season is under way for 2020.

All eyes were on the financial sector today – and specifically JP Morgan (JPM) and Citigroup (C). 

Surprise surprise… 

JPM handily beat earning expectations on strong trading revenue – however the stock gave back 1.6% (expected after a ~10% run higher the past four weeks)

On the other hand, Citi’s result wasn’t good. It missed and its stock plunged 5% – trading at decade lows. 

As regular readers will know – if you are drawn to the banks – then JPM’s one of the best to own (BAC also good)

The US’ largest bank posted third-quarter profit of $9.44 billion, or $2.92 per share, exceeding the $2.23 per share expected by analysts. It generated revenue of $29.94 billion, about $1.5 billion more than what analysts had expected, fueled in part by better-than-expected trading results. 

Furthermore, provisions for loan losses were lower than expected – reducing them by $569 million.  . 

But there is a fly in the earnings ointment…

And that is margins.

They are declining as the yield on the 10-year falls closer to zero. Remember – the bank’s business model is to “buy short and lend long”. 

The short-end is okay – as the Fed slashes rate to zero. The problem is the long-end is trading close to that value too. 

For JPM – their margins dropped 14 basis points.

If we look at the weekly chart – I still think JPM looks reasonable here – with a stop of $90 (the last major low). However, the stock is seeing some strong near-term resistance around the $100 level. 

Energy Sector Under Immense Pressure

One sector I’ve been keeping a close eye on lately is energy.

Energy stocks are now trading at multi-decade lows due to:  

• Lower demand as a result of COVID (and expected weak economic growth);
• Far too much global supply (which isn’t slowing); 
• Political pressure to curb fossil fuels and incentivize cleaner renewable sources (solar, wind, geothermal etc); and
• Producer operations remain under pressure with an oil price below US$60/bl

Let me talk to the demand picture for a moment… 

Consider this graphic showing the year on year change in key transportation industries – and note the plummet we see with airlines (down 80% year on year)

Now with respect to the 80% plunge in airline demand – we received a compelling snippet from Delta today (which is possibly the best run airline in the industry – certainly in terms of its balance sheet strength)

Delta told us they lost more than $11 billion in the last two quarters  – as they move to cut their cash burn to $18 million a day in September from $27 million a day at the end of the second quarter. 

But in terms of the outlook – their CEO said it could be 2+ years before they start to recover.

Other airlines (like American and United) have said it could be as long as 4-years.

None of this bodes well for growing oil demand. 

As another data point – Paris-based IEA said earlier this year that “deduced jet and kerosene deliveries will impact total oil demand until at least 2022 … the aviation industry is facing an existential crisis”

Yep. 

Given what we see above – the comparative returns from these 4 leading energy giants (from 2016) should not be surprising:  

• Exxon Mobil (XOM) – down 59% (orange)
• Chevron (CVX) – down 20% (green)
• Cocono Phillips (COP) – down 36% (blue)
• Phillips 66 (PSX) – down 39% (red)  

Note – these are the share price returns only – exclusive of any dividends.

XOP vs CVX vs COP vs PSX — Oct 13 2020

And this is what we see with the West Texas Crude over the same period 

West Texas Crude – Oct 13 2020

And whilst the price is largely unchanged the past four plus years – the problem is $40 to $45/bbl crude is not sustainable for these companies.  For example, if we consider the cost curve for oil – producers typically need the oil price back above $60/bbl. 

Here we see how this curve flattened between $50 and $60 over the past few years. 

But to encourage higher levels of investment (at an acceptable level of profitability) – higher oil prices will become necessary at some point in time.

Otherwise, investment will dwindle which in turn will reduce overall supply. 

As I have said in the past “… the best thing for higher oil prices are often lower oil prices”

Exxon Mobil – Trading at 20-Year Lows

Earlier this year – Exxon Mobil was removed from the Dow Jones Industrial Average and replaced by Salesforce. 

As recently as 2008, energy stocks were 15% of the S&P 500.

After a decade of underperformance (as I illustrated above) – they make up just 2.5%.

Once the largest company in the world, Exxon had a market cap of over $500 billion as recently as 2008. But it is now around $146 billion. 

Exxon has underperformed Chevron (CVX) this year (where Chevron is a better run company)  in part because investors are worried about its ability to maintain its dividend while keeping its debt load in check going forward.

The company has also that said the dividend is a priority and that it does not intend to take on new debt

Now at the current price of $34.22 – it’s projected dividend is over 10%. 

My view is this dividend will be slashed to below 5% as Exxon looks to make better use of (scarce) capital (and they should!) 

Let’s take a look at the long-term (25-year) chart

XOM – Long-Term Chart – Oct 13 2020

First up, it’s staggering to see XOMs chart trading at levels not seen since 1997 to 2003 (excluding the plunge in March earlier this year). 

Second, there appears to be a $30 price level which has acted as firm support.  There’s no guarantee this will hold – however this is what we have seen so far. 

Third, take a look at the green arrows in the lower window (RSI). The four occasions we have seen the RSI down at these levels – the stock has found support and rallied. 

Let’s now look up close and then a potential (higher risk) trade: 

XOM – Weekly Chart – Oct 13 2020

From a trading (technical) perspective – this has been a text book “short sell”

From the moment our weekly trend turned bearish – every rally to the 35-week EMA (red arrows) has been met with stiff resistance – forming a nice series of “lower highs”

What I am watching now is how the price performs after the most recent rejection and where it (potentially) finds support. For example, will the long-term level of $30 hold? 

Now to be clear – I am not looking at buying the stock here. 

It’s incredibly high risk – especially with the trend bearish and likely to fail on any rally. 

But I am willing to put up a smaller amount of risk capital (e.g, 1% of my total) on a trade which gives me:  

• A 20% ‘margin of safety’ (in the event the stock moves lower); and
• will generate an 11.2% annualized return

Today I sold Nov 20 $27.50 strike puts on XOM for a premium of 32c to achieve these two objectives. 

Below are the specific option quote prices from Yahoo!Finance 

XOM Nov 20 2020 Put Options

Now these options have 38 days to expiry. 

What’s more – the strike price of $27.50 is 19.6% below today’s close of $34.22 (i.e., my margin of safety)

So how did I calculate my annualized return on my risk capital?

((0.32 / $27.50) * 365) / 38 days = 11.2%

Put another way, if the stock doesn’t fall more than 20% over the next 38 days, then I will keep the 11.2% annualized return on my risk capital. 

Managing Your Risk Capital

With a chart like this – the probabilities are not in your favour. 

This is a bearish weekly trend and has every chance of breaking down further. 

Therefore, when taking a trade like this I risk a smaller portion of your total capital. 

For example, assume you will be exercised at $27.50 (which will be a very low price for Exxon).

And from there – what that could look like if the stock proceeded to fall another 10% to $24.75?

What potential damage would that do to your portfolio?

If it’s more than a 2% loss to your total portfolio – then consider how much capital you are putting up as risk.

I feel that Exxon will attract a strong bid around $30 (if nothing else for the dividend alone) – where value buyers will start to assess the stock (from a long-term perspective). 

Like all my other trades – I will let you know how I go with this speculative (higher risk) position.

Before I close – I caught this Gallup Poll tonight which asked US citizens if they felt they were better off today than in 2016: 

I found this curious given the impact of COVID and how many have lost jobs. 

What’s more, in 2012 when citizens were asked the same question (i.e., were they better off today vs 2008) – 45% said no. 

My question is will this come through when people vote? 

Maybe not. 

They also asked the question whether Biden or Trump would be a better leader; and who they sided with on issues. 

For mine, it was not surprising they sided with Biden as the preferred leader. 

Biden is very likeable.

Trump on the other hand is not a palatable leader. Quite the opposite! 

Given the way he conducts himself – I am not surprised this result was not closer to 20%. 

However, what was interesting is more people (49%) agreed with Trump on the issues (vs Biden 46%)

Again, how will this traslate come November 3rd with just 21 days to go. 

Who knows?

Regards,
Adrian Tout