Wednesday, February 4, 2015

The Energy Company I want to buy

The other day, I posted an article which discussed a few investments I have recently made. I had previously bought some ConocoPhillips in early 2015, at which point forward earnings expectations hadn’t really gone as low as they are now. In previous research I had mentioned that I was looking to adding more to my positions in Exxon Mobil, ConocoPhillips and potentially even Chevron.

You might be surprised to see that I have not added to any of my energy holdings. The reality is that stock prices have not fallen as much as the price of oil, which reduced future earnings power.

2015 EPS
$       2.92
$       1.59
$       4.28
$       4.73
$       2.76
$       4.29
Note: Data is as of Friday, Jan 30, 2015

The reduced prices on oil have resulted in lowering of the expected earnings for 2015 for ConocoPhillips (COP), ExxonMobil (XOM) and Chevron (CVX) of and $1.59, $4.29, $4.73. Since prices have fallen much less than earnings, those oil companies are now selling above 20 times expected earnings. In all three, the forward dividend payout ratios are very high.

I am well aware that cyclical companies appear cheapest at the top of the cycle when earnings are highest, and that they appear most expensive at the bottom of the cycle when earnings are lowest. However, I also want to knowingly avoid purchasing companies that cannot support their dividend out of expected earnings.

This essentially rules out further investment in ConocoPhillips for me, and potentially even Chevron which should sell below $95/share to enter value territory. For ExxonMobil, my ideal value price would be below $86/share. Given its low payout ratio, ExxonMobil looks like the ideal candidate to build out an energy position.

It also looks like many participants have not priced in low prices, and are acting as if low prices are a temporary event. In the case the drop is temporary, buying today makes a lot of sense. In case prices stay low for longer than expected however, share prices might reflect that new reality. Most importantly, shares in many companies seem slightly overvalued, despite going down in price. Of course, I am also well aware that I should not blindly look into next years earnings as well. As someone who plans on holding for 20 - 30 years, I expect that oil prices will recover at some point, which would result in higher earnings over time ( especially if production volumes increase). However, I also want to avoid situations where a short-term pain ( 1-2 years) causes a company to cut dividends - this would disqualify it right away for my strategy. As most of you are aware, my goal is to generate a defensible stream of dividend income, which grows above the rate of inflation. I am trying to avoid companies which might be prone to dividend cuts as much as possible.

ExxonMobil is the one oil company, where I want to build out a full position over time. I already own a lot of Chevron, which is one of the reasons why any additions there will be limited. Given the high payout ratio on ConocoPhillips, I might not be able to buy more however. When I am presented with new evidence, I believe that the smart thing to do is change my view and manage risk accordingly.

I did add to my ExxonMobil position early this week. I might take the plunge into more ExxonMobil sometime in March, especially if stock prices go lower from here.

Full Disclosure: Long all companies listed above

Relevant Articles:

Margin of Safety in Dividends
Not all P/E ratios are created equal
Why do I use a P/E below 20 for valuation purposes?
Are Energy Stock Values Today a Once in a Lifetime Opportunity?
Are Energy Investments Today a Once in a Lifetime Opportunity (Part 2)


  1. Both CVX and XOM goes ex-dividend in february. I have initiated a position in both companies yesterday. Might have been a dead cat bounce, but getting in before the ex-dividend seems like the logical thing to do here.

    1. Most probably was a dead cat bounce due to short covering. I would be hopeful for further declines from here, that's when it will get really interesting.

  2. Thank you for the article. I started building up my energy positions at the end of December and I think in the next 20+ years I'll be very happy I pulled the trigger on BP, CVX, XOM, KMI. For the P/E in your table, are you using projected or TTM? I haven't seen anyone show XOM that high (usually in the 11-13 range for TTM and 15-16 for forward looking). Just wondering, thanks.

    1. As I mentioned in the article, I used forward earnings, which come from wallstreet analysts. I look at 10 year trends in EPS, PY EPS and forward EPS. no TTM. That's why investing is part art, part science

  3. I like CVX best of those listed. (Disc: long XOM,CVX)

    The dividends are probably more sustainable than you are calculating. Integrated oil companies have HUGE capex budgets which they slash by billions when the price is low. There is plenty of room to give in the budget and the downstream portion acts as a hedge as it makes more money when prices are low.

    Personally, I think the way to play it is to write cash secured puts. The annualized yield is sky high right now and your "downside" is to get into something you already wanted at a price below spot.

    1. What you are saying is probably true, as evidenced by capex decreases for RDS.B and CVX ( and buyback reduction for XOM). And yes, integrated ones like CVX and XOM earn money from R&M ops. However, energy companies need to constantly invest in E&P to at least cover DD&A; otherwise they could theoretically dry up their reserves. If things get tighter for the smaller players, companies like XOM & CVX that have massive resources, might be able to scoop up assets at prices that are cheaper than exploring for and finding oil.
      As for selling puts, it could work but provides own set of risks – there is no free money in investing. In my investing, I end up missing big movers in large part of the situations ( missed WFC at 35, HSY, SBUX etc). The premium received is a price you get for reducing your flexibility and potentially missing an opportunity.

  4. I bought my energy positions mostly in 2010 and 2011. I was fortunate to get over half of my Exxon holdings at $59.70. The remainder of my Exxon holdings were acquired in the mid 80 range. I just added a smaller lot at 89.65.

    1. Oh nice, that sounds good. I was buying CVX around that time..(2008 - 2013). I am hopeful we will see XOM at a 4% yield or somewhere in the $70s sometime in 2015.. But who knows.

  5. "This essentially rules out further investment in ConocoPhillips for me, and potentially even Chevron which should sell below $95/share to enter value territory. For ExxonMobil, my ideal value price would be below $86/share."

    I would like to hear more about the algorithm you use to determine what price an equity must reach to be considered a value. How do you determine this value number?

    1. Hi Embo,

      The article shows links to other articles i have written. Follow the links in the article, Poke around the site, and you will find what I do, how I do it, etc.

      Good luck in your investing journey

  6. Good explanation and good strategy! Couldn't agree more with it! XOM should continue to increase dividend... not always a good reason to buy but can be good news when you already hold it.

  7. I think XOM is excellent considering the current valuation. I can't wait to add my initial position once I accumulate my minimum purchase cash point.



    1. Just because a stock has gone down in price, doesn't mean it is a good investment. Given the impairment in earnings due to decrease in oil prices, I am not so sure that valuation is really that attractive. It will be more attractive at lower prices

  8. I hope to add to our CVX and COP positions. XOM looks pretty interesting too and would love to hold XOM in our portfolio too. Thanks for the article and sharing your thoughts.

    1. Hopefully we get lower prices to buy more shares on the cheap. Good luck in your dividend investing journey!

  9. I'd like to better understand the P/E shown in your table as they don't match what I see on other sources.

    1. NG,

      I explained where I obtained the 2015 forward EPS in article and comment replies above. You have the prices I used the make the calculations ( listed above). Then simply crunch the numbers.

      Good luck!


  10. DGI,
    I know that you are not a fan of DRIPs, but I am using them to add to BP, COP, CVX, KMI, and XOM. With yields as high as they are, I think it is a lower risk way to add while prices are low without risking additional funds.

    1. I am not a fan of drips due to a variety of factors and due to my evaluation of those factors and data over several years. Many investors reinvest regardless of valuation, and plus the prices you get from DRIPS might not be as optimal.

      I would not buy COP today, although XOM sounds nice and potentially CVX might be added to in 2015. But no KMI for me - I own too much. As for BP, you might remember that I will likely buy some in April if my puts are exercised ( looks like they will). I am not so hot on BP for whatever reason. I get why everyone likes the high yield, but the 20% stake in Rosneft is worrying me a little. I view BP as the weakest one of the majors.. If things turn around though, it might provide the best returns.

  11. Long time holder of XOM. It is a bank masquerading as an oil company. Engineers or geologists run it, financial types need not apply. I have been in the business since 1970. Plenty of Exxon folks clipping coupons around here. Great blog !

    1. Interesting analogy Anonymous Texas. I would be happier with XOM if they paid special dividends rather than do buybacks, but noone is asking me. It is important to keep perspective when it comes in investing - today's crash in prices might be a good opportunity to buy assets at lower prices. If someone holds for the next 20 years, and reinvests those dividends selectively, they should do fine for themselves. The boom-bust cycles are just part of the game. I would be interested in your perspective on the early 1980s, 1986, 1992 and late 1990s.

  12. Cannot wait until my next paycheque and tax returns to initiate positions on those companies when they are cheap as well as Suncor. I don't know whether oil prices are bottomed out or not but they are still well below the average of last 10 years.

    Thanks for sharing!

  13. Thanks DGI. Started a position of 18 shares on 7/17 @ 82.49.


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