The ongoing shale bust is proving to be nothing short of catastrophic, leaving investors wondering whether even the titans will come out of it in one piece. Shale pioneers Chesapeake Energy and Whiting Energy have already filed for Chapter 11 with dozens more expected to follow suit while a colossal wave of asset write-offs sweeping through industry serves as an ominous sign that the sector might never be the same again. Thankfully, ExxonMobil (NYSE: XOM) and Chevron Corp. (NYSE: CVX), two of the most recognizable oil and gas supermajors, are considered as some of the most financially sound thanks to their respective strong balance sheets that help them weather downturns better than most.
But just because they face no immediate danger of going under does not mean that investors will happily continue throwing good money after bad.
XOM stock has lost 37% in the year-to-date with CVX dropping 28% in what is turning into another annus horribilis for the industry. Investors are voting with their wallets and have lost patience with a sector that has become an investment black hole, guzzling billions of investors' dollars with little to show for it in the way of profits. The energy sector is deeply out of favor, and the Covid-19 pandemic has only served to add to the uncertainty facing the industry.
Nevertheless, investors who buy at these discounted levels can still profit if the global economy can recover over the coming months, and oil demand bounces back.
Prior to the pandemic, a cross-section of Wall Street was beginning to warm up to Exxon, believing years of investments were about to start paying off.
Specifically, Bank of America Merrill Lynch had tapped XOM as its top 2020 stock pick, arguing that the stock could surge as production in the Permian Basin and projects in offshore Guyana ramped up.
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Unfortunately, that playbook has changed dramatically.
Unlike the past couple of years, investors are no longer rewarding shale companies with aggressive expansion plans. Instead, they are rewarding the shale companies that demonstrate better cost discipline.
XOM stock has fared worse than CVX partly because Exxon's counter-cyclical spending model has left the company cash flow negative for years and put the all-important dividend in danger.
Chevron has generally maintained more modest capital investment plans and was quick to lower its 2020 capex when oil prices nosedived. CVX has made further spending cuts as conditions further deteriorated, taking its planned capex from $20 billion to $14 billion.
Exxon delayed its spending cuts but finally lowered its 2020 capex from $33 billion to $23 billion. Unfortunately, that has not stopped the company's debt from ballooning, with XOM's long-term debt surging 30% to $19 billion at the end of the June quarter. Exxon's debt-to-equity ratio of 0.36 is still considerably lower than that by most of its supermajor peers but could present a problem considering the company's juicy dividend--XOM's dividend yield of 8.05% is at an all-time high.
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Chevron's debt has also been expanding, but at a more manageable clip of 20% during the period. The company's debt-to-equity ratio of 0.24 is the lowest among the supermajors, while its dividend yield of 5.98% appears more sustainable than Exxon's.
Chevron more resilient
With so much uncertainty surrounding the oil and gas sector and fears that the downturn might last for years, the ability of a company to withstand a prolonged bust cycle is an important consideration.
And...Chevron wins the stress test by a country mile.
Wood Mackenzie, a global energy, renewables, and mining research and consultancy group, has reported that Chevron Corp and Royal Dutch Shell (NYSE: RDS.A) are the most resilient, thanks to their robust deepwater projects and LNG as well as less exposure to high-cost assets.
WoodMac has reported that Exxon is the most vulnerable of the majors due to its huge exposure to low-margin assets.
Exxon might stack up poorly against its giant peers but is still better placed than many shale players who lack its deep pockets.
Goldman Sachs has been backing CVX and ConocoPhillips (NYSE: COP) ahead of their earnings and saying to sell XOM because the former "...could see net debt broadly unchanged at quarter-end, thanks to capital discipline and boosted by asset sales closed during [Q2], while Exxon could see large debt builds."
At this juncture, we will have to concur.
By Alex Kimani for Oilprice.com
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These are important issues to consider before investing in either company. While a write-down does not have any direct impact on cash flow, it does alter the balance sheet. Specifically it reduces assets and equity. So if either Exxon or Chevron take a sizable write-down, it will explode the debt-to-equity ratio and compromise credit ratings. Worse yet if these companies refuse to take a write-down to cover up real declines in asset value, shareholders are being deceived and can be in for even nastier surprises.
At a minimum, these companies need to be transparent about the assumptions they current make to support current valuations. This would allow investors to evaluate whether they find those assumptions credible. But failure to offer even this modest amount of transparency should be taken as a red flag in the present context.