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Morningstar | Exxon Delivers in 2018, Tracking Toward 2025 Targets; Shares Undervalued

ExxonMobil topped expectations for the fourth quarter largely because of stronger-than-expected downstream earnings. Total adjusted earnings increased 72% to $6.4 billion from $3.7 billion last year. Upstream earnings increased to $3.7 billion from $2.5 billion last year on higher oil and gas prices. Production finally grew, albeit slightly, with volumes increasing less than 1% as new growth from the Permian and the Hebron project offset portfolio effects and natural gas decline. Importantly, excluding entitlements and divestments, liquids volumes grew 7% during the quarter and 3% for the year despite total production falling nearly 4%. The growth in liquids volumes demonstrates the shift to higher-value production, which should continue to play out in the coming years and result in margin expansion. Permian growth remained strong, with volumes increasing 90% year over year.

The downstream segment posted strong results as well, with earnings increasing to $2.7 billion from $952 million last year due to asset sales gains but also higher margins from the capture of North American crude differentials and an improved yield/sales mix. Chemical earnings remained an area of weakness, falling to $744 million from $935 million last year on lower margins and maintenance activity. Our fair value estimate and narrow moat rating are unchanged.

The ability to offset weak price differentials in upstream assets in Canada and the Permian through physical integration with downstream assets is a key element of differentiation for Exxon. To this point, Exxon announced this week a reorganization whereby it is streamlining its upstream business and centralizing project delivery, which will simplify the organization and increase integration with the downstream and chemical segments.

Exxon has historically set itself apart from peers as a truly integrated organization as opposed to a collection of assets, which we believe has contributed in part to its superior returns on capital. The reorganization should further this advantage, in our view, and increase the potential for delivery of its 2025 targets.

Fourth-quarter cash flow improved to $8.6 billion from $7.4 billion last year, bringing the full-year total to $36 billion compared with $30.1 billion last year. Free cash flow went toward dividends, capital expenditures, and debt reduction. Exxon remains a standout among integrated oils in not repurchasing shares but increasing investment to meet its 2025 target of doubling earnings.

On this note, the company looks to be off to a good start relative to its targets laid out in March. On the upstream side, it increased its recoverable reserve estimate and 2025 production targets in Guyana and is running ahead of plan on its targeted Permian production of 600 thousand barrels of oil equivalent per day in 2025. In the downstream segment, three of its six planned major refining investments are on line with the remaining three on schedule. In the chemical segment, seven of 13 new planned facilities came on line in 2018 with the remaining six on schedule. A new update on Exxon's progress and targets should be forthcoming in March at the annual analyst day.

Exxon's shares have lagged, given the nature of its long-term story and investor preference for integrateds with greater oil leverage or a commitment to return cash to shareholders. Exxon has taken a different path of stepping up investment, which should ultimately pay off but will require time. With the shares trading at a healthy discount to our fair value estimate, Exxon presents a compelling opportunity but remains a long-duration story.