When it comes to energy businesses, ExxonMobil (NYSE: XOM) and BP (NYSE: BP) sit in rare company. To call them industry giants would be an understatement. However, the two stocks have seen widely divergent performance since early 2016, when oil prices started to recover from a deep downturn. BP's 38% stock advance has trounced Exxon's sideways run. However, with oil back in a bear market again, it's worth re-examining Exxon and BP to see which would be the better buy today.
Making the right moves
After oil prices started to crater in mid-2014, eventually falling below $30 a barrel, BP focused on cutting costs. That's basically what every major oil producer was doing. At this point, the company believes it can cover its operating expenses and dividend with oil around the $50-per-barrel level. The goal, however, is to keep pushing the break-even point lower, hitting the $35 to $40 range by 2021.
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That's good news, since Brent crude prices recently fell from over $80 a barrel to $60 in roughly two months. BP's shares have fallen about 14% over that span, which is hardly a surprise. Exxon's shares, by comparison, were down around 10%. The key takeaway here is that oil prices will continue to be a major factor in BP's financial and stock performance. But they aren't the only factor.
While successfully cutting costs, BP has also been executing well on the production front. Production rose 10% in 2017, with continued gains in 2018. Production, for example, was up 7% year over year in the third quarter. And with the recent acquisition of U.S. land assets from BHP, it should continue its upward march.
What about leverage? At the end of the third quarter, long-term debt made up around 35% of the capital structure, which is a reasonable figure even though the company's leverage is toward the high end of its oil major peers. And even if the entire $10.5 billion BHP deal, which closed after the quarter ended, were funded with debt, leverage would only rise to around 39% of the capital structure. That's easily manageable so long as oil doesn't crater again.
BP is, basically, in pretty good shape today. That said, investors have taken notice. The company's price to tangible book value is historically low, but materially higher than it was during the worst of the 2014 oil downturn. That, however, highlights the crux of the issue when comparing BP and Exxon.
Muddling through to brighter days
Exxon hasn't been executing nearly as well as BP. One of the biggest differences has been on the production front. Exxon's production fell 1% in 2016 and another 1.7% in 2017. It has continued to decline in 2018, with year-over-year production off 2% in the third quarter.
Investors have taken notice, which helps explain why Exxon's shares have gone nowhere for nearly three years. But the weak stock performance presents an opportunity, because Exxon's price to tangible book value is now lower than it has been since the mid-1990s (and lower than BP's). The company's 4.1% dividend yield, meanwhile, is higher than it has been since about that same time period.
That said, Exxon's dividend yield is lower than the 6% yield BP is offering, which might entice income investors to lean toward BP. However, Exxon has a much more impressive dividend history, with 36 consecutive dividend increases behind it. By comparison, BP cut its dividend in 2010 following the Gulf of Mexico disaster and held it steady following the oil drop in mid-2014. It only started to increase the dividend again in 2018. Another material oil downturn, when considering BP's leverage, would likely lead management to hold the line on the dividend again. Exxon easily has the edge here despite the lower yield if dividend growth and consistency are important to you.
A historically low valuation and high yield, however, aren't that compelling if Exxon's production keeps heading south. But that doesn't appear to be in the cards. For starters, Exxon has material plans to boost production over the long term, including investments in onshore U.S. oil, offshore oil, and natural gas. To management's credit, it is focused on profitable production and not quick fixes (as the last 2.5 years clearly shows). However, there was a notable shift on this front in the third quarter: Exxon's production rose 5.5% sequentially between the second and third quarters on the strength of its onshore U.S. operations. That's just one of the company's key production growth initiatives and suggests that management's long-term plans are starting to pan out.
Moreover, Exxon's long-term debt is only around 10% of its capital structure. Even if oil prices fall, it can afford to support its investments and grow the dividend, like it did during the last downturn. And while Exxon doesn't really discuss break-even points, it projects that it will be able to increase earnings by 35% by 2025 even if oil falls to $40 per barrel. The downside risk here seems pretty limited.
Go with the value play here
Effectively, investors have rewarded BP for its operating performance and left Exxon to languish as it tries to play catch-up. There's no question that BP is doing well right now, and investors who are seeking a high-yield oil play should probably take a close look. But when you take valuation into consideration, Exxon starts to look a lot more interesting. Add in Exxon's rock-solid balance sheet, dividend history, and what appears to be a turn higher on the production front, and it looks like a better overall option than BP at this point.
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