So why have I sold all of my Exxon shares?

Cyclical energy markets

Energy markets tend to be cyclical. When selling prices are high, producers invest in new projects. Those can have long lead times. So by the time oil gets pumped, the economics may have changed completely. Suddenly, a glut of oil leads to crashing prices. In turn, that leads to less spending on new projects for the future – setting up the whole cycle to start again.

A couple of years ago, energy demand was uncertain and producers like Exxon dramatically cut their capital expenditure. In 2020 alone, Exxon spent almost $10bn less on capex than it had originally planned. Other energy majors also made deep cuts. Meanwhile, pandemic-era falls in energy use are a thing of the past in most markets. There have also been unexpected supply shocks, such as those caused by the Russian invasion of Ukraine.

Soaring Exxon stock price

All of this has helped push Exxon’s price upwards. A tighter supply outlook, robust demand and high selling prices have meant the company has been in clover. It earned $5.5bn in the first quarter alone.

But that is not the only explanation for the surging Exxon share price, in my view. A couple of years ago, some investors worried that the oil giant’s huge Guyana project could turn out to be a white elephant. What was the point of spending vast sums to develop a new oil project when there were doubts in some quarters that oil and gas demand would ever recover to 2019 levels, let alone grow further?

Fast forward two years and a lot has changed. With resurgent oil demand, the massive Guyana project looks like a smart move on Exxon’s part. It ought to be pumping 340,000 barrels per day later this year.

Pandemic-era cost cuts also mean the company is now leaner, so it can turn a profit at a lower oil price than before. Its breakeven cost per barrel of oil has fallen well below $40. Meanwhile, the benchmark WTI crude oil price has soared to $120 per barrel.

My move on Exxon

It feels like everything is suddenly going swimmingly for Exxon. That makes me a bit nervous, given the cyclical nature of the oil market. High prices will not last for ever — but I think they have been a key factor in driving up the price of Exxon lately.

That is why I have sold all my Exxon stock. Both oil prices and the Exxon share price may go higher from here. But, as Warren Buffett cautions, I am sometimes fearful when others are greedy. At some point I think the current oil bubble will pop, so I have taken my profits off the table now. I will continue my search for what I see as more reliable stocks I can hold for the long term

British American Tobacco

One of my favourite passive income ideas that I use in my own portfolio is owning shares of British American Tobacco (LSE: BATS). The company behind famous brands such as Lucky Strikes is a cash generation machine. Cigarettes are cheap to make but can be sold at a premium price. That helps explain the £9.8bn of net cash the company generated from its operating activities last year.

BATS has substantial net debt – around £40bn when it last reported. So some of that cash generation is used for interest payments. Even after that, the strong cash flows allow for generous dividends. Last year the company paid out a mammoth £4.7bn to shareholders in the form of dividends. With a 10-year compound annual growth rate of 7% and annual increases for over two decades, the BATS dividend is highly attractive to me.

On top of that, the company’s share price means that currently the yield is around 7.8%. That means that if I put £1,000 into the shares today, that investment alone would hopefully give me £78 of passive income next year.

But dividends are never guaranteed and there are risks to the BATS dividend. For example, mounting regulation could impose additional costs, eating into profit margins. Declining rates of cigarette purchase in key markets could lead to falling revenues.

ExxonMobil

Another of the passive income ideas I use in my portfolio is ExxonMobil (NYSE: XOM). The US-based energy company is an oil and gas giant. While there is a risk that shifting energy demands cuts revenues, personally I reckon oil and gas could remain profitable for decades to come. A growing global population and lack of cost-effective substitutes in many cases should keep oil demand high for a long time.

Exxon has energy expertise that might allow it to benefit from an increase in alternative energy sources too. That could boost revenues and profits, although in the coming years I see it as insignificant compared to the main profit drivers of oil and gas. Last year saw many companies including Exxon cut back heavily on capital expenditure. That could lead to lower oil availability several years down the line. That could help support pricing.

Exxon yields around over 5%. As well as the risk of declining demand and oil price falls, there is an exchange rate risk. As the shares pay out in US dollars, currency shifts could affect how much I earn in passive income from my Exxon position.

Two simple passive income ideas

If I put £5 a day away, after a year I would have over £1,800 saved up. I could split that between BATS and Exxon. At the current yield, that would give me a projected passive income stream of around £120 per year in future. Both companies have a history of dividend growth so my passive income could increase in years to come, although that is not guaranteed.

A popular US stock, but for good reason

The first is Amazon (NASDAQ:AMZN). Before people roll their eyes at such a generic choice, hear me out. I get that Amazon is one of the most popular stocks globally for investors. Yet there are good reasons for this. The share price might only be up 7% in the past year, but it’s provided a 4.5x return over five years.

The business is also still showing growth. In its Q3 filing, net sales were up 15% versus the same period last year. Even though operating income was lower, it still made $4.9bn for the quarter, quite a staggering amount.

With the scope of diversification in business operations and recent acquisitions, I think Amazon is well-placed for the future. Clearly, one risk is that Amazon grows to such a size with so many fingers in pies that it becomes less focused and efficient.

Dividend stars

With a lot of focus on the top US stocks posting share price gains, I could easily forget about some great income picks. For example, Exxon Mobil (NYSE:XOM). It has a dividend yield of 5.8%, with a share price gain of 46% over one year.

The oil and gas company is one of the largest in the sector and has a rich history over decades since the merger of Exxon and Mobil in 1999. This gives me confidence the business will continue to function in years to come, even during tough times. 

One risk is the projection for oil prices for 2022. If we do see tighter restrictions on travel, then fuel demand will fall. If supply stays the same, this will lower the oil price and negatively impact Exxon Mobil.

Another top US stock that pays dividends is Western Union. The dividend yield for one of the world’s largest international payment businesses is 5.3%. The share price is down 17% over the past year, which is one reason why the yield has moved higher.

The share price has fallen due to decreasing offline money transfers due to the pandemic. If restrictions on travel continue, this could be a risk with investing. However, the company is able to offset some of this via growth in digital payments instead. Further, as travel picks up again, the business should naturally see a rebound.

Allocating the cash

These three top US stocks are viable options for me to consider as a UK investor. With my £1,000, I’d split it equally between the them. However, I could also invest more in a particular stock if I had a high conviction. I think Western Union is the most undervalued stock of the trio, so could put more than 33% of my money in the stock.

Overall, they’re my top pics as we head into 2022.

Let’s imagine I had £20,000 to put to work in the stock market today. If I was looking for a mixture of growth and income potential from blue chip names, here’s how I might do it. I would diversify across five sectors to reduce my risk, putting £4,000 into shares of a leading company in each one.

Digital giant: Alphabet

One of the ways I sometimes first become aware of businesses I could invest in is through using them as a customer.

Like many people, one company I interact with many times a day as a customer is Alphabet (NASDAQ: GOOG), the parent company of Google. The internet giant is ubiquitous in many people’s daily lives. From search to email, Google is the front page of the internet for hundreds of millions of users worldwide.

I think that has helped it build a level of customer loyalty that should help Alphabet remain profitable for decades to come. Its business model of selling targeted adverts is highly lucrative. But Alphabet has evolved into a diverse set of revenue streams, so that it is not purely reliant on ad income. With profits last year of $72bn, it is hard to remember that the company is little over a couple of decades old.

I like Google shares as an idea for my portfolio because I see them as a sort of royalty on future internet use. In the long term, I expect internet use to keep growing substantially. With its huge user base and proprietary technology, Google is set to continue being a key beneficiary. If profits continue to rise over time I expect the shares to do well, even if there are bumps along the road.

There is a risk that Google could become less popular with younger users as some social networks have done, which could hurt revenues and profits.

Banking shares to buy now: Lloyds

I think a recent pullback in the Lloyds (LSE: LLOY) share price offers a buying opportunity for me.

Over the past year, the shares are up 27%, at the time of writing this article earlier today. I still think there is a long-term growth story here, though. As the UK’s leading mortgage lender, the company is well-positioned to benefit from ongoing strength in the housing market. It is also looking to expand its business lines. For example, it has set out ambitions to grow its own letting property portfolio. I think there is a risk that could distract management from its core business. But if it works out, it could well add to the company’s profitability.

I also expect good news on the company’s dividend in 2022. It has a growing cash surplus, at least some of which could be put to use by boosting the dividend in line with Lloyds’ progressive policy. But dividends aren’t guaranteed and any downturn in the economy is a risk for the bank. Higher borrower defaults could hurt profits.  

Consumer goods leader: Unilever

With an eye on the long term, another name on my list of shares to buy now for my portfolio is Unilever (LSE: ULVR).

The consumer goods company owns popular brands from Dove to Hellmann’s. I like its broad portfolio of premium brands, which gives it pricing power. I also like the fact that it is highly exposed to a full gamut of markets. It does a lot of business in developing markets like India and Indonesia, as well as developed ones. That brings a risk that when there are economic downturns, revenues may fall. But it offers the benefit that, as more people worldwide increase their disposable income, Unilever can benefit from some of their spending.

For several years, the company has underwhelmed investors. In the past year, for example, the Unilever share price has slipped 8%. Some of the reasons for underperformance remain as risks. For example, rampant cost inflation could lead to lower profit margins. But I see the price fall as an opportunity to pick up a quality blue chip company for my portfolio at a more attractive price than before.

Energy titan: ExxonMobil

There’s a lot of discussion about future energy demands. No matter what may happen, one of the companies I reckon should keep doing well is energy giant ExxonMobil (NYSE: XOM).

I don’t think oil demand will disappear any time soon. In fact, unlike many commentators, I don’t even expect it to decline. While some customers may switch to alternative energies, the global customer base keeps increasing with population growth. I think that will compensate for some customers abandoning oil. With its huge operations and recent efforts to lower production cost per barrel, Exxon should keep pumping profits from its oil wells for decades. It also has a large natural gas business which I think has a promising future.

On top of that, if alternative energy really does become a big thing, I think the company’s expertise will stand it in good stead to develop a strong market position.

Energy pricing is cyclical, so the Exxon share price can be volatile. I like its income prospects, though. Having raised its dividend annually for over three decades, the iconic company currently offers a 5.7% yield.

High yield tobacco: British American Tobacco

I’d also buy British American Tobacco (LSE: BATS). The owner of famous tobacco brands including Rothmans, Camel, and Pall Mall pays a yield of 8%. That makes it one of the juiciest income shares right now in the FTSE 100.

There’s clearly a risk here. As cigarette use declines in many markets, it could hurt both revenues and profits at the company. But I think the yield helps to compensate me for that. The company has been developing non-cigarette products, including vaping and heated tobacco. They could help it grow revenues in coming years. Last week, it guided the market to expect revenue growth of over 5% for the year, adjusted for currency fluctuations. With its broad portfolio and iconic brands, BAT makes my list of five blue chip shares to buy now for my portfolio and hold for the long term.

Indeed, Shell’s first quarter earnings release issued today revealed that the firm had made $1.6bn in earnings in the first quarter on a current cost of supplies basis, excluding identified items down 58% year-on-year. This comfortably beat expectations. City analysts were expecting the company to report earnings of $1bn.

On the other hand, when BP reported first-quarter results at the end of April, the company reported a much larger year-on-year drop in profits than its larger peer. BP made a profit of $523m on an underlying replacement cost basis, 80% below the figure of $2.6bn reported in the year-ago period. Still, the market had expected the company to report a first quarter loss of $140m, so BP comfortably beat City expectations.

Crunching numbers

During the first three months of 2016, BP lost $747m from its upstream operations on an underlying basis and made $1.8bn on refining and trading, boosted by what the company said was an improved performance from its trading arm. Shell lost $1.4bn from its upstream activities ($994m in its integrated gas unit, which in previous quarters had been part of the upstream business) and $2bn from refining, trading, and retail.

Both companies also announced drastic cuts to capital spending. Shell, which acquired smaller BG Group in February, is cutting capital spending to $30bn this year, 36% less than the two companies combined spent in 2014 and BP is planning to cut capex to between $15bn and $17bn. Shell’s capex is the highest among its rivals, exceeding that of US rival ExxonMobil putting the company in a prime position to benefit if the price of oil returns to historic levels in the near future.

The one main difference between BP and Shell’s first quarter results was management’s tone on debt. You see while Shell is committed to reducing its debt after buying BG, BP’s managers seem to want to increase the group’s debt. The company specified alongside first quarter results that it was looking to increase gearing from a range of 10% to 20% to a range of 20% to 30% now that the company has agreed a $20bn settlement with the US authorities. Meanwhile, Shell is looking to reduce its gearing from around 25% back to a mid-teens level. Asset sales will be the main lever Shell is going to pull to reduce debt.

Both companies have forecast dividend yields of 7.2% for 2016.

The bottom line 

Overall, Shell and BP’s first quarter results were broadly similar. However, Shell is committed to both maintaining capital spending to ensure the group can continue to grow when oil prices recover and the company is also trying to clean up its balance sheet. BP it seems, is heading in the other direction. 

Analysts at investment bank Jefferies have suggested that Shell-BG could become bigger than ExxonMobil (NYSE: XOM.US) by 2018, reheating suggestions that Exxon might seek to protect its size advantage by acquiring one of the smaller oil majors, such as BP.

BP’s market capitalisation of $125m is only a third of ExxonMobil’s $360m market cap, and the US firm would probably have the financial firepower to take control of BP if it chose to.

Legal woes a problem?

BP’s current US legal troubles might deter ExxonMobil, which would probably be reluctant to get involved in BP’s long-running and high-profile US legal battles. Exxon’s US roots mean it may not want to be seen to be profiting from a major US oil spill, albeit indirectly.

However, BP’s battles are partly of its own choosing: I suspect that the vast majority could be settled quite quickly, if the firm wanted to smooth the way for a takeover deal.

History repeated?

The last major downturn in the oil industry, at the end of the 1990s, triggered a wave of major deals that reshaped the oil and gas landscape. Exxon joined with Mobil to become ExxonMobil. Texaco merged with Chevron, and BP acquired Amoco.

This time round, I believe there’s a possibility that BP could be on the receiving end of a bid. For ExxonMobil, the attraction would be twofold.

Firstly, the US giant could cement its position as the largest publicly-listed oil and gas producer in the world.

Secondly, and perhaps more importantly, acquiring BP at a relatively depressed price would give a significant boost to Exxon’s reserves, which like those of many large oil producers, are being depleted from production faster than they are being replaced through exploration.

Is BP cheap enough?

BP currently trades on a historical P/E ratio of less than 10, but earnings downgrades caused by the falling price of oil mean that the firm trades on a 2015 forecast P/E of 17.

However, BP’s earnings will recover strongly when the price of oil starts to rise — and if Exxon did acquire BP, the US firm’s size and famed operational efficiency would be likely to improve the profitability of BP’s operations.

Buy BP?

In my view, BP is a reasonably good buy at today’s price, regardless of any eventual takeover activity.

Buffett’s $3.7bn investment in Exxon Mobil, dating from 2013, had made the company a top 10 holding in the portfolio of his Berkshire Hathaway group.

Following Buffett’s bold move, should UK investors call time on FTSE 100 oil giants BP (LSE: BP) (NYSE: BP.US) and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US)?

The first thing I’d say is that Buffett has a patchy record of investing in the oil sector. For example, on one hand he booked a $3.5bn profit when selling out of PetroChina in 2007; on the other, he made what he called “a major mistake” when betting on ConocoPhillips right before crude prices peaked in 2008.

Another thing to note is that we don’t know exactly why Buffett dumped his Exxon Mobil shares. Is he bearish on oil, or bearish on the company, or does he simply see better opportunities for greater returns elsewhere?

Certainly, with billions of dollars under his control, there are factors behind some of Buffett’s decisions that simply don’t apply to smaller investors. Certainly, too, Exxon Mobil’s valuation is markedly different to the valuations of BP and Shell.

Analysts expect oil companies’ earnings to fall by somewhere in the region of a third to a half in 2015. Forecasts put Shell on a P/E of 16.2 (at a share price of £22), BP on a P/E of 19.1 (at a price of £4.45) and Exxon on a P/E of 22.3 (at $91).

Exxon, then, is pricier than its UK counterparts, and remains so if we look out to 2016, where the forecast P/Es are: Shell 12.2, BP 12.9 and Exxon 17.3.

The FTSE firms also appear much superior value to Exxon when we look at dividends. While Exxon’s trailing 12-month yield of 3% isn’t bad for a US company, BP and Shell both boast yields of 5.4%.

Admittedly, analyst forecasts for 2015 mean Shell’s dividend will barely be covered by earnings and BP’s will be uncovered (compared with 1.4x cover for Exxon), but the UK companies’ cover improves with the rise in earnings forecast for next year.

Of course, BP and Shell’s dividends could come under pressure, if analyst earnings expectations for 2016 prove way too optimistic. Even so, though, BP boss Bob Dudley, who expects low oil prices to persist “into the medium term”, seems confident of managing “the new reality of lower prices” with the dividend as “the first priority within our financial framework”. Similarly, Shell boss Ben van Beurden recently told Bloomberg Television: “The dividend is an iconic item at Shell and I will do everything to protect it”.

On balance, given the relatively attractive earnings ratings of BP and Shell compared with Exxon, and their much superior dividend yields, I think if I were a shareholder, I wouldn’t be rushing to follow Buffett’s lead, and selling out of my big oil investments.

Oil Majors: In A Sweet Spot?

“Oil prices tumbled on Thursday after another big weekly build in US crude inventories and a possible rise in Saudi output stoked worries about oversupply,” Reuters reported on Thursday. In early trade, Brent crude futures for April were down $1.67 at $58.86 a barrel, extending declines from Tuesday’s two-month high of $63, Reuters added. Only two days ago, the headline was: “Oil up from early sell-off as Brent sets 2015 high”.

If you are confused, don’t lose focus. 

Oil prices are holding up relatively well: Brent crude at $30-$40 a barrel is not the medium-term target. Saudi Arabia and other Opec members won’t sit idle for long, in my view. Oil prices go up and down in cycles, and this is simply a time when oil majors must cut back on heavy investment and slash operating costs in order to continue to pay dividends and report economic profits.

Things are a bit different for smaller players. As revenues plunge, they find it more difficult to procure the necessary working capital funding — for survivors, one option would be to consider deeper diversification into, say, services.

It Could Have Been Worse…

Brent crude has halved since July 2014, yet the shares of Exxon are down only 10% over the period, while BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) have lost about 12% of value. Dividends do not mitigate the losses. 

That’s not a terrible short-term performance, however. You’d feel safer if you were invested in oil majors in a world where oil prices surge to $80 a barrel, wouldn’t you? Well. that’s the world you may be living in by the end of this year. 

Either way, it’s not just about oil prices for the stocks of major oil producers. What matters, really, is how quickly producers adapt to a changing environment. Based on trading multiples, Exxon’s 33% more expensive than BP, which, in turn, is less attractive than Shell. Their strategies and the way they have communicated with investors in recent months are elements to like, in my view.

If anything, asset disposals won’t be easy to execute. 

10% Upside 

I have been keeping a close eye on Exxon for a few years now: the world’s largest publicly traded oil company is still a terrific yield and growth play, in spite of depressed oil prices, although I appreciate Exxon does not trade in bargain territory. 

Exxon has had some problems in the last couple of quarters, as one would imagine, yet there’s no reason why a value investor should jump ship now, in my view. In fact, I believe this would be a good time to add Exxon to your portfolio, betting on parity for the USD/EUR exchange rate and on a more stable USD/GBP rate. 

Exxon And Tesco: So Different, So Similar? 

Buffett’s Berkshire Hathaway got rid of 41 million shares in Exxon in the last quarter of 2014, after about a year, having acquired the $3bn-plus stake in the second half of 2013.

At that time, Exxon was high on my radar: the opportunity to invest in such an attractive yield proposition (forward yield above 3%) and on the strength of the US dollar against the euro and the British pound (+20% and +4% since the third quarter of 2013, respectively, on average) was almost too good to be true.

I gave it a pass because I found a higher yield with lower risk elsewhere, recording roughly the same pre-tax performance over the period, but now am tempted to snap up Exxon, and I don’t think current weakness in oil prices justifies Buffett’s move. 

In truth, Buffett’s exit may be a big mistake — just like when he decided to cut his Tesco losses in October. Since he divested, Tesco shares have rallied to record a pre-tax-return return of about 50%…

https://youtu.be/tvx_sFbAdps

WASHINGTON, DC — BP (LSE: BP) (NYSE: BP.US) still faces uncertainty around its 2010 Gulf of Mexico oil spill lawsuits. Despite this uncertainty, the company’s stock is slowly recovering. Even if BP ends up paying much more than it had initially estimated for the plaintiffs of the oil spill-related lawsuits, is the company’s current price still a bargain?

Oil spill lawsuits

It’s still unclear how the Deepwater Horizon oil spill lawsuit will end for BP. Up to now, the Fifth Circuit Court hasn’t approved BP’s efforts to ward off claimants whose alleged injuries were not a direct result of the 2010 oil spill. BP didn’t account for this provision and could wind up paying much more than it had initially estimated. But there is also a chance, which currently doesn’t seem too high, that BP’s lawyers will succeed in preventing BP from paying BEL claims. The main issue is how high the market currently values BP compared to its peers, which don’t have such uncertainty hovering over their heads.  

Does BP measure up to other oil companies?

Let’s see how BP is priced compared to other top-tier oil companies such as ExxonMobil (NYSE: XOM.US) and Chevron  (NYSE: CVX.US) . BP’s current market value is around $156 billion, and its P/E is relatively high at 15.8. In comparison, Chevron’s P/E is only 12.1. But this measurement doesn’t account for the level of debt or cash on hand, and it considers net earnings rather than operational profits. If we were to use the enterprise value-to-EBITDA ratio, then BP’s ratio is at about 5.8; this is much lower than the current ratios of ExxonMobil and Chevron as indicated in the table below.

Source of Data: Yahoo! Finance

Moreover, the current oil and gas average EV-to-EBITDA ratio is around 6.5. If BP’s value was increased to this average, assuming all else equal, the company’s market cap would reach more than $180 billion. The table below shows the gap difference between the two valuations.

Source of Data: Yahoo! Finance

Based on a market cap of $180 billion, the company’s stock should have been $57-plus rather than $50.

This means, under these assumptions, BP’s valuation is off by $23 billion. In other words, if most of BP’s undervaluation comes from the oil spill lawsuits, the market currently estimates the potential loss in value by $23 billion.

This brings us to the second question: What is the value of the uncertainty around the claims for economic loss?

Until year-end 2013, the company spent $12.8 billion on economic recovery and committed $2.3 billion to economic loss of claims. It also paid under the plaintiffs’ steering committee settlements $2.7 billion. In total, the company allocated $42.7 billion toward all out-of-pocket and spill-related expenses, including government penalties. Currently, the company estimates the economic loss claims will reach $9.2 billion — a higher figure than initially estimated.

Even if we were to consider a worst-case scenario, the company winds up paying $10 billion more than its initial estimates; this doesn’t come close to the $23 lower value the market currently puts on shares of BP. Moreover, the company has already allocated a significant amount of assets toward paying potential additional claims (BP plans to divest $10 billion worth of assets by year-end 2015.) Thus, it seems the market still estimates the company’s future settlements at a higher price than what BP may wind up paying.

In conclusion…

The oil spill settlement is likely to keep curbing BP’s rally. But the current market estimates still seem to undervalue BP’s stock, which should be 5% to 10% higher than its current price.