Image Source: Simon Cunningham
There is no way… hold on, let me start over.
There is absolutely no way that a company whose primary product price can fall 50% or more in a couple months is a pristine AAA-rated credit. It makes little sense. Having evaluated the credits of hundreds of companies spanning all sectors and industries, you’re never going to convince me that such a business model is worthy of a coveted AAA credit rating.
Never.
This week, Standard & Poor’s (MHFI) reiterated Exxon Mobil’s (XOM) AAA rating, as if the conditions that shellacked the energy markets the past 6 months simply do not apply to Exxon. Instead, the rating agency opted to lower the firm’s liquidity rating from “strong” to “adequate.” If you’re scratching your head at this point, so are we. From our perspective, S&P likely didn’t want to send reverberations through the credit markets with a headline-making downgrade, not that we think it would have been material in any case. The bond markets tend to price credit risk well in advance of any moves by the rating agencies.
Throwing aside the fact that crude oil prices have collapsed in recent months resulting in Exxon’s cash flow from operations being practically cut in half from last year’s first-quarter levels on a GAAP basis ($8 billion versus $15.1 billion), the company’s net balance sheet is weaker and the firm is significantly more capital intensive than either of the two other credits it shares the AAA rating with–Microsoft (MSFT) and Johnson & Johnson (JNJ). If we assume mid-single-digit annual cash dividend expansion relative to a high-single-digit pace for J&J and double-digit growth rate for Microsoft, Exxon’s dividend obligations are also quite hefty.
Source: Valuentum Securities
Neither the volatility of its business model, nor the relative comparison of its balance sheet and free cash-flow generating capacity on a forward-looking basis support Exxon’s credit rating. And our forecasts factor in a return to normalcy in the crude-oil markets! It’s time for a true downgrade. Exxon is no longer a AAA-rated credit in my book. S&P has this one wrong.