Exxon Mobil, ConocoPhillips, and Chevron reported improved earnings and cash flow during the first quarter of 2018, thanks largely to higher realized energy resource pricing. The group may be better positioned for further bottom-line expansion moving forward as volume growth is expected to continue over the course of the year.
By Kris Rosemann
Key Takeaways
Crude oil markets continue to improve, and higher realized prices are benefitting major oil producers, but geopolitical uncertainty and strong growth in US production continue to cast shadows over the space. The unpredictable nature of commodity prices, and the geopolitical uncertainty that sometimes drives them, will never go away.
Exxon Mobil’s earnings and free cash flow generation improved thanks to higher realized prices, and its balance sheet continue to improve. However, concerns over logistics in certain operations and potentially weak upstream production positioning relative to rivals should be monitored closely.
ConocoPhillips continues to battle back following the prolonged downturn in energy resource pricing earlier this decade. Adjusted earnings turned positive in a meaningful way from the first quarter of 2017, and free cash flow improved nicely. However, we’re only two short years removed from a dividend cut caused by volatility in the crude oil markets, which can never be ruled out as a possibility in the future.
Chevron reported impressive earnings growth in the first quarter of 2018, but its improved free cash flow generation continues to run below cash dividends paid. Nevertheless, we like its opportunity to continue recent volume growth in high-margin areas, which has it well-positioned to take advantage of the recent and potentially ongoing strengthening of crude oil prices.
Exxon’s Free Cash Flow Takes a Step Back Despite Higher Prices
Exxon Mobil’s (XOM) first-quarter 2018 report, released April 27, left a bit to be desired despite GAAP earnings jumping 16% from the year-ago period. Management is quick to point to its highest level of quarterly cash flow since 2014, but this company-specific calculation of cash flow from operations plus asset sales is not the best representation of its true cash flow generating capacity. GAAP cash flow from operations did advance in the quarter, growing more than 4% on a year-over-year basis to just over $8.5 billion, but significantly higher capital spending ($4.9 billion compared to $4.2 billion) resulted in free cash flow taking a step back to ~$3.7 billion from $4 billion in the comparable period of 2017.
In Exxon’s upstream operations, crude oil realizations were $10.80 per barrel higher and natural gas realizations $0.90 per kcf higher than the first quarter of 2017, and management noted that global refining margins remained generally strong, especially in its North American downstream operations. However, concerns in its Canadian operations due to an increased discount for heavy-crude grades found in Western Canada as supply outpaced pipeline and rail capacity created logistic constraints are weighing on optimism in its near-term outlook. Heavy crude from Canada typically carries lower margins, relatively speaking, and increased discounts created by logistical issues only exacerbate this effect.
Nevertheless, free cash flow generation, as measured by cash flow from operations less capital spending, was sufficient in covering quarterly dividends paid of ~$3.3 billion, and the company made progress in improving its balance sheet health in the quarter as its cash balance grew to $4.1 billion from $3.2 billion at the end of 2017 and total debt fell to $40.6 billion from $42.3 billion at the end of 2017. Management raised its second-quarter dividend 6.5%, marking the 36th consecutive year of an increase in the annual dividend.
While we continue to like Exxon’s cash flow generation in this stabilizing energy resource price environment, we’re not discounting concerns over its upstream growth opportunities, and it should be noted that its $3.5 billion in upstream earnings in the quarter included a gain on assets sales of $366 million. Management remains upbeat on its growth projects in areas such as Guyana and unconventional US production in the Permian and Bakken regions, but we’ll be watching closely as developments unfold. Excluding entitlement effects and divestitures, oil-equivalent production fell 3% at Exxon in the first quarter, but management expects to return to production growth in the second half of 2018 after another quarter of declines in the second quarter.
We currently value shares of Exxon at $89 each, and its free cash flow coverage of dividends in the first quarter supports is healthy Dividend Cushion ratio of 1.4. Shares yield ~4.3% as of this writing.
ConocoPhillips Turnaround Efforts Progressing
ConocoPhillips’ (COP) first-quarter report, released April 26, revealed a flip to positive adjusted earnings of $1.1 billion from an adjusted loss of $0.2 billion in the year-ago period thanks in large part to higher realized energy resource prices. Production in the quarter excluding Libya advanced 4% when excluding the impact of divestitures, and management raised its full-year production expectations as a result of its first-quarter outperformance and reduced disposition assumptions.
Cash flow from operations grew 34% on a year-over-year basis to $2.4 billion, resulting in free cash flow generation of $864 million, a 5% increase over the comparable period of 2017, despite capital expenditures growing nearly 60%. The company’s improved cash flow generation easily covered dividends paid of $338 million in the quarter, as well as share repurchases of $500 million. It was able to reduce total debt by $2.7 billion, but the company still held a net debt position of ~$11.8 billion compared to ~$11.5 billion at the end of 2017.
ConocoPhillips was able to outpace consensus expectations in the first quarter, and we liked the improved free cash flow generation despite a significant increase in capital spending, which reflects the improved project investment environment. The company’s total realized price of $50.49 in the first quarter compared to $36.18 in the year-ago period underscores the dependence of oil majors’ on volatile commodity prices, and though the global crude oil market appears to be rebalancing effectively, geopolitical tensions are inherently unpredictable and have a significant impact on energy-resource pricing, perhaps more so than any other space in the market.
We’re sticking with our $50 per share fair value estimate for ConocoPhillips for the time being, and its strong Dividend Cushion ratio of 2.2 was reflected in its ample coverage of dividends with free cash flow in the first quarter. Management raised its quarterly payout 7.5% during the first quarter, but we must remind investors that it was only two short years ago that the company was forced to cut its payout as a result of turmoil in the crude oil market. Shares yield ~1.75% as of this writing.
Chevron Notes Momentum in Upstream Production
Chevron (CVX) turned in a solid first-quarter report April 27, which revealed solid improvements in earnings and free cash flow generation thanks to rising volumes and materially improved price realizations. Earnings leapt more than 35% on a year-over-year basis to $3.6 billion, marking its highest earnings since the third quarter of 2014, as material upstream growth was offset by a decline in downstream earnings, but management remains upbeat on its downstream potential despite realizing lower margins in the first quarter as operations began at its 50%-owned new ethane cracker, which will be one of the largest of most energy-efficient operations of its kind in the world.
Cash flow from operations advanced nearly 34% from the year-ago period to more than $5 billion, and free cash flow generation came in at $638 million compared to negative $615 million in the comparable period of 2017. Free cash flow generation is still running well below dividend obligations as the company paid out $2.1 billion in dividends in the first quarter, though management is quick to note that working capital impacts of cash flow generation occur unevenly throughout the year. Total debt advanced to more than $39.7 billion in the quarter from $38.8 billion at the end of 2017, but its cash balance improved nearly $1.7 billion to $6.5 billion.
While we are not particularly fond of Chevron’s current dividend coverage and balance sheet, its momentum in high-margin volume growth (notable strength in its Australian and Permian Basin operations) is encouraging, and upstream volumes are expected to continue increasing. The company looks to be well-positioned to continue taking advantage of the stabilizing energy resource markets despite relative weakness in its downstream operations. It sold its Canadian refining asset in 2017, which weighed on international downstream input, a move we like given the heavy grades of crude that come out of Canada.
Our fair value estimate for Chevron currently sits at $111 per share, and its 0.9 Dividend Cushion ratio appears appropriate given its current dividend coverage, debt load, and expectations for further higher-margin volume growth. Shares yield ~3.6% at the time of this writing following a 4% increase in the payout in the first quarter.
Oil & Gas – Independent: APA, APC, CHK, CLR, COG, DNR, DVN, EOG, MRO, NBL, OXY, PXD, RRC, STO, SWN
Oil & Gas – Major: BP, COP, CVX, RDS, TOT, XOM
Related: XLE, USO
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.