An investing theory has developed around buying stocks that get booted from the Dow Jones Industrial Average or the S&P 500 because they tend to go on and outperform both the indexes and the companies that replaced them for the next year or so. ExxonMobil (NYSE: XOM) is a case in point.
The oil and gas giant was kicked off the Dow in August 2020, and one year later, it beat the index with a total return of 37% to 29%. Exxon has gone on to open a dramatic lead over the Dow in the years since, with its total return more than tripling in value versus the index, generating a 25% total return for investors.
In its just-released fourth-quarter earnings report, the energy behemoth explains why it has become such a stellar stock and why it’s more than just the current conditions being favorable to the industry.
A gusher of profits
Exxon just posted its best year for profits in the oil company’s 135-year history, generating earnings of $55.7 billion, making it one of the most profitable stocks on the market (only Apple and Microsoft are better, so far).
While rising gas prices that were exacerbated by Russia’s invasion of Ukraine were certainly a large contributing factor in Exxon’s performance, and excluding impairments related to its withdrawal from its Sakhalin-1 oil fields off Russia’s Sakhalin Island, adjusted profits were $59.1 billion. There were other factors involved, ones that point to future profitability potential.
Chairman and CEO Darren Woods pointed to years of under-investment in production by the industry, causing supply to be constrained. Oil and gas companies won’t be able to meet the outsized demand from its collapse during the pandemic over the coming years.
Crude supplies have been depleted, and natural gas inventories have been reduced, a situation that has only worsened with Europe’s concern over where it will get its needed energy.
Pricing for both is well above their 10-year historical averages, and refining margins have soared because of the large numbers of refineries that were closed during the pandemic leading global refining capacity to drop by 910,000 barrels per day in 2021 — the first time in three decades there has been a decline in global capacity.
Capacity follows profits
The loss of capacity led to higher crack spreads, or the difference in pricing between a barrel of oil and the refined products produced from it, through 2022. But the higher refining margins being generated is leading to increased capacity and the U.S. Energy Information Administration expects it to increase by an additional 1.6 million barrels per day this year.
The Al-Zour refinery in Kuwait is one of the largest oil refineries in the world, able to process as much as 615,000 barrels of crude daily, and it shipped its first exports of diesel and jet fuel to Europe late last year. Saudi Arabia and the United Arab Emirates are also expected to increase European exports in 2023.
Exxon has also upgraded its own refinery in Beaumont, Tex. to increase capacity by 65%, or some 250,000 barrels a day, that should come online this June. It represents the largest capacity addition to the U.S. refining fleet since 2013, but it’s important to remember Exxon is a global energy giant, and of the $12.75 billion in net profits it generated in the fourth quarter, $7.9 billion, or 62%, came from outside the U.S.
Going against the grain
The energy giant was able to capitalize on the current conditions because it zigged when other industry players zagged. Woods said, “of course, our results clearly benefited from a favorable market, but to take full advantage of the undersupplied market our work began years ago, well before the pandemic when we chose to invest counter-cyclically.”
Exxon invested heavily in its core businesses, like its refining business with projects in the Netherlands and Texas; in liquefied natural gas (LNG) export facilities around the world, such as in Mozambique, where it began shipping in November its first cargos from the Coral South project; and in new production in the Permian Basin and the vast oilfield off the coast of Guyana, where it is the lead operator and believes it could produce as much as 1 million barrels of oil per day by the end of the decade.
Exxon says it will invest between $20 billion and $25 billion annually through 2027 on further capital expenditures across the company.
Sharing the wealth
With operating cash flows rocketing 60% higher this year to $76.8 billion, it spent $30 billion on stock buybacks and dividends last year. It expects to repurchase $35 billion’s worth of stock over 2023 and 2024. Exxon also increased its dividend 3% last year, the 40th consecutive year the payout has risen.
With global structural imbalances between supply and demand, a head start years in the making of investments to narrow the gap, and sharing its success with its shareholders, ExxonMobil is an integrated oil and gas stock that still has many years of growth ahead of it.
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Rich Duprey has positions in ExxonMobil. The Motley Fool has positions in and recommends Apple and Microsoft. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.