Exxon Mobil Corp. (NYSE:XOM) has had a tough time recently. Many years of reduced oil selling prices have lower into the Texas-centered oil titan’s cash flow, which has induced it to get rid of much of its market capitalization. Things arrived at a new low past yr many thanks to the financial disruptions wrought by the coronavirus pandemic. Like so many other oil producers, Exxon faced profound economic problems as oil costs plummeted.

As 2021 kicks off, there are some symptoms that Exxon’s decades of underperformance might be coming to an close. Morgan Stanley (NYSE:MS) is the newest Wall Road firm to highlight Exxon’s prospective. On Dec. 11, the financial investment bank anointed Exxon as its new top select amongst big oil shares, replacing Chevron Corp. (NYSE:CVX). I am not so sure.

Chopping back again on overhead and growth financial commitment

According to Morgan Stanley, there are 3 motorists behind Exxon’s turnaround story. To start with and foremost is its prosperous initiatives to reduce expenses:

“In response to the 2020 oil value collapse, XOM prudently deferred its countercyclical progress ideas, reducing 2022-2025 capex from $30-35B to $20-25B, with more substantial reductions to $16-19B in 2021. On top of this, administration has disclosed programs to slice cash functioning expenditures by at minimum 15{e0233a5a8ca3dab8ed448c5451aba2c38c77d167988a5d203483ecea09d61312} with total information very likely to be disclosed in excess of the coming months. We have analyzed XOM’s cost composition relative to CVX and estimate reductions can arrive at ~23{e0233a5a8ca3dab8ed448c5451aba2c38c77d167988a5d203483ecea09d61312} from 2019 concentrations, exceeding advice and consensus expectations.”

Exxon’s prepared 15{e0233a5a8ca3dab8ed448c5451aba2c38c77d167988a5d203483ecea09d61312} reduction in operating overhead would definitely allow for it to far better temperature potential economic shocks. The 23{e0233a5a8ca3dab8ed448c5451aba2c38c77d167988a5d203483ecea09d61312} reduction predicted by Morgan Stanley would be even much better. If the organization can carry on to execute on its charge-slicing efforts productively, there is sufficient motive to imagine it will get well at minimum some of its lustre in the in the vicinity of phrase.

However, Exxon’s cost reductions also incorporate strategies to slash expansion capex. When that might assist the company’s economic wellness in the quick operate, it also dangers hampering development about the extensive run. Bringing new extraction tasks on the net demands considerable investments of time and resources. Exxon could end up shelling out a higher value for its economizing down the line.

Income flow fueled by oil price rebound

The next driver discovered by Morgan Stanley issues Exxon’s totally free money stream anticipations. Especially, the financial investment bank predicts that rebounding oil and gasoline rates will act as a tailwind:

“A tightening world wide oil marketplace, rebounding gas rates, forward crack spreads that have started to rally, and an increasing chemical compounds outlook supports margins transferring back again inside of historical ranges for all of XOM’s core company units.”

In accordance to Morgan Stanley, the rate of Brent crude must reach $60 per barrel in the second 50 {e0233a5a8ca3dab8ed448c5451aba2c38c77d167988a5d203483ecea09d61312} of 2021, which would make it possible for Exxon to boost cost-free cash circulation substantially. In fact, the financial commitment bank predicts that the enterprise will develop about $17.5 billion in cost-free dollars circulation this calendar year, perfectly previously mentioned the Wall Avenue consensus estimate of roughly $12 billion.

The price of oil is crucially critical to the operational and economical well being of Exxon, as it is for all oil producers. If Morgan Stanley’s oil cost prediction retains genuine, the company could certainly delight in a surge in funds flow. Nevertheless, the prospect of $60 for every barrel is significantly from specific. Indeed, whilst need is without doubt selecting up, so far too is offer, which, in accordance to the U.S. Power Details Administration’s December marketplace outlook, is established to raise by 5.8 million barrels for each working day in the new 12 months. In the for a longer period operate, oil may experience nonetheless even further pricing pressures as the price of oil discovery improves in the coming years.

Dividend no extended in risk

The 3rd and last arrow of Morgan Stanley’s Exxon thesis is all about the dividend. The company’s dividend has been below force for some time. It unsuccessful to include the dividend and capital expenditures organically in equally 2018 and 2019. Final year’s crisis-driven collapse of the oil selling price drove Exxon’s dividend cover deeply negative, main several to dilemma no matter if it could afford to pay for to continue shelling out. According to Morgan Stanley, this is established to adjust in 2021:

“Proactive cost & capex cuts coupled with rebounding commodity prices and downstream & chemicals margins assist outsized fee of modify in FCF and dividend deal with for XOM in 2021.”

Morgan Stanley predicts that Exxon’s dividend protect will boost substantially in 2021 as rebounding strength price ranges travel far more money circulation. But that prediction relies on the assumption that the oil price tag rally will continue on indefinitely. In accordance to Morgan Stanley’s calculations, Exxon will will need the price tag of Brent to stay at or above $49 per barrel in get to address even its minimized capital expenditure plans and dividend. Nevertheless even now Brent is hovering around $51 per barrel.

Further more oil selling price declines in the deal with of increasing offer are surely not off the table. In fact, Exxon’s have interior forecast, released by the Wall Road Journal on Nov. 25, predicts a prevailing oil price tag of $50 to 55 for every barrel in excess of the upcoming five several years. Underneath this sort of situations, Exxon’s dividend could once more arrive beneath stress.

My verdict

With an 8{e0233a5a8ca3dab8ed448c5451aba2c38c77d167988a5d203483ecea09d61312} yield and comfy deal with in 2021, Exxon’s dividend may verify increasingly desirable to earnings investors. A close to-phrase inventory price rebound could also be on the playing cards if oil selling prices go on to organization up all through the yr.

Nonetheless, I am not absolutely sure about Exxon’s prospective buyers above the lengthy operate. Its future is at the mercy of prevailing oil selling prices. Additional demand from customers shocks, in addition to secular offer raises, could effectively undermine the value of oil. That could verify problematic for Exxon’s generous dividend. Additionally, slicing back on development investments may possibly force cash circulation in the many years in advance.

In my assessment, buyers would do perfectly to check out Morgan Stanley’s fresh optimism with a nutritious dose of skepticism. Exxon’s foreseeable future could confirm brighter than its recent previous, but it may well tumble quick of bulls’ expectations.

Disclosure: No positions.

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About the creator:

John Engle

John Engle is president of Almington Cash Service provider Bankers and main financial commitment officer of the Cannabis Money Group. John specializes in value and special problem methods. He retains a bachelor’s degree in economics from Trinity Higher education Dublin, a diploma in finance from the London School of Economics and an MBA from the College of Oxford.