A $41 Billion Mistake That Doesn’t Really Matter
To keep energy profits growing, Exxon Mobil (XOM) made a huge bet on natural gas with the 2010 acquisition of XTO Energy. Despite weaker natural gas prices and the resulting hit to profits, CEO Rex Tillerson opined to energy analysts last month that the purchase of North America’s second-largest producer of natural gas will ultimately play out in delivering longer-term growth to earnings and cash flow.
With the $41 billion acquisition, Exxon overnight became the largest producer of natural gas in North America, catapulting beyond erstwhile leader Chesapeake Energy (CHK) and other big players, like ConocoPhillips (COP), Southwestern Energy (SWN) and Anadarko (APC). In 2012, proved reserves and production totaled 14.47 trillion cubic feet equivalent (Tcfe) and 3.82 billion cubic feet daily, respectively, up from 7.47 Tcfe and 1.27 billion cubic feet daily in 2009.
In hindsight – at least on paper – the all-stock transaction still looks terrible. Though most deals are liquid rich these days, metrics for natural gas assets purchased in the past year show that the $2.89 per thousand cubic feet equivalent (Mcfe) of proven reserves paid by Exxon for XTO assets is more than double that of current deals: In June 2012, MLP Vanguard Natural Resources (VNR) bought Piceance and Wind River gas assets in Colorado and Wyoming, respectively, from Bill Barrett Corp. (BBG) for about $1.00 per Mcfe; Lone Pine Resources (LPR) sold Alberta Deep Basin (conventional) gas assets to Canadian Natural Resources (CNQ) for $0.90 per proved Mcfe.
Nonetheless, chief executive Tillerson insists that longer-term, the XTO deal will prove accretive to earnings and cash flow. “By the year 2040,” said Tillerson,” unconventional gas will account for about one-third of global production, up from less than 15% in the year 2010.”
Despite the drag on earnings from gas-heavy XTO Energy, Exxon’s forward 12-month PE ratio of 11.2 suggests that the energy giant is inexpensive at current prices.
Unlike other natural gas players, such as Chesapeake Energy and Range Resources (RRC), Exxon hasn’t had to scramble to sell assets to generate cash needed to fund 2013 drilling budgets. In 2012, with a balanced portfolio of natural gas and liquids-rich assets, the company delivered earnings of almost $45 billion; generated free cash flow of about $22 billion; and, exited the year with $9.9 billion in cash on-hand.
The company’s ‘AAA’ bond rating attests to the strength of its credit metrics, too: In 2012, Exxon generated a return on capital employed of 25.4% (about 700 basis points higher than closest competitors); EBITDA that could satisfy annual fixed finance expenses (such as interest on long-term debt of $7.3 billion) more than 62 times; and, debt to equity was well below 10%.
Additionally, with a dividend yield of 2.56%, shareholders can patiently wait for this natural gas wager to play out Tillerson’s profitable vision further down that winding road.
David J. Phillips, a contributing editor at YCharts, is a former equity analyst. His journalism has appeared in Bloomberg BusinessWeek, Forbes, and Kiplinger's Personal Finance. From 2008 to 2011, David was a reporter for CBS News Interactive. He can be reached at firstname.lastname@example.org.
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