Exxon Mobil Stock: Strong Buy Based On Improving Fundamentals (NYSE:XOM)

Exxon Mobil (XOM) already benefited from higher petroleum prices in 2021, but 2022 could lead to record free cash flow for the firm if petroleum prices remain as high as they are now. Petroleum (crude) prices increased 7% today to reach a record $115 a barrel on growing fears about an escalating war in Eastern Europe. Based off of free cash flow, shares of Exxon Mobil, despite a growing valuation, is still undervalued.

Exxon Mobil is set for a record (free cash flow) year

Russia’s invasion of Ukraine has changed the fundamentals in petroleum markets materially since the invasion began a little more than a week ago. The price for a barrel of crude oil has shot up by $30 in the last couple of weeks, bringing petroleum prices to record levels not seen since 2008. Petroleum prices shortly spiked close to $140 a barrel on fears that Europe and the U.S. could go a step further and impose sanctions on the Russian energy sector.

Petroleum prices are already soaring, but prices could climb significantly higher in the short term, especially if other countries sanction Russia’s important energy sector. Embargos on Russian energy sales are now openly discussed, which, should they be implemented, would likely result in sharply higher prices for oil and natural gas products. Exxon Mobil also said that it will discontinue Russian operations and abandon its venture investment in the Sakhalin-1 De-Kastri oil terminal in Khabarovsk Krai. Exxon Mobil’s Russian assets were valued at approximately $4.0B before the exit was announced and leaving the country is said to lower Exxon Mobil’s earnings and production by 1-2% annually. The production impact, however, is only small and the material increase in petroleum pricing should make more than up for a 1-2% earnings decline.

The significant increase in pricing for petroleum products is set to fuel Exxon Mobil’s free cash flow growth. Exxon Mobil’s significant earnings growth in FY 2021 was chiefly related to higher market prices for petroleum products.

Due to the strong increase in petroleum prices in the first quarter, Exxon Mobil is looking at massive gains in free cash flow as well. I estimate that ExxonMobil will see a $4.0B quarter over quarter increase in free cash flow in Q1’22. Exxon Mobil’s operating-cash-flow-to-free-cash-flow conversion will likely remain comparable to 4Q-21 levels as production costs remain steady and only market prices changed to the benefit of Exxon Mobil. This means Exxon Mobil will likely keep a larger share of operating cash flow in 1Q-22.

With $22.0B in operating cash flow and $19.0B in free cash flow expected for Q1’22, Exxon Mobil could even announce an increase in its $10.0B share buyback that is set to begin in the first quarter of 2022. With this much cash accumulating on Exxon Mobil’s balance sheet, the company could easily double its buyback and give shareholders a substantial dividend increase as well.

	2022	2021
$B	Quarter 1 (E)	Quarter 4	Quarter 3	Quarter 2	Quarter 1
Cash Flow from Operating Activities	$22.0	$17.1	$12.1	$9.7	$9.3
Proceeds from Asset Sales	$0.0	$2.6	$0.0	$0.3	$0.3
Cash Flow from Operations and Asset Sales	$22.0	$19.7	$12.1	$9.9	$9.6
PP&E Adds / Investments & Advances	($3.0)	($4.6)	($3.1)	($3.0)	($2.7)
Free Cash Flow	$19.0	$15.1	$9.0	$6.9	$6.9

(Source: Author)

Exxon Mobil retains upside in FCF if petroleum prices continue to climb, especially in case of sanctions being imposed on Russia’s energy sector.

Exxon Mobil has been more profitable than its rivals

Exxon Mobil generated higher capital returns than its rivals in the last decade which has been the result of large strategic investments in new energy projects, a strong production business generating 68% of company cash flow and a relentless focus on lowering break-even costs.

Exxon Mobil’s break-even cost for a barrel of petroleum was $41 in FY 2021 and the firm is cutting structural costs to lower the break-even level even more. If petroleum prices remain high and break-even costs continue to fall, as projected, then Exxon Mobil makes a larger profit on each barrel produced. By FY 2027, Exxon Mobil’s break-even level is projected to drop 27% to $30 a barrel.

Unless petroleum prices really crash in 2022, Exxon Mobil is likely going to achieve a record year regarding free cash flow. I can see Exxon Mobil achieve $55B to $60B in free cash flow in FY 2022, assuming that petroleum prices remain above $100 a barrel. My previous estimate implied FY 2022 FCF of between $45B and $50B.

Exon Mobil’s free cash flow is still cheap

With up to $60B in free cash flow expected this year, shares of Exxon Mobil are still cheap. Exxon Mobil currently has a market capitalization of $356B. Based off of $55B to $60B in free cash flow in FY 2022, shares of Exxon Mobil have a 6.0 X – 6.5 X P-FCF ratio.

Risks with Exxon Mobil

The big risk with Exxon Mobil is that the firm doesn’t achieve consistent investment returns over time. Exxon Mobil is forced to endure cycles of falling and rising petroleum prices which are entirely out of control of the company. The consequence is that Exxon Mobil does extremely well during bull cycles which go hand in hand with high prices and very badly during bear cycles where prices are much lower. Petroleum prices are also not going to stay as high as they are now, which implies that Exxon Mobil’s free cash flows are going to decline in the future.

A rapid solution to the war in Eastern Europe would likely cause petroleum prices to drop quickly and the potential for free cash flow growth may not materialize for Exxon Mobil. If the situation gets worse, however, Exxon Mobil could benefit from higher petroleum prices for a longer period of time.

Final thoughts

Exxon Mobil is going to benefit greatly from the surge in petroleum prices above $100 a barrel in the first quarter and the company is likely to report record free cash flow in Q1’22 and possibly in FY 2022. Based off of free cash flow, shares of Exxon Mobil are still cheap and the firm may decide to increase its dividend and buybacks because of record profitability!