Exxon Mobil (NYSE:XOM) shares are down 52% in 2020. With Exxon Mobil stock now trading at just 21 times forward earnings with a 10.5% dividend, a new debate is raging. Is Exxon one of the highest-yielding blue chip stocks on the market? Or is its 10% yield the bait for the market’s biggest value trap?
There is certainly plenty of evidence that Exxon is a value trap. But there’s also a case to be made that Exxon has simply been the victim of unprecedented circumstances in 2020.
If Exxon can simply stop the bleeding at some point, the stock could be worth a gamble for the dividend alone.
Exxon Mobil Stock: The Value Trap Case
Former hedge fund manager Whitney Tilson has been calling Exxon Mobil stock a value trap since back in February. Even with the stock down more than 40% since that time and banished from the Dow Jones, Tilson says little has changed about his bearish outlook. In fact, he says there’s a case to be made that Exxon is even more of a value trap now than it was at the beginning of the year.
As recently as 2012, Exxon Mobil’s operating cash flow far exceeded the cost of both its capex and dividends. However, in the past four quarters, Tilson says Exxon’s operating cash flow hasn’t even covered its capex alone, much less its dividends.
Instead, Exxon has covered its capex and dividends by taking on more and more debt. In 2012, Exxon had less than $5 billion in net debt. As of the second quarter of 2020, that number is now above $55 billion.
“In conclusion, my message to investors hasn’t changed: ExxonMobil’s stock is a classic value trap,” Tilson says. And he thinks the dividend is in danger.
“The company doesn’t come within a country mile of generating the cash flow to cover it, so it will eventually be forced to cut it,” he said.
The Case Against A Dividend Cut
At this point, the biggest selling point for Exxon Mobil is that massive dividend. But if Exxon is truly a value trap, the dividend’s days are likely numbered. Borrowing more and more money to pay a dividend is a losing long-term recipe.
A dividend cut or suspension would likely go a long way in improving Exxon’s near-term financial situation. But investors care much more about the share price. And there’s evidence that a dividend cut would only make things worse.
Exxon is a member of the prestigious “dividend aristocrats.” The dividend aristocrats are S&P 500 stocks that have raised their dividends for at least 25 consecutive years. On April 30, Royal Dutch Shell (NYSE:RDS.A, NYSE:RDS.B) announced its first dividend cut since World War II. The idea was for Shell to be aggressive in shoring up its balance sheet to manage the difficult market. In the meantime, Exxon has continued to rely on debt to pay its dividend.
In the five months since Shell cut its dividend, Exxon Mobil is down 27.2% while Shell’s stock is down 33.2%.
Bank of America analyst Doug Leggate says the dividend is the biggest reason to own Exxon at this point.
“Absent the dividend, what is the investment case?” Leggate says.
Why Invest In Exxon?
Many investors don’t seem to fully understand the Exxon Mobil bull case. Leggate says owning Exxon Mobil stock is all about the dividend, even in the long-term.
“We believe XOM has the capex, opex and balance sheet flexibility to sustain its growth strategy through the bottom of the cycle, and the objective of that strategy that is to support a reliable and growing dividend,” Leggate says.
Exxon Mobil reported zero cash flow in the second quarter. However, the company is executing a plan to double its 2017 cash flow through 2025.
Exxon has invested in more than 30 major projects since 2013, most of which have higher margins than its legacy business. Leggate is projecting more than $12 billion in free cash flow for Exxon in 2021, even higher than 2018 levels. In 2022, he is projecting more than $16 billion in free cash flow. In fact, Bank of America has a “buy” rating and $77 price target for Exxon.
At the end of the day, there’s a strong case to be made that Exxon Mobil stock is a value trap. But Bank of America’s projections paint an entirely different picture. If Exxon is able to generate the type of free cash flow growth that Leggate is projecting in the next two years, the stock could be a great buy. If not, the stock and its dividend are likely dead in the water.
For now at least, investors are getting paid 10% to wait and see.
On the date of publication, Wayne Duggan held a long position in RDS.B.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book Beating Wall Street With Common Sense, which focuses on investing psychology and practical strategies to outperform the stock market.