The Oil Majors – Update
8th January 2021
Introduction
We have previously commented on the recent fortunes of ExxonMobil. It was once one of America’s great companies and is currently under attack from several shareholders, most notably Engine No. 1. Since the publication of our previous blog on the subject in December 2020, the company has released its third quarter numbers. In addition, we now have the year-end share prices from which we can go on to finalise the total shareholder return (TSR) numbers for 2020.
There is no denying that the Covid-19 pandemic has had a dramatic and pernicious impact on the trading conditions of the four major oil producers under review ie BP, Royal Dutch Shell, Chevron and ExxonMobil. However, our hypothesis is that the longer-term economic performance of the business and the consequent performance for shareholders reveals that the strategic challenges facing the company predate by some years the onset of Covid-19.
Recent Performance
To begin with, let us look at the TSR performance of the four companies against the S&P 500;
The data behind the above chart is illustrated below;
In effect, the differential in TSR performance between the S&P 500 and the lowest performance value of the above sample (Royal Dutch Shell) is a staggering 55.2% (38.9% + 16.3%) and for ExxonMobil it is an equally worrying 52.2% (35.9% + 16.3%).
A Longer-Term Perspective
Of course, we would always argue that whilst the TSR performance over the past year is indeed interesting, a more informed perspective requires analysis over a longer period. Accordingly, set out below is the TSR performance of the four oil majors against the S&P 500 rebased to 100 in December 2014 – a six-year period.
The above chart clearly demonstrates that from around the middle of 2015 through to the end of 2020, ExxonMobil has significantly underperformed when compared with its three principal competitors. Over the entire period, BP is the best performing share, ahead of both Chevron and Royal Dutch Shell.
However, the broader point is that from a shareholder perspective, ExxonMobil has been significantly adrift of its competitors for a considerable time period.
Economic Performance
We believe that share prices are driven by multiple, often obscure, forces. In the end, the fundamental financial performance of the business and expectations thereof is the most significant long-term driver of share prices and, by inference, market valuation. Again, we believe that the best indicator of fundamental financial performance is Economic Profit defined as NOPAT (Net Operating Profit After Tax) less a charge for ALL of the capital used by the business. It is a measure, which unlike accounting profit and the rather suspect ‘EBITDA’ includes ALL of the costs of running a business and therefore gives a much more informative picture of business activity.
Set out below is the economic performance of ExxonMobil from 2014 through to the third quarter of 2020 ie the 9-month period ending 30th September 2020;
Thus, some facts regarding ExxonMobil’s economic performance…
- The last time the business covered all of its costs and produced an economic surplus was back in 2014 with an economic profit of $11.5bn.
- Over the above period, the total economic loss is a hefty $39.3bn.
- The average annual loss over the 6.75 years from 2014 through to the end of September 2020 is $5.8bn.
- In the first 9 months of 2020, the economic loss stands at $19.8bn. This is £12.2bn greater than the 2019 annual total of $7.6bn, which in itself is an indication of how hard the pandemic has hit the business.
- When examining the company’s economic track record, it is difficult to argue that the capital markets are being irrational in their assessment of the company via its share price.
For the sake of clarity, the economic profit measure combines three things: information from the profit and loss account, the balance sheet and capital market expectations via the “Beta” within the cost of capital calculation.
In our view, such a combination gives the metric a signalling attribute with clear advantages over return on investment, earnings per share or even cashflow.
Of course, there is more to business strategy than a relatively straight forward economic profit calculation but, that said, the choice of performance objective has a profound impact on strategy and its formulation. For instance, a company that decides to select or gives precedence to ‘return on investment’ will have markedly different strategies to that of a similar company focussed on earnings per share. In fact and from experience, the wrong choice in the performance objective is often the root cause of strategic difficulties further downstream.
We do firmly believe that the Boards of publicly quoted companies should have a performance objective of maximising economic profit and its growth over time. We see no reference to economic profit or this objective within the ExxonMobil Annual Reports.
Let us emphasise once again, no one is denying that the pandemic has been ruthless in its consequences for the major oil producers. However, as the above analysis clearly reveals, the challenges facing the executive team at ExxonMobil long predate the pandemic and its onset.
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