Exxon Mobil Corporation (NYSE: XOM) had a decent third quarter; $ 4 billion in net income is pretty good considering the expected rise in stronger oil prices will occur this quarter. One thing that really stood out in this earnings cycle was the comment on the future capital allocation strategy of Exxon Mobil Corporation that investors should take into account.
Capital allocation priorities do not include additional repurchases
Exxon spent $ 496 million during the first nine months of 2017 to repurchase six million of its common shares to offset dilution related to stock-based compensation. That was overwhelmed by the 96 million shares issued during that period to finance the purchase of several companies in the Permian basin of the Bbad family and its acquisition of InterOil. This is the reason why the number of outstanding XOM shares rose from 4,148 million at the end of last year to 4,237 million at the end of the third quarter of 2017.
In the Exxon earnings press release, he noted that "the corporation will continue to acquire shares to offset the dilution along with its benefit plans and programs, but currently does not plan to make purchases to reduce outstanding shares." Exxon Mobil generally completes its first quarter antidilution repurchases of the year. During the conference call, management commented:
"ExxonMobil did not repurchase shares to offset the dilution related to our benefit plans and programs [during Q3] and we do not currently plan to make additional purchases to reduce outstanding shares in the fourth quarter. "
When the broader repurchase problem was pressed during the Q & A session, management made it clear that beyond the current anti-dilution program, share repurchases are not a priority in the agenda Exxon:
"[T] The way we think about our sources of funds, the first thing that is financed is our dividends and our investment program, and if there is cash left at that moment, given that the corporation does not want to have large reserves of cash, it is at that point, we will look for what is the next best option.
And maybe, if we have some venci debt, we will pay that debt. But quarterly, we will make a decision on whether to go ahead and repurchase some shares. "
It seems that Exxon Mobil first wants to obtain a consistent and sustainable cash flow position before deciding what to do with the generation of surplus cash, covering its dividend and capital expenditure is a priority, since they are organic and continuous requirements. After that, debt reduction and having a good cash balance is Exxon's second priority.Rebuys seem to be in third place on that list, and that is a reasonable capital allocation strategy.
share buybacks are only justified by doing so with free cash flow, particularly when there is already debt on the books Accept a debt (or spend in cash) to repurchase ordinary shares, except for those shares that exhibit an abnormally high dividend yield , is (in my humble opinion) a terrible idea, especially in an industry as volatile as the oil and gas space.
Exxon is aware that they have A large debt burden creates a large overprice in the price of its shares, and it is eaten in its final balance. The company spent $ 1.4 billion on activities related to reducing debt and financing in the third quarter, which reduced its total debt burden by $ 1.3 billion (compared to the end of the second quarter) to $ 40.6. one billion The rest was presumably used for other financing and debt retirement costs.
Measuring the cash flow situation
Factoring in an accumulation of working capital of $ 1.4 billion (mainly due to Hurricane Harvey, which created a $ 1 billion construction), $ 0.9 Exxon Mobil generated $ 8.9 billion in organic cash flow ($ 4 billion in net income plus $ 4.9 billion in non-cash depreciation expenses) versus $ 3.3 billion in dividend payments and just under $ 6 billion in capital expenditures the last quarter.
Capital spending includes the acquisition of Jurong Aromatics, which saw Exxon's investment in non-US chemical products go from $ 100-150 million quarterly to $ 1,800 million in Q3 (agreement closed in August). Investors must bear in mind that the acquisition of 2,800 million dollars in Mozambique should be closed this quarter, which will be added to Exxon's rising international capital spending. Exxon is buying the mbadive gas discoveries in the offshore block of Area 4 that theoretically should be able to support a mbadive land LNG export complex.
Exxon intends to spend $ 22 billion in capital spending in 2017 and so far (Q1-Q3) has spent just under $ 14.2 billion. The purchase of Area 4, the increase in unconventional spending and operations in Brazil will boost Exxon's quarterly capital spending this quarter, possibly up to $ 8 billion, but management has room to push capital spending slightly below of the orientation to conserve cash (a decision that will be based on the price of oil).
In the short term, Exxon should reap huge profits from rising Brent and WTI prices, and higher Brent prices will also improve LNG prices (both for spot prices and long-term LNG sales) ). forward contracts). Whether this will be enough to drive Exxon's cash flow generation high enough to cover a high level of capital spending in the fourth quarter remains to be seen. The price improvement of Alaska North Slope, which closely follows Brent, will be a big help for its oil production streams.
Assuming that Brent / ANS averages $ 60 and WTI $ 55 in 2018 (against $ 52 Brent and $ 48 WTI in Q3 2017), the increase should be enough to allow Exxon to achieve at least the neutrality of the cash flow. If the company controls its capital expenditure, then it is possible to generate free cash flow.
Debt reduction, controlled spending habits, better bottom-up realizations (oil, natural gas liquids and liquefied natural gas) due to a better fixation of Brent environment, and to build its downstream division (particularly on the Chemicals side) , both nationally and internationally) are the three main ways in which Exxon expects to increase its cash flow generation until 2020.
It is forecast that its upstream production base will remain flat at -4.4.4 million BOE / d during that period of time, but investors should keep in mind that Exxon's production fell to 3,878 million BOE / d in Q3. That is a risk that needs to be monitored.
Exxon has been growing its Permian footprint through surface acquisitions (Level 1-2), midstream investments (buying an oil terminal in Wink, TX, and its stake in the newly formed Permian Express Partners), and a growing upstream production base. That will help offset decreases in mature fields elsewhere, but it has been an uphill climb so far.
The increase in Liquefied Natural Gas exports from the Gorgon LNG company in Australia and (potentially) the growth of its Bakken / Three-Forks operations in North Dakota will boost Exxon's production closer to the lower end of its orientation . In the longer term, several important oil discoveries in Guyana, exploration and evaluation efforts in the Campos basin of Brazil, and the optimization and delineation efforts in Argentina's Vaca Muerta shale will help Exxon manage its upstream production base.
On a side note, Hurricane Harvey negatively impacted Exxon's bottom line at $ 160 million last quarter. While hurricane activity caused a sharp increase in refining margins for many operators, upstream closures, repair costs and a blow to Exxon's national chemical unit damaged its financial performance. The restart and acceleration of its operations in the Gulf of Mexico should correspond to Exxon this quarter, or at least mitigate the impact of the reduction in refining margins.
Exxon Mobil Corporation is making the right decision by reducing its debt burden and expecting more certainty about oil prices before deciding how it wants to reward shareholders. In case Brent is worth more than $ 60 for a long time, Exxon Mobil Corporation can increase its dividends, pay its debts, invest more in growth projects in an attempt to increase profits and / or repurchase shares to reward the investors.
However Exxon Mobil Corporation has to manage those cash uses within the realities of its "limited" cash flow generation compared to the boom days of $ 100 + WTI / Brent. From now on, covering the organic uses of cash and ensuring that your dividend can be maintained in perpetuity is a top priority, followed by a reduction in the debt that frees the cash flow by reducing your interest expenses. Stock repurchases will have to wait. To read more about Exxon Mobil Corporation, see its Permian growth story by clicking here.
Disclosure: We have no positions in any of the aforementioned actions, and there are no plans to start any positions in the next 72 hours.  I wrote this article myself, and expressed my own opinions. I am not receiving compensation for it (which is not from Seeking Alpha). I have no business relationship with any company whose actions are mentioned in this article.