Exxon Mobil – Free Cash Flow Does Not Cover The Dividend

XOM’s Q3 results saw revenue drop by more than 35% and earnings fall nearly 50% compared to 3Q14, driven by weak upstream results (upstream earnings fell 79%). However, strength in XOM’s downstream businesses resulted in earnings actually rising 1% compared to last quarter. While headline figures remain ugly, we are optimistic that XOM’s fundamentals are nearing a bottom and are happy to keep the stock in our Conservative Retirees dividend portfolio.

With most of its earnings dependent on the price of oil, there is only so much XOM can do to manage its business throughout the current downturn. The company grew its production by 2.3% in Q3 compared to the year-ago quarter, and XOM appears to be doing a nice job executing on its strategy to improve its mix towards higher-margin barrels. From a cost perspective, XOM has reduced capital and cash operating costs by $8 billion YTD (3.8% of sales) and should make additional progress in future quarters.

Unfortunately, none of these actions are significant enough to overcome the major challenges caused by oil prices, which remain down over 50% from early 2014 and hover near a 6-year low. From a demand perspective, growth has generally remained sluggish or weak in the U.S., China, and Japan, although Europe has shown some signs of stabilization. Longer-term, emerging economies will need to build out infrastructure and their populations will consume more oil-based products, but these trends don’t help the outlook over the next few years.

Regardless, supply has been and continues to be the biggest issue weighing on the price of oil. The onslaught in oil markets started over a year ago as the Organization of Petroleum Exporting Countries (OPEC) executed its plan to protect member countries’ share of the oil market by out-producing higher-cost rivals led by U.S. shale drillers.

According to the U.S. Energy Information Administration, OPEC member countries produce about 40% of the world’s crude oil. Equally important to global prices, OPEC’s oil exports represent about 60% of the total oil traded internationally. Despite the significant supply pressure from OPEC, North American production continued increasing last year before starting to slow in the first half of 2015. According to a report by OPEC earlier this year, the increase in non-OPEC supply last year was more than twice that of global oil demand growth. However, OPEC expects this relationship to flip this year before widening in 2016 so that world oil demand growth exceeds the change in non-OPEC supply.