16th December 2013
Warren Buffett, the US veteran investor, has taken a $3.75bn position in Exxon Mobile. Jonathan Waghorn, co-manager, Guinness Global Energy Fund considers the implications below.
The sage of Omaha has recently taken a $3.75bn position in ExxonMobil. We view this move with great interest and are pleased to see some contrarian value investors getting involved in the energy sector. We review here Berkshire Hathaway’s history in the energy sector, and pontificate on his rationale for buying into the world’s biggest oil and gas company and the implications for the energy sector.
Warren Buffett has made few significant investments in the energy sector in recent years. There was a US$7.0bn investment in ConocoPhillips mostly acquired in 2008 (which he latterly referred to as being a “major mistake”), a US$0.5bn stake in Suncor in mid 2013 and now this new US$3.75bn position in ExxonMobil.
The public apology in 2009 for the ConocoPhillips investment was widely captured in the world’s media and as a result, you would be forgiven for thinking that Warren Buffett is an amateur when it comes to energy investing. However, we note that an investment in ConocoPhillips made in May 2008 would have generated a total return of around 37% to date (an annual rate of around 6.0%pa) and would have beaten the MSCI World index total return of 25% over the period (an annual rate of 4.0%pa). In early 2008, ConocoPhillips screened as a typical value and restructuring story within the energy sector and the subsequent spin-off of Phillips66 has created significant shareholder value. . Despite the extremely volatile crude oil price and broader market movements in the 2008/2009 period, the investment in ConocoPhillips as a company was pretty sensible, in our opinion. Not a phenomenal return, but reasonable nonetheless.
The investment in Suncor has been very successful so far. We estimate that it has delivered a positive return of just under 20% based on an entry price of US$30/sh in the second quarter of 2013, with the current share price at c.US$36/sh today. This is clearly a very good return in a six month period and one that we believe will continue to deliver well as North America demands production from the oil sands in Canada. We are very happy holders of Suncor in the Guinness Global Energy fund.
Although he regarded his ConocoPhillips investment as a “terrible mistake”, we would argue that Warren Buffet’s recent track record in energy has actually been pretty solid.
So, what has he actually bought? At a market cap of US$420bn, ExxonMobil is the biggest oil company in the world with 4.3mnb/d of production split just over 50% in oil and just under 50% in natural gas. We expect top line production growth of around 1%pa which, when combined with a potential share buyback programme of US$20bn pa, generates a per share production growth in excess of 5%pa over the next few years. While the dividend yield of 2.5% is mediocre versus its global peers, the cash return to shareholders is clearly supplemented by the continuous and meaningful share buyback programme. Either way, ExxonMobil is a phenomenal cash generator and the stalwart of the global energy sector.
However, we do not believe that this strong cash generation comes especially cheaply at the moment. ExxonMobil is trading at 12.6x P/E and 9.3x EV/DACF for 2013, which puts it as one of the more ‘expensive’ stocks within the global energy sector (a sector which is currently dominated by low multiple stocks!) although cheap versus the S&P which is trading at 16.5x P/E for 2013. We still see upside in ExxonMobil shares, based on long term Brent oil prices of around $100/bl.
On the basis of a $100/bl oil price assumption, we believe an investment in ExxonMobil could deliver a compound return of as much as 10%pa based on the combination of production growth, share buybacks and dividend payments over the next five years. Nice, again, but not outstanding really relative to the energy sector as a whole.
…and why has he bought it? In many ways therefore, ExxonMobil could be considered as a utility company with oil price leverage. Berkshire Hathaway owns a number of utilities directly and Exxon aligns with that group by offering a strong yield but with the added attraction of exposure to higher world oil and gas prices. In addition, Exxon has underperformed the broader US markets by 65% over the last five years and Berkshire Hathaway is flexing its contrarian muscle in this investment.
Despite the size and breadth of ExxonMobil’s business, the oil price is still the major driver of ExxonMobil’s share price. Since 2001 Exxon’s share price has been correlated 82% with the 12mth forward Brent oil price. The correlation is higher than the correlation between ExxonMobil and the S&P Index (47% R2) and the Dow Jones (57% R2). However, ExxonMobil is much less correlated to the energy sector than many of its US energy sector peers. While Warren Buffett has stated before that he has “no special insight into the future movements of oil price”, we think that that Berkshire Hathaway would have to have a view that future oil prices will be higher than the current forward curve in order to justify this move. We would argue that Exxon Mobil shares start to look expensive versus their peers on the basis of a $90/bl Brent oil price (the current five year forward Brent oil price).
To be fair, Berkshire Hathaway doesn’t have many options available to it, if it wants to invest these kinds of sums in concentrated positions and still maintain some liquidity. Exxon shares trade c. US$1.25bn per day, which is nearly double the volume of Chevron and around four times the volume of the North American domestic peers. To get this kind of concentrated exposure, there are few other names he could have considered.
These all seem to be reasonable enough reasons to buy ExxonMobil for Berkshire Hathaway: suitable liquidity, contrarian characteristics, free cash generation and, more than likely, a view on oil prices being in excess of the current forward curve.
So, what are the implications for the energy sector? We view the Berkshire Hathaway move with great interest. The energy sector has been a particularly poor performer for the last two and a half years and we see the sector as offering a deep value contrarian investment opportunity based on oil prices of US$100/bl. We take some comfort in seeing contrarian value investors getting involved in the sector – and we very much hope that Warren is right again this time!
We hold a 3.3% position in ExxonMobil in the Guinness Global Energy fund and, in fact, hold similar weights in all five of the Super Majors (ExxonMobil, ChevronTexaco, BP, RD/Shell and TOTAL). So, we concur with the stock selection. However, there are many other companies that we would chose in preference over ExxonMobil.
As a more ‘nimble’ investor in the energy sector, Guinness Asset Management invests in core value names like the Super Majors as well as global energy names with combinations of greater oil price leverage, growth and value characteristics than those apparent in ExxonMobil alone. Since inception, the Guinness Global Energy fund has delivered a 15.3%pa compound total return and has outperformed ExxonMobil by an average of 6.7%pa while delivering more balanced global energy sector exposure.
Our point is a simple one: if you believe that Warren Buffett is right in his big picture outlook and rationale for buying ExxonMobil, then the outlook for the energy sector and the Guinness Global Energy Fund especially is attractive.
Jonathan Waghorn, co-manager, Guinness Global Energy Fund