1

Analysts: Michael Piri (Michael.piri12@stjohns.edu)

Todd Hinson (Todd.Hinson14@stjohns.edu) Danni Sun (Danni.Sun14@stjohns.edu)

Fangxia Peng (Fangxia.Peng14@stjohns.edu) Share Data (as of 12/18/15): Fundamentals (as of 12/18/15): Price: $77.28 LTM P/E: 16.3 Shares Outstanding: 4.163M GAAP EPS[2014]: $7.60 Market Cap: $309.47 B E[EPS 2015]: 3.90 52 Week High: $95.18 ROA LTM Sept 2015: 5.75% 52 Week Low: $66.55 ROE LTM Sept 2015: 11.35%

2

Table of Contents: Executive Summary 4

Company Overview 5

Management and Segment Breakdown 5

Strategic Direction 6

Oil and Gas Reserves 6

Industry Risk Factors 7

Supply 7

Demand 8

Economic Conditions 9

Governmental and Political Factors 9

Management Effectiveness 9

Fundamental Analysis 10

Summary 10

Custom Industry 10

Growth 12

Sales 12

Net Income 13

Cash Flow From Operating Activity 14

EBIT 15

Profitability 16

Gross Margin 16

EBIT Margin 16

Net Profit Margin 17

SG&A Margin 17

ROE 18

ROA 18

Liquidity 19

Current Ratio 19

Quick Ratio 19

Efficiency 20

Receivables Turnover 20

Asset Turnover 20

3

Inventory Turnover 21

Long Term Solvency 22

Long-term debt/Equity 22

Times Interest Earned (TIE) 22

Financial Leverage Ratio 23

Income Statement Forecast 24

Relative Valuation 26

Absolute Valuation 27

Conclusion 31

Citations 32

4

Executive Summary:

The MBA SMIF team of Fall 2015 hereby makes an add recommendation in

the amount of 200 shares to the MBA SMIF’s current holdings of Exxon Mobil. We

came to this conclusion after a comprehensive analysis of the current status of the

company, evaluation of the macroeconomic factors effecting the industry, ratio

analysis, relative valuation of Exxon Mobil using comparable companies, and an

absolute valuation analysis.

Crude Oil closed at $34.95 on December 18, 2015 (Oil-Price, 2015). These

prices represent the lowest the commodity has been priced in the last seven years.

Exxon Mobil and other oil and gas companies’ prices for its products are heavily

reliant on the prices of commodities in the market. Therefore, the entire oil and gas

sector has been exposed to the downward pressures of Crude Oil over the medium-

term. However, after a current, and historical, ratio analysis of Exxon Mobil, we feel

that the company is well positioned, relative to many of its peers, to outlast the

recent collapse in prices. In addition, while some smaller companies in the industry

are slashing dividends paid to shareholders, Exxon Mobil has grown its dividend in

each of the last 32 years (Dividend, 2015).

In addition, our relative valuation model suggests that the current estimate

of Exxon Mobil’s price is $94.13. The model examined the P/E to P/E relationships

of Exxon Mobil and our selected peers over the last ten years by applying an

appropriate adjustment factor to each company and our E (EPS 2016). Given this

information, we feel that Exxon Mobil is undervalued in the market, supporting our

add recommendation. Furthermore, our absolute value analysis also upheld our

recommendation. For instance, we calculated various different costs of capital using

data from Bloomberg to use the CAPM and Fama French methods. We then

calculated the intrinsic value of the future expected cash flows and found a growth

rate that equaled our intrinsic value. We predict that in the years after 2021, Exxon

Mobil’s actual growth rate will increase as commodity prices begin to stabilize.

Overall, our research, assumptions, calculations, ratio analysis, valuation models,

and expectations for the future, support our add recommendation for Exxon Mobil.

5

Company Overview:

Management and Segment Breakdown

Exxon Mobil was founded in 1882 by John D. Rockefeller and is currently

headquartered in Irving, Texas. Exxon Mobil is currently the largest publicly traded

oil and gas company in the world. Exxon Mobil’s key management figures include;

Rex W. Tillerson (Chairman & Chief Executive Officer), Andrew P. Swinger (Chief

Financial Officer & Senior Vice President), and Mark W. Albers (Senior Vice

President).1 For over 125 years Exxon Mobil has been exploring, developing, and

distributing crude oil and natural gas to various businesses and individuals around

the world. In addition to the exploration and production of crude oil and gas, Exxon

Mobil also produces commodity petrochemicals, including olefins, aromatics,

polyethylene and polypropylene plastics and a variety of specialty products2. The

company conducts its business operations under three main segments; Downstream,

Chemical, and Upstream (Figure 1).

Figure 1

The Downstream segment refers to the manufacturing and selling of

petroleum products. The refining and supply operations within the Downstream

segment encompass a global network of manufacturing plants, transportation

systems, and distribution centers3. Downstream operations, the largest segment of

318.17

38.2

37.2

Revenue by Segment (Billions)

Downstream

Chemical

Upstream

6

Exxon Mobil’s operations, accounts for approximately 81% of Exxon Mobil’s total

revenue. In contrast, the Upstream and Chemical segments of Exxon Mobil’s

Operations combine for approximately 19% of Exxon Mobil’s total revenue. The

Upstream segment primarily is tasked with the exploration and production of crude

oil and natural gas. The Chemical segment of Exxon Mobil’s operations manufactures

and sells the aforementioned commodity petrochemicals to a wide number of

consumers and businesses. In addition, Exxon Mobil categorizes the regions in which

it conducts business operations into United States, Non-United States, Canada, and

Other (Figure 2).

Figure 2

Strategic Direction:

Oil and Gas Reserves

Exxon Mobil’s overall volume capacity outlook for the subsequent years is

expected to increase. Exxon Mobil ascertains the expected volume related figures in

its 10-K report through “advanced reporting technology such as wellbores, well logs,

reservoir core samples, fluid samples, static and dynamic pressure barometers, and

surveillance information.” (Exxon, 2014). Despite the accuracy of the copious

reporting tools at Exxon Mobil’s disposal, the company recognizes that the actual

148.7

90.3

36.1

119

Revenue by Region (Billions)

United States

Non-United States

Canada

Other

7

reported figures, and the time in which they are reported, may vary from estimates

due to the various detailed risk factors that will be discussed later in this report.

Exxon Mobil has decreased its exploratory and development activities in the

United States, and the other regions in which it operates, in 2014 compared to 2013.

These specific activities include Syncrude Operations and the Kearl Project. Syncrude

is a joint venture established to recover shallow deposits of oil sands using open-pit

mining methods to extract the crude bitumen, and then upgrade it to produce a high-

quality, light, sweet, synthetic crude oil4. The Kearl Project is another joint venture,

similar to the Syncrude Operations, located approximately 40 miles north of Fort

McMurray in Alberta, Canada. In the 2014 10-K report, Exxon Mobil mentions that

the “Kearl Expansion Project was essentially complete by the end of 2014…”, thus

explaining the decline in activities (Exxon, 2014).

In addition to exploration and extraction activities, wet and dry well drilling

were also down in fiscal year 2014 compared to the previous year. Although Exxon

Mobil has operations in all of the contiguous 48 states in the United States, it primarily

focuses its operations in “Permian Basin of West Texas and New Mexico, the Bakken

oil play in North Dakota and Montana, and the Woodford and Caney Shales in the

Ardmore and Marietta basins of Oklahoma”5 (Exxon Mobil, 2014).

On December 18, 2015, Congress officially lifted the “40-year ban on U.S. Crude

Oil Exports.” (BBC News, 2015). The passage of this bill into law means that Exxon

Mobil can now sell their oil products in certain areas of the global market that they

previously were not allowed to. Immediately following the release of this news, oil

prices began to marginally climb from their recent seven-year lows. We affirm that

this news will allow Exxon Mobil to diversify its business segmentation and reach

new markets in the medium-to-long term.

Industry Overview:

Risk Factors:

Supply

The oil, gas, and petrochemical businesses (the three major segments of Exxon

Mobil’s operation strategies) are fundamentally commodity businesses. Given the

nature of these businesses, operations and earnings are significantly influenced by

fluctuation in commodity prices. In fact, perhaps the biggest challenge facing Exxon

Mobil right now is the continued downward pressure in commodity oil prices. On

8

December 4, 2015, the Organization of the Petroleum Exporting Countries (OPEC)

announced that the supply of oil in 2016 is to remain unchanged from current levels

of production. OPEC produces approximately 81% of the world’s oil on a yearly basis

(OPEC, 2015). The immense presence of OPEC in the global economy allows the

Organization to manipulate the prices of certain commodities through its levels of

production. For example, since this announcement Crude Oil has plummeted to six-

year lows, closing at $37.23 on December 9, 20156. The decision by OPEC has caused

losses of approximately $240 billion in market value across the entire oil and gas

industry since its announcement. According to Bloomberg, “…companies producing,

refining, piping, and exploring for oil, along with those that provide them with

services, had a market value of about $3.72 trillion as of Friday, December 10, 2015

compared with $3.96 trillion on December 3, 2015, the day before OPEC’s meeting in

Vienna.” (See Figure 3)7 . Exxon Mobil is not the only oil and gas company suffering

from lower commodity prices. For example, the second largest oil and gas company

in the nation, Chevron, has announced that it plans to cut its budgetary spending for

2016 by an immense 24% from its 2015 plan8. OPEC has declared that “the global oil

surplus will persist at least until late 2016 as demand growth slows and OPEC shows

‘renewed determination’ to maximize output.”9

Figure 3

Demand

Demand for Exxon Mobil’s resources can also be influenced by improvements in

alternative energy sources. There has been a growing sentiment in many parts of the

world to become more efficient in energy consumption due to the effects it may have

9

on the environment. One instance in which this particular phenomenon can be seen

is the trend in fuel-efficient cars. Many consumers are opting for hybrid and electric

vehicles in efforts to preserve the environment. Furthermore, demand for oil and gas

products is influenced by seasonality in weather patterns. For instance, extended

periods of cold weather will require businesses, municipalities, and residential homes

to consume more oil in order to keep areas at appropriate temperatures.

Economic Conditions

Like several different businesses, Exxon Mobil is not immune to the ever-changing

economic conditions in the countries in which it operates. In particular, the demand

for the commodities that Exxon Mobil produces, manufactures, distributes, and sells,

is heavily influenced by growth rates in the economy. The aggregate annual GDP

growth rate in the world has increased from 2.2% in 2012 to 2.5% in 201410. Exxon

Mobil, along with other oil and gas companies must be cognizant of the recent,

marginal growth rates in the aggregate economy.

Governmental and Political Factors

Exxon Mobil faces risk in access limitations that could be mandated, at any time,

by the countries they conduct business in. Regulatory and litigation risks are also

prominent in the oil and gas industry. The United States, and other areas that are

known to impose large punitive damages for violations of environmental regulations,

represent a huge risk for Exxon Mobil and its affiliate companies considering the large

portion of revenue it generates in these locations. Exxon Mobil is forced to comply

with the regulations and restrictions in any given country it chooses to conduct

operations in. Specifically, these risk factors can include, increase in local tax rates,

governmental royalties, price manipulation, changes in environmental regulations,

fluctuation in cost of compliance, adoption of regulations mandating the use of

alternative fuel sources, and by the change in currency rates.

Management Effectiveness

Although many of the previously stated risk factors are seemingly out of Exxon

Mobil’s direct control, there are aspects of risk that can be effectively controlled by

the company. These factors can include, but are not limited to, exploration and

development programs, project management, ability to negotiate with outside forces,

operational efficiency, research and development, safety measures, and

preparedness for unforeseen natural occurrences.

10

Fundamental Analysis

SUMMARY:

The team analyzed growth rates, profitability, solvency, and operating

efficiency from 2005 to 2015: year-to-date + Q4 2015 estimates to complete calendar

2015 for growth rates, last twelve months (LTM) Sept 2015 for ratios. Two

prominent macroeconomic factors were prevalent in every graph – the financial crisis

of 2008 and the current overabundance of oil in the market beginning approximately

in 2013, which caused barrel prices to drop. For these reasons, and although our

figures date back to 2005 for reference, we will only focus on the time period from

2010, when the market began to rebound, to present.

Additionally, we also believe the current drop in the price of oil to be a

significant factor in the overall downward trend in the industry metrics rather than

firm specific risk factors. For this reason, we have focused on Exxon’s position in the

market relative to its peers, despite the industry-wide drop. We found the following

trends in our analysis regarding Exxon:

a. Growth rates – Industry leader

b. Profitability – Top 3 most profitable in the industry

c. Short-term solvency – Top 4

d. Long-term solvency – Top 4 and stable, relative to volatility of industry.

e. Operating Efficiency – Industry leader in operating efficiency

CUSTOM INDUSTRY:

We analyzed Exxon compared to its 3 largest competitors by market share and

industry performance - Chevron (CVX), BP (BP-US), and Shell (RDS.B) as well as a

custom industry comprised of 16 companies in the oil & gas sector. The custom

industry is as follows:

11

Ticker Company

Market

Cap

Market

Share

XOM ExxonMobil 309.47$ 7.80%

CVX Chevron 162.68$ 4.03%

OXY Occidental Petroleum 59.42$ 0.42%

857.HK PetroChina ADR 32.51$ 8.03%

RDS.B Royal Dutch Shell ADR 9.71$ 8.13%

CHK Chesapeake Energy 14.43$ 0.35%

COG Cabot Oil & Gas 222.02$ 0.05%

COP ConocoPhillips 13.98$ 1.01%

DVN Devon Energy 44.16$ 0.45%

MPC Marathon Petroleum 6.66$ 2.23%

VLO Valero Energy 94.19$ 2.86%

EOG EOG Resources 141.38$ 0.30%

HES Hess 41.17$ 0.18%

PSX Phillips 66 13.79$ 2.89%

NBL Noble Energy 2.77$ 0.11%

BP BP ADR 50.43$ 6.64%

12

GROWTH (Year-to-Year)

Sales

The financial crisis of 2008 and the current overabundance of oil in the market

have both contributed to drastic decreases in sales for the industry as a whole. The

financial crisis drastically impacted sales as shown by the dip in sales during the back

end of 2008. Notably, as sales began to rebound in 2009 to their pre-crisis levels,

Exxon was able to maintain its market position and has continued to maintain that

position despite the oversaturation of oil in the market, causing prices to drop to their

lowest levels in years.

13

Net income

Exxon’s net income has been consistently higher than its competitors since at

least 2010. The financial crisis and overabundance of oil in the industry have

drastically impacted sales and since operating costs have remained relatively stable

over the same period, net income has also suffered. Despite this, Exxon has managed

to maintain higher net income relative to its competitors.

14

Cash flow from Operations

The company’s cash flow from operations steadily increased from 2005 to

2008, and although it has not been able to reach pre-crisis momentum, was and

remains higher than its competitors to date. YTD 2015 actual cash flow from

operations + the Q4 projection is higher than its competitors at $33.91B, followed by

Shell with $30.42B.

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00

450.00

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 YTD

Exxon vs. Competitors - CF from Ops (including industry line)

Series1 Series2 Series3 Series4 Series5

15

EBIT

Exxon’s EBIT consistently grew from 2005 up until the financial crisis of 2008.

Post-crisis, Exxon’s EBIT has remained higher than its competitors, even after 2012

when the price of oil began to drop.

16

PROFITABILITY Gross Margin

Briefly in 2010, Exxon’s gross margin trailed behind that of Chevron. Post-

2010, Exxon has had one of the highest gross margins in the industry. Gross profit

margin has remained relatively stable year-to-year, however, a larger downward

trend can be seen.

EBIT Margin

Exxon has been top 3 in the industry in terms of its EBIT margin. EBIT margin has remained relatively stable compared to EBIT margins of its competitors. Post financial crisis to present, Exxon’s EBIT margin trailed behind Chevron’s.

17

Net Profit Margin

Exxon’s net profit margin has remained relatively stable since 2010 as well, again despite volatility among its peers.

SG&A Margin

Exxon’s SG&A margin has remained on par with that of the industry since at least 2005 to present.

18

ROE

ROE has been consistently higher than its competitors and the industry average over the entire time period 2005 to LTM Sept 2015 shown in the chart.

ROA

ROA for Exxon/Mobil and Chevron have been similar, with Exxon/Mobil usually the industry leader.

19

LIQUIDITY Current Ratio

Exxon’s current ratio has been consistently less than that industry since

2009. Keep in mind that current ratio does not take into consideration the quality of the assets – which can be used to generate more income relative to lower quality assets.

Quick Ratio

Exxon’s quick ratio has also been consistently less than that industry since

2009.

20

EFFICIENCY Receivables turnover

Exxon has been particularly efficient and quick in collecting on its receivables. Since roughly 2006, Exxon’s receivables turnover has remained stable and has been higher than the industry.

Asset turnover

Exxon’s asset turnover was on an upward trajectory up until the financial crisis, where aggregate industry asset turnover fell steeply. The industry has not been able to reach pre-crisis levels, and is gradually declining since 2011.

21

Inventory turnover

Inventory turnover has been somewhat volatile since at least 2005. Relative to the industry, Exxon’s inventory turnover has been less, but has followed the same trajectory – sharp fall experienced during the crisis followed by a rebound period post-crisis in 2009 to about 2011 where turnover slowly and steadily has been declining.

22

LONG-TERM SOLVENCY Long-term debt/Equity

Exxon has used the least amount of debt financing. This suggests that Exxon may not be using enough debt, which is the cheaper source of financing. However, it has recently increased its increased its debt load, which could be to finance value adding projects.

Time Interest Earned (TIE) Owing to its low debt levels and income generation, Exxon/Mobil has one of the higher interest coverage ratios in the industry.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 LTM

Exxon vs. Competitors - LT Debt to Equity

Exxon Chevron BP Shell

23

Financial Leverage

Exxon/Mobil exhibits a stable and consistent financial leverage ratio, in line with most of its peers.

24

Income Statement Forecast:

Total Revenue: In order to forecast Exxon Mobil’s total revenue for FY 2016, we

first considered the companies within our “Custom Industry” located earlier in this

report. We then added the FactSet revenue estimates for these companies in FY

2016 to help us derive our FY 2016 estimate. Specifically, we considered Exxon

Mobil’s five and ten year market share percentages to come up with an estimate of

17% for FY 2016 based upon Exxon Mobil’s peers’ estimates. By coming to this

conclusion, we were able to estimate our FY 2016 revenue as 267 billion.

Cost of Goods Sold (Excl. D&A): To estimate our COGS for FY 2016, we first took

the five and ten year averages for COGS as a percentage of sales, to analyze the

historical relationship between the two line items. We found that the latest five-

year average was the was an appropriate adjustment factor to use as a basis for

estimating the subsequent year due to its consistency. Therefore, we decided to

estimate COGS for FY 2016 as 72% of sales.

Depreciation and Amortization: On Exxon Mobil’s 10-K report, they refer to this

cost as “Depreciation and Depletion” (Exxon, 2014). In order to forecast

depreciation and depletion expense for FY 2016, we calculated the depreciation

expense as a percentage of the prior year’s gross and net Property Plant and

Equipment. We came to the conclusion that gross was a more consistent indicator

of the following year’s reported PP&E. However, we found that the 10-year average

was a better indicator than the five-year average because the previous couple of

fiscal years were closer to 4% (the 10-year average) than they were to 8% (the five-

year average). Finally, we came to our estimate of 18.00 billion by multiplying the

prior year’s Gross Property Plant and Equipment (450; as reported on FactSet’s

restated 2014 Balance Sheet) by 4%.

SG&A Expense: We estimated FY 2016 SG&A expense to be higher than it has been

in any year since 2011. We saw that the 2015 SG&A Expense as a percentage of

sales is tracking higher in 2015 YTD than it has been in the previous couple of fiscal

years. Upon further investigation, we found that in the most recent 10-Q,

management indicated that “higher maintenance” related costs were the cause for

this phenomenon (Exxon, 2014). The report did not go into copious detail on this

new cost to the firm. However, because they gave no indication as to the duration of

these new costs, we incorporated the higher expected costs into our estimates for

2016. Specifically, we determined that simply evaluating the SG&A Expense as a

percentage of sales was not an appropriate assumption for 2016. Therefore, we

25

came up with an adjustment factor of 5%, which is higher than the historic averages

and close to the current rate for the in-progress fiscal year. We applied that 5% to

our revenue estimate of $267b to estimate SG&A expense for 2016.

Other Operating Expense: Similarly, “Other Operating Expense” as a percentage of

sales was tracking higher for YTD 2015 than it has been in any year since 2010.

While the report gave no specific mention as to the phenomenon that is causing this

increased rate, we decided to use an adjustment factor of 10%, which is slightly

higher than the most recent five-year average of 9.3% of sales.

Other Income Expense: In order to come up with this estimate, we simply

compared the five and 10-year averages (4.49 and 4.57, respectively). Since these

numbers were very consistent, we chose to use an estimate of 4.5 for 2016.

Interest Expense: In order to derive the interest expense estimate for 2016, we

closely examined the debt structure for the firm over the past few years. For

instance, we first looked at 2012’s debt structure in order to come up with a forecast

for 2013, to compare to the income statement actual. We multiplied the amount of

debt outstanding by the given coupon rate, located either in FactSet or the 10-K, and

summed up the totals to forecast net interest for the next year. After a few

iterations of this process (2012 for 2013, 2013 for 2014, and 2014 for 2015), we felt

confident in our ability to accurately predict our estimate of .479 for our interest

expense for 2016.

Income Taxes: In order to calculate estimated income taxes, we first calculated the

effective tax rates for the previous 10 years by simply dividing each year’s income

tax by it’s pre-tax income. We saw that the effective tax rate in 2014 was

significantly lower than it has been in the prior years (.3489 compared to .4202 in

2013). Upon further investigation, the 10-K demonstrated that this was because of

“favorable tax legislation” in the previous year (Exxon, 2014). Furthermore, YTD

2015 is tracking to ultimately be at or around the .3489 rate used in 2014.

Therefore, we have decided to use an adjustment factor of .35 as our income tax

estimate for 2016.

Minority Interest: Minority Interest was estimated by calculating historic averages

as a percentage of pre-tax income. We found that there was more volatility in this

rate in the past five years as compared to the whole 10-year sample we considered.

Therefore, we felt more comfortable using an adjustment factor of 2.17% (the five-

year average) to forecast minority interest because it was greater than the 10-year

sample (1.82%).

26

Earnings Per Share: Finally, we have forecasted earnings per share figure of $4.76

for FY 2016. This number was derived from our net income divided by the

estimated weighted average of diluted shares outstanding in 2016. In order to

accurately predict this number, we found some helpful information in the 10-Q. We

found that Exxon Mobil does not currently employ a ‘formal’ annual share-

repurchasing program. However, in each of the past four fiscal years, the firm has

been systematically buying back an average of 3.6% (found by examining the yearly

growth rate in reported shares in the 10-K) of its outstanding common shares to

compensate for the shares administered as compensation.

Relative Valuation

Relative Valuation is a method to determine the value of an asset.

Specifically, this valuation method can be used to determine how the asset is valued

relative to its peers. In order to calculate Exxon Mobil’s relative valuation, we used

the following formula:

Estimate of Current Price = E [EPS1] * P/E (EPS1) * Adjustment Factor

This formula encompasses our forecasted earnings per share for 2016

($4.76), the forward P/E of a given comparable asset, and an adjustment factor

based upon the P/E to P/E relationship of Exxon Mobil to that specific peer. Our

findings derived from this calculation are featured below:

We prudently calculated two separate averages from our relative valuation

table. The first average is simply the average of all 7-price estimates. However, we

realized that this is not the best way to estimate Exxon Mobil’s current price

because there were two significant outliers present in the sample. Therefore, we

27

calculated an average excluding both Occidental Petroleum and Conoco Phillips due

to their extremely high estimates. Essentially, our average price, without the

presence of outliers, of $94.13 demonstrated that Exxon Mobil is undervalued

relative to the selected comparable companies and energy sector.

Absolute Valuation

The absolute valuation model is used to determine a company’s intrinsic

worth based on its projected cash flows. The business valuation model uses

discounted cash flow analysis to determine a company’s financial worth. By

comparing what a company's share price should be given its intrinsic value to the

price at which the stock is actually trading, investors can determine if a stock is

currently under or overvalued. We used the CAPM model to calculate the cost of

capital “k’s”. And we used the Fama-French Three-Factor Model as reference to

verify that our k’s assumptions were reasonable.

We used the Dividend Discount Model to estimate the intrinsic value of the

company’s stock price. The Dividend Discount Model discounts predicted dividends

in an attempt to value a stock, the justification being that dividends represent the

actual cash flows going to the shareholder, thus valuing the present value of these

cash flows should give us a value for how much the shares should be worth. The

companies that pay stable and predictable dividends are typically mature blue-

chip companies in well-developed industries. And Exxon is one of these types of

companies that are often best suited for DDM valuation method.

Cost of Capital (K)

As cost of capital can be calculated based on multiple assumptions and

multiple rates, we decided to calculate four different k’s to get a better idea of cost of

capital. The formula for CAPM is as follows:

E[Rasset] = rf + βasset*[E(rmkt – rf)]

Where,

E[Rasset] = Expected Return of the company

rf = Risk Free Interest Rate

βasset = Beta of company vs S&P500

(rmkt – rf)= Market Risk Premium

28

The following table shows the costs of capital based on different input assumptions:

Treasury

Rates

(As of

12/02/1

5)

Source:

Bloomberg

10 Year 2.1780%

Premium

=

7.1440

%

30 Year 2.9066%

6.4154

%

U.S. Country Risk Premium

9.3220%

Beta Source: Bloomberg

5 Year 10/29/10-10/30/15 0.926

10 Year 10/31/05-10/30/15 0.616

WACC

from

Bloomber

g

(As of

12/02/15) Source: Bloomberg

9.2401%

Calculate

k or

multiple

k's

Excess Return=8.40% from Table 5.2 in Portfolio Theory, and we

assume beta=0.9 from above.

k 1)= 0.02178+0.9*(0.09322-0.02178) = 8.61%

k 2)= 0.02907+0.9*(0.09322-0.02907) = 8.68% ----->k1 8.70%

k 3)=

0.02178+0.9*(0.0840)

= 9.74%

k 4)=

0.02907+0.9*(0.0840)

= 10.47% ----->k2 10%

We used both the 10-year and 30-year treasury rate as our risk free rate, and

Exxon’s 5-year beta of 0.90 in the CAPM equation, with both market risk premiums

from Bloomberg Terminal as 7.1440% and 6.4154%, and the historical excess

return of the S&P500 over a treasury rate as 8.40%. Based on the four combinations

of CAPM calculations above, we got four different k’s from CAPM, which we decided

to amend as two costs of capital.

29

As a reference, we used the Fama-French method to calculate the 5-year, 10-

year, and 20-year Exxon beta coefficients on the market premium, SMB and HML

factors, which gave us 3 k’s in the range of 5.85%-13.06%. Our calculations

excluded coefficients which were not significantly different from zero. These k’s

would be unrealistic if we had chosen to use one of them to substitute our CAPM k’s,

but these brought us to the k’s we reached from CAPM.

Dividend Discount Model

The chart below contains the annual earnings per share, dividends per share,

dividend yield and payout ratio data used in our analysis: 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005

Q1+Q2+Q3

actuals + Q4 qtrly forecasts

EPS

(Diluted) 3.93 7.60 7.37 9.70 8.42 6.22 3.98 8.69 7.28 6.62 5.71 Dividends

Per Share 2.88 2.70 2.46 2.18 1.85 1.74 1.66 1.55 1.37 1.28 1.14 Stock

price as of

12/31 74.35 92.45 101.2 86.55 84.76 73.12 68.19 79.83 $93.69 76.63 56.17 Dividend

Yield 3.87% 2.92% 2.43% 2.52% 2.18% 2.38% 2.43% 1.94% 1.46% 1.67% 2.03% Dividend

payout

ratio 73.28% 35.53% 33.38% 22.47

% 21.97

% 27.97

% 41.71

% 17.84

% 18.82

% 19.34% 19.96% Year-over-

year

growth 6.67% 9.76% 12.84% 17.84

% 6.32% 4.82% 7.10% 13.14

% 7.03% 12.28% 7.55%

Using these data, the geometric average annual growth rate of the DPS was

calculated over 3, 5, 7, and 10-year time periods.

DPS Average Annual Growth Rate

10yr 2005-2015 0.09711

7yr 2008-2015 0.09254

5yr 2010-2015 0.10603

3yr 2012-2015 0.09727

From our relative valuation and pro-forma income statement, we forecasted

expected EPS in 2016 as $4.76. The payout ratio in 2015 is higher than in any other

year shown at a staggering 73.28%, because of the sharp decline in the EPS, which,

as we decided, was not appropriate to base on to forecast our future dividends. Also

30

it would not make our estimated DPS growth rate comparable with the year average

growth rate. So instead of using payout ratio, we took the recent five-year average of

Exxon’s ROE at 20.90%, and multiplied it with the retention ratio at 35% in a

conservative estimate. This gave us a dividend growth rate of 6.90% constantly six

years in the future. From here, the predicted constant growth rate and cost of capital

(k2) brought us the expected dividend per share from 2016 to 2021and their

present value as of 2015.

2016 2017 2018 2019 2020 2021

E[DPS 2016] 6.90% $ 3.08

$ 3.29 $

3.52 $

3.76 $

4.02

E[DPS 2021] $ 4.30

PV of

E[DPS]

back to

2015, k = k2

= 10% $ 2.80 $ 2.72 $

2.64 $

2.57 $

2.50 $ 2.43 when k = k1

= 8.70% $ 2.83 $ 3.03 $

3.24 $

3.46 $

3.70 $ 3.95

The next step involved estimating Exxon’s present value at 2020 of all post

2020 dividend cash flows, and its intrinsic value at 2015, which were achieved by

the scenario test, growing the estimated 2021DPS value by nine different growth

rates ranging from 1% to 9%. The charts below illustrate these methods using our

two different “k’s”.

k1 8.70% Present value of FCF 2016 2017 2018 2019 2020 2021

k2 10.00% back to 2015, as k2 $

2.90 $

2.83 $

2.76 $

2.69 $

2.63 $ 2.56 Current Price as of 12/16/15 $78.77 TERMINAL

VALUES k1 1% 2% 3% 4% 4.35% 6% 7% 8% 9% Terminal

value at FY

2020 $

4.30 $

55.81 $

64.14 $

75.39 $ 91.43 $ 98.79

$

159.16 $

252.78 $

613.89 $ (1432.40) PV (back

to 2015) $

36.77 $

42.26 $

49.68 $

60.25 $

65.10 $

104.88 $

166.57 $

404.52 $ (943.88) Intrinsic

Value at FY

2015 $

50.47 $

55.96 $

63.38 $ 73.95 $

78.79 $

118.57 $

180.27 $

418.22 $ (930.18)

k2 1% 2% 3% 4% 5% 5.93% 7% 8% 9% Terminal

value at FY

2020 $

4.30 $

47.75 $

53.72 $

61.39 $

71.62 $

85.94 $

105.58 $

143.24 $

214.86 $ 429.72 PV (back

to 2015) $

29.65 $

33.35 $

38.12 $

44.47 $

53.36 $

65.56 $

88.94 $

133.41 $ 266.82 Intrinsic

Value at FY

2015 $

42.87 $

46.58 $

51.34 $

57.70 $

66.59 $

78.78 $

102.17 $

146.64 $ 280.05

31

Summary

We found that using k1 = 8.7%, the post-2021 growth rate that makes the

stock fairly valued now (its price is $78.77 on 12/16/15) is 4.35%; with k2 = 10%,

the fair value growth rate is 5.93%. This means that if our model assumptions are

correct, the market is assigning a growth rate in perpetuity between 4.35% to

5.93% beyond 2021. With our 5-year dividend growth rate projection of 6.90% and

our expectation that the oil price will soon recover, we should buy more XOM

shares. Since our k2 is higher than k1, we used the higher cost of capital (k2) to

finish our calculation based on the conservative perspective, which implies the

scenario under k1 will definitely bring us a better performance beyond expectation.

And if the earnings would go back to where it should be as previous years’ trend in

the future, our expectation on the growth of the stock performance could be greater.

Conclusion

Exxon has shown consistent growth with no signs of letting up. Fundamental

analysis puts Exxon in a strong position relative to its peers; the company holds first

place, if not in the top three in the industry in terms of growth, profitability, and

efficiency. The company has a solid management team that has continued to make

value-adding decisions. Additionally, the company has consistently paid dividends

and there is no indication of that stopping. We have decided to add 200 shares of

Exxon doubling our current position of 200.

32

Citations

Coy, Peter. "Shale Doesn't Swing Oil Prices-OPEC Does." Bloomberg.com. Bloomberg, 9 Dec. 2015. Web. 16 Dec. 2015.

"Crude Oil Price, Oil, Energy, Petroleum, Oil Price, WTI & Brent Oil, Oil Price

Charts and Oil Price Forecast." OilPricenet RSS. N.p., n.d. Web. 16 Dec. 2015.

"GDP Growth (annual %)." GDP Growth (annual %). N.p., n.d. Web. 16 Dec. 2015.

Katakey, Rakteem. "Oil Investors Are $240 Billion Poorer a Week After OPEC

Call." Bloomberg.com. Bloomberg, 11 Dec. 2015. Web. 16 Dec. 2015

"OPEC Share of World Crude Oil Reserves." OPEC :. N.p., n.d. Web. 15 Dec. 2015.

"US Spending Bill Lifts 40-year Ban on Crude Oil Exports - BBC News." BBC

News. N.p., n.d. Web. 16 Dec. 2015.

"XOM: Dividend Date & History for Exxon Mobil - Dividend.com." XOM: Dividend Date & History for Exxon Mobil - Dividend.com. N.p., n.d. Web. 16 Dec. 2015.

1 FactSet: Exxon Mobil Corporate Information 2 FactSet: Exxon Mobil Business Description 3 FactSet: Exxon Mobil Business Description 4 XOM 10K page 13 5 XOM 10K page 13 6 Bloomberg Business: “Shale Doesn’t Swing Oil Prices – OPEC Does” 7 Bloomberg Business: “Oil Investors are $240 Billion Poorer a Week After OPEC Call” 8 Bloomberg Business: “Oil Investors are $240 Billion Poorer a Week After OPEC Call” 9 Bloomberg Business: “Oil Investors are $240 Billion Poorer a Week After OPEC Call” 10 The World Bank: Annual Aggregate GDP Growth