Chevron – Exxon Mobil-Chevron Merger: Might It Work (NYSE:CVX)

Each few years, the potential of an Exxon Mobil (XOM)-Chevron (CVX) merger rears its head. Only a few weeks in the past, this concept was mentioned in Barron’s, and naturally then made its means by the monetary press. Whereas considerably ludicrous on its face, it’s a query that even astute traders have thought-about at instances. Latest tendencies in valuations have made it all of the extra alluring to some, as the 2 giants have seen their market caps converge. So-called stock for stock “merger of equals” have been the soup du jour of senior executives trying to scale up in an oil and gasoline market that, even with factoring within the current restoration commerce, stays in bedlam. With each valued equally now, why not mix?

One Man’s Opinion: No Deal

Sadly, causes are quite a few that creating such a large enterprise won’t previous muster. On the high of my thoughts, moreover the tradition variations, there are the numerous regulatory hang-ups. Primary is the Gorgon Challenge in Australia, a $50B+ play that turned Barrow Island – as soon as most identified for its native wildlife – right into a LNG powerhouse fed by the Jansz-Io and Gorgon offshore gasoline fields. It’s the one of many world’s largest pure gasoline property and a cornerstone of the Australian oil and gasoline economic system; Chevron owns 47.3% of Gorgon whereas Exxon Mobil owns 25%. Regulators would by no means permit majority management by a mixed entity, and each events rely Gorgon as an necessary a part of their future plans. The record of potential consumers for a partial stake is small and, fairly frankly, these consumers aren’t lining as much as spend tens of billions of {dollars}. Related complications could be discovered within the retail enterprise. Regulators would frown upon one singular entity controlling (or leasing the gross sales rights to) almost 20,00zero retail gasoline stations. For perspective, the FTC required Alimentation Couche-Tard (OTCPK:ANCUF) to divest north of 1 thousand shops when it acquired Speedway from Marathon Petroleum (MPC); the corporations would see comparable involvement right here to keep away from geographic overlap. Any mixture of the 2 would require, in whole, tens of billions of {dollars} in asset gross sales to ease issues of regulators world wide.

Aggravatingly – and echoing fixed dialogue on Looking for Alpha – the dividend is a matter as effectively. At present, Chevron pays much less of a dividend than Exxon Mobil. If mixed, would the brand new professional forma entity minimize the payout to Chevron ranges (aggravating the retail possession base of Exxon Mobil, additionally a key voting bloc on the deal) or bump the dividend for Chevron traders, arguably erasing a part of the explanation many traders have gravitated to that oil main within the first place (higher capital self-discipline)? It is a powerful ask. For my part, each are higher off impartial.

The Higher Purchase: Chevron Or Exxon Mobil

*Supply: Creator Calculations.

If a merger is off the desk, which is the higher purchase? At present, each Chevron and Exxon Mobil commerce at roughly 6.5x 2022 debt-adjusted cash stream (“DACF”), the primary normalized yr which ought to see largely recovered fossil gas demand throughout most merchandise. The query is what asset base is healthier, and whose administration staff is extra strongly aligned with traders. Chevron has (in my view) finished a significantly better job at managing itself on a wide range of property. Exxon Mobil has dedicated extra closely to long run, extra typical performs (e.g., Guyana) which might be characterised by the inflexibility of excessive fastened prices; they can’t be ramped up or down. Onshore North American shale, for all its issues, is extra simply oscillated in response to present pricing. Additional, the leverage on the Exxon steadiness sheet – tens of billions of {dollars} of extra nominal internet debt by 2023 – and decrease dividend obligation provides extra management to administration. Chevron, for sure, has the higher setup for navigating vitality markets which have change into more and more extra cyclical lately. For my part, traders must look previous the (incrementally) higher credit standing at Exxon Mobil to comprehend this actuality.

There’s a caveat. Exxon Mobil and its downstream companies (refining, chemical compounds) have been traditionally extraordinarily underappreciated by most traders. Whereas the main focus from many continues to be oil and gasoline costs, that’s the mistaken method for extremely built-in majors like Exxon. Refining crack spreads and chemical compounds margins are way more necessary to driving enchancment in free cash stream versus small modifications in oil costs. By comparability, Chevron doesn’t have this construction, and has historically generated most of its earnings from its upstream section.

Whereas nonetheless effectively above the five-year common of 125mm barrels, as proven above, distillates have seen huge attracts because the stubbornly excessive ranges seen between July and September. Decrease refinery utilization charges is a driver of that, however so too is the almost 3mm barrels of refining capability that has been idled completely globally, particularly in the USA which has been way more fast to reply (Marathon Petroleum, Shell (RDS.A) (NYSE:RDS.B), PBF Power (PBF) are only a few which have shuttered operations). Distillate cracks have improved alongside that, as have jet gas cracks which have mainly tripled because the starting of October. Whereas enchancment has at all times been anticipated, the vaccine information plus the speedy changes in provide have actually pushed a turnaround in refining markets, shifting ahead a restoration within the downstream markets by a number of quarters. As an built-in participant, Exxon Mobil stands to profit closely from this. Whereas true mid-cycle refining margins continues to be a great distance away, enhancing downstream margins (alongside capital spend funds cuts) is the largest driver of the development seen in Exxon Mobil’s potential cash flows from 2020 to 2021.

Takeaways

Each have their attract, however I nonetheless lean in direction of Chevron – as I’ve for a number of years now. Oil firms, whether or not they’re a small store operation in a tertiary basin or a supermajor, have continued to be rewarded for balanced capital allocation insurance policies. Smaller traders such as you or me have the benefit of with the ability to nimbly transfer out and in of corporations as they arrive into favor. It’s a huge one and one thing that giant funds, for all their benefits, simply can not do. Being contrarian works, nevertheless it must be finished on the proper time. Whereas the proverbial “skate to the place the puck goes, not the place it has been” is related in investing, there is no such thing as a purpose to get there so early.

As long as the market continues to view fossil gas demand as prone to enter a relentless state of decline with pricing solely held up by OPEC+ constraints, bold tasks that considerably add to manufacturing and are years away from manufacturing are going to get severely discounted. Flexibility is the secret, and whereas Exxon Mobil has made it a behavior of counter-cycle investing, it’ll take time for investor emotions to vary.

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Disclosure: I/now we have no positions in any stocks talked about, and no plans to provoke any positions inside the subsequent 72 hours. I wrote this text myself, and it expresses my very own opinions. I’m not receiving compensation for it (apart from from Looking for Alpha). I’ve no enterprise relationship with any firm whose stock is talked about on this article.