I have been bullish about the energy sector (XLE) since March 2023 amid the throes of the regional banking crisis. Hence, I’ve not been surprised by the relative outperformance of the energy sector, driven by leaders such as Exxon Mobil (NYSE:XOM) and Chevron (CVX).
Being the largest constituent in XLE, accounting for nearly 23% of its exposure, energy investors are likely focusing on Exxon’s next move on Pioneer Natural Resources Company (NYSE:PXD). Pioneer is a leading upstream E&P player with significantly cost-advantaged assets in the Permian Basin. It’s also a top-ten constituent in XLE, accounting for 4.1% of its exposure. Although Exxon is an integrated oil and gas behemoth, its Permian production trails that of Pioneer. Accordingly, Pioneer contributes “9% of gross production in the region,” making it the Permian Basin’s most significant producer. Exxon’s 6% production attribution ranks the energy giant in fifth place.
Given Exxon’s acreage in the Basin, it does make sense for Exxon to consider integrating with Pioneer through an acquisition. It could drive accretive cost synergies and economies of scale, lifting its upstream ambitions. The updated acquisition deal value suggests an all-stock acquisition price exceeding $250, slightly above 5% of yesterday’s (October 10) closing price. As such, market operators have rapidly priced in the terms of the deal, with earlier reports suggesting a value of about $60B. An all-stock deal does make sense for the company at this juncture.
Exxon boasts a robust balance sheet with nearly $30B in cash and an estimated FY23 adjusted EBITDA leverage ratio of 0.11x. However, given the elevated cost of debt at the current levels, it would be markedly higher than its forward dividend yield of 3.4%. As such, an all-stock deal would put less stress on its balance sheet than a debt-supported acquisition.
Furthermore, XOM’s balanced valuation relative to its sector peers is an advantage in an all-stock acquisition. Seeking Alpha Quant rated XOM with a “C-” valuation, suggesting it’s not undervalued and leaning toward the premium zone. Its adjusted forward P/E of 11.8x implies a 14.4% premium against its sector peers. Therefore, I believe an all-stock deal is expected to work in its favor, notwithstanding the potential impact of dilution. However, investors need to consider that the terms of the acquisition have not been finalized. As such, developments remain dynamic and could still change.
Despite that, I believe XOM investors have already anticipated challenges relating to the terms of the deal as they assessed whether Exxon could overpay. Accordingly, XOM fell more than 12% through last week’s lows from its September highs, even though PXD rose more than 14% toward this week’s highs from its lows last week.
An all-stock deal could create headwinds on share dilution unless Pioneer’s earnings are expected to impact Exxon’s bottom line positively. The near-term caution is justified, although Bulls could argue that it has been priced in (remember, the market is forward-looking; look at PXD’s surge).
Analysts’ estimates suggest that Exxon’s adjusted EBITDA is expected to stay relatively stagnant through FY25, reaching $73.2B from this year’s estimated $74.1B. Wall Street expects Pioneer’s adjusted EBITDA to increase 9.5% in FY24 to $10.5B before a further 3.4% uptick to $10.8B in FY25.
Translating to adjusted EPS, Exxon’s FY25 adjusted net income is expected to reach $34.1B, down from FY23’s $37.6B estimates. Pioneer’s FY25 adjusted net income is expected to reach $5.6B, up nearly 12.2% from FY23’s estimates. Excluding cost synergies emanating from the transaction, Exxon’s adjusted net income could rise just 5.6% above FY23’s levels.
Accordingly, based on an all-stock acquisition per share price of $250, Exxon is expected to issue about 525M new shares against its current outstanding shares of about 3.99B. As such, Exxon’s share count is expected to rise by about 13%. When I consider enterprise value metrics, Pioneer’s FY25 adjusted EBITDA of $10.8B is expected to lift Exxon’s adjusted EBITDA by about 13.4% by FY25, suggesting the deal value doesn’t seem to be excessive, as I have not accounted for potential cost synergies.
As such, I believe the recent pullback in XOM likely reflected execution risks as investors priced in the potential acquisition quickly, suggesting the risk/reward seems attractive at the current levels.
Key Takeaway
I have turned bullish on XOM since my previous May 2023 update. I have also remained bullish on the energy sector. With the sector’s leading constituent on the verge of making a big splash in the Permian Basin, consolidating its market leadership, I believe the sector’s fortunes remain robust and constructive.
With the recent pullback in XOM, I assessed XOM as attractive again from a valuation and price action perspective.
Rating: Maintain Buy.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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