Are Cash Flow Problems Dragging Exxon Mobil Stock?

• Net cash from operations has dropped to $9.3 billion through the first 6 months of the year which is worrying.
• Lost reserves from 2015 need to be replaced in 2016.
• If Exxon can combine higher production levels with higher crude oil prices, its upstream earnings in Q3 will increase significantly.

For a few decades now, Exxon Mobil (NYSE:XOM) has definitely been the preferred choice for dividend investors in the energy sector and for good reason. The company is highly integrated (which lowers volatility) and has the best balance sheet by far in the energy space. However, with deteriorating earnings in recent quarters, there have been plenty of question marks about the viability of the dividend. Why? Well, most of the company’s peers have either cut their dividend payouts or frozen them but Exxon Mobil has remained defiant. In saying this, the energy behemoth continues to finance its cap-ex and dividend budgets through deficit spending which is a growing concern for dividend investors.

Exxon finds itself in a situation where it needs to cut capex heavily in order to meet its cash flow obligations. For example in its latest fiscal second quarter, the company reported $1.7 billion in net income but paid out $3.13 billion in dividends. Long term debt is now close to $30 billion and since the company is at the peak of its spending cycle, I can only see this figure continuing to rise if crude oil prices stay in the $40’s. Astute dividend investors watch cash flow balances carefully to see if a dividend freeze or cut could take place. A cut would definitely tank the Exxon stock. Here are the metrics one should look out for.

Exxon Is Still Not Spending Enough Towards Production Growth

Investors should be aware that Exxon now will only pump in strategic projects where cash demands are at a minimum. It’s a balancing act. Cut enough to raise cash but not too much in the case a recovery happens quickly. Even with oil prices rallying substantially off their lows since February, Exxon is still canceling drilling contracts as the company maintains that it is still too risky to deploy cash on upstream projects at present. The company has invested $7.49 billion thus far this year, which is low compared to previous years.

Furthermore, its cash flow from operations has only amounted to $9.3 billion for the first six months which explains the reduced spending. Conservative dividend investors will need to see these figures increase before committing any extra money. Bulls will state that eventually these smaller capex budgets will lead to supply constraints but this remains to be seen. At present, Exxon needs higher crude oil prices to raise the dividend meaningfully.

Cash Flow Components ($m)	FY13	FY14	FY15	Q1 &Q2-2016
Net cash provided by operating activities	$44,914	$45,116	$30,344	$9,331
Net cash used in investing activities	($34,201)	($26,975)	($23,824)	($7,496)
Net cash used in financing activities	($15,476)	($17,888)	($7,037)	($1,251)

Exxon Mobil Needs To Replace Reserves Lost In 2015

Therefore the reduced spend on the investment side of the business is crucial from a reserves point of view. The company only replaced 67% of its output in 2015 so numbers this year are crucial to ensure the company can continue producing meaningfully. Furthermore, Exxon will continue to shift its production into liquids which have higher price realizations than natural gas. The reserve base in the Papua New Guinea LNG project is currently being re-assessed and Exxon Mobil here definitely has the potential to land long term deals with customers if production remains elevated. LNG projects have their spot prices linked to oil and need very little spending once they are up and running. The dispute on the ground there finally seems to have been resolved so cash flow figures should get a boost in Q3.

Production Levels To Rebound In Q3

I have written in a previous article that Exxon Mobil is a solid defensive stock in this sector but may under-perform its peers if crude oil keeps rallying. However, I feel that the third quarter will finally bring to an end the decline in earnings as I see production levels rising meaningfully through the back end of this year. Problems in Canada and Nigeria which had hindered production last quarter have come to an end, so I see upstream earnings coming in far better in the next quarter.

Capex came down by 38% in the second quarter but these decreases will turn around quickly if crude prices remain over $45 a barrel. Bears have stated that US shale players will keep crude oil prices capped at around the $50 to $55 level which may be a problem for strict upstream players but not Exxon. In fact, by the end of next year, Exxon could achieve cash flow neutrality at the $40-$45 level which means dividends would be safe and increasing.

Takeaway

To sum up, Exxon Mobil shareholders are mindful of the deficit spending the company is undertaking to reward shareholders. Less money is being spent on future initiatives because cash flow from operations have taken a huge hit in recent quarters. Long term dividend investors need to watch how quickly the company is replacing its reserve levels. This metric may not affect shareholders today but will certainly do so in the future if the company continues to raise its dividend every year.