Sunday, January 25, 2009

XOM long-short idea- Barron's published over the weekend with the title "Buy Oil". Ironic, given the last Barron's cover to blithely beg readers to "buy" anything was its "Buy GM" issue, when the stock was in the teens. Not a good omen, but the proof is in the pudding.

In fact, there may be buys in the oil sector, but they might require more intellectual insight than simply "buying the sector". One idea that stands out slightly is to short XOM (Exxon Mobil). Currently, Exxon is trading at a market capitalization of $400Bln. After netting out $36Bln cash, less $10Bln debt we derive an enterprise value of $375Bln. This suggests that Exxon alone is worth more than 5% of the S&P 500.

Interestingly, at $78/share, Exxon stock is trading roughly 15% below its mid-2008 price (when oil prices were above $100/barrel). Given that oil is close to $50/barrel now, this alone suggests that the price may have further to fall.

Another signal that Exxon may be overvalued is that you could construct an oil conglomerate by purchasing BP($106Bln), Chevron ($144Bln), and Conoco($72Bln) for a combined $322Bln. The combined reserves of this "conglomerate) is roughly 39.2Bln BOE (17.6, 10.8, 10.8, respectively). This reserve total is 73% greater than XOM's reported reserves of 22Bln BOE.

From a revenue standpoint, this "conglomerate" would have generated combined revenue of $886Bln in 2008, vs $457Bln for XOM (94% higher).

While Exxon has the strongest cash position, it is not nearly large enough to justify the valuation differential. Thus, either Exxon is dramatically overvalued, or the other oil companies (collectively) are significantly undervalued. My guess is that the answer is somewhere in between. As such, there is a compelling case for doing a long-short (buying a basket of oil names vs. selling XOM), or simply selling Exxon (buying puts)

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