Earnings Notes I (Q4 2024)

Exxon Mobil Corporation (XOM)
Exxon's free cash flow for the fourth quarter of 2024 was $8 billion, which was the same as a year earlier. For the full year, Exxon generated $34 billion of free cash flow versus $36 billion in 2023. (Note that Exxon acquired Pioneer Natural Resources in May 2024 for $60 billion, which added a large amount of production in the Permian.) The market capitalization of Exxon (at $108 per share) is $478 billion and the enterprise value is $500 billion, which puts the annualized FCF/EV yield at 6.4%.

Exxon's upstream earnings were $6.5 billion for the quarter (up 5.5% y/y), downstream earnings were $0.4 billion (down 70% y/y), chemical earnings were $120 million (down 87% y/y), and specialty products earnings were $746 million (down 6% y/y).

Imperial Oil Limited (IMO)
Imperial's free cash flow for the fourth quarter of 2024 was $3.5 million (USD), which was up 54% from a year earlier. For the full year, Imperial generated $2.9 billion of free cash flow versus $1.4 billion in 2023. The market capitalization of Imperial (at $66 per share) is $34 billion and the enterprise value is $36 billion, which puts the annualized FCF/EV yield at 10.8%.

The share count was down 5% year-over-year. They returned a total of $2.7 billion to shareholders in 2024, which is a shareholder yield of 8%. On the operations side, Imperial's cash cost per barrel in 2024 was $3 (USD) lower than in 2023. (Cornucopian.)

Suncor Energy Inc. (SU)
Suncor's free cash flow for the fourth quarter of 2024 was $2.5 billion (USD), which was up 27% from a year earlier. The market capitalization of Suncor (at $38.41 per share) is $49 billion and the enterprise value is $57 billion, which puts the annualized FCF/EV yield at 17.5%. They returned a total of $2.1 billion by way of share repurchases, dividends, and debt repayment in the fourth quarter, which is a yield on the market capitalization of 17%. Suncor has hit its net debt target and is now focused on buybacks and dividends. The oil sands segment produced 539k bbl/d in the fourth quarter with a cash operating cost of $18.59, which was down 14% ($3 per barrel) from the year earlier. 

Intercontinental Exchange Inc. (ICE)
For the full year 2024, ICE earned $3.9 billion of free cash flow on $9.3 billion of total revenue (less transaction-based expenses) for a royalty-like 42% free cash flow margin. Free cash flow for 2024 was up 26% from the prior year. The current market capitalization is $92 billion and the enterprise value is $113 billion, which makes the FCF/EV yield 3.5%.

Enterprise Products Partners L.P. (EPD)
The $0.74 earnings for the fourth quarter are a 9% annualized yield on the current unit price of $32.78. The quarterly distribution is only $0.535 because they are retaining earnings, so the current dividend yield is ~6.5%. The big question with Enterprise is whether all of the "growth" investments pay off by resulting in higher free cash flow generation? If so, cash from operations would increase and capital expenditures would (hopefully) decrease, resulting in a lot more cash available for distributions to unitholders.

General Motors Company (GM)
Was surprised to see that General Motors shares outstanding ended the year 17.53% lower. The market capitalization is $48 billion and in 2024 GM generated $20 billion of cash from operations, spent $11 billion on capital expenditures, and did $7 billion of share repurchases.

Earnings Q1 2024: Exxon Mobil (XOM), Chevron (CVX), and Imperial (IMO)

Chevron (release)
First quarter liquids production for CVX was 1.1 million barrels per day of liquids in the U.S., with another 800k barrels per day in the international upstream. Their U.S. upstream liquids production was down 3% from the prior quarter and up 29% year-over-year. Capex for the U.S. upstream was up 27% y/y. That gives a "production shortfall" (remember Shale Treadmill) of negative 2%.

Unfortunately, they don't break out the "liquids" production between crude and NGLs, but the price realization for liquids was $57/bbl (vs $73 for intl upstream), indicating that it must have a substantial, low-value NGL component.

International liquids production was down 1.2% from the prior quarter and down 2.2% from the prior year. International upstream capex was up 56% y/y. The international natural gas realized price is much higher than the U.S.: $7.25 per mcf instead of $1.24.

Overall, upstream earnings were $5.2 billion (up 1.5% y/y) and downstream earnings were $783 million (down 57% y/y).

Chevron's free cash flow for the quarter was $2.7 billion, which was down 36% y/y. With a market capitalization of $305 billion (at $165 per share) and net debt of $15.6 billion, Chevron's enterprise value is $320 billion, which puts the annualized FCF/EV yield at only 3.4%.

Exxon (release)
First quarter liquids production for XOM was 816k barrels per day of liquids in the U.S., with another 1.7 million barrels per day in the international upstream. Their U.S. upstream liquids production was down 4% from the prior quarter and flat year-over-year. Capex for the U.S. upstream was flat versus the prior quarter and up 8% y/y. That gives a "production shortfall" of 8%.

International liquids production, which is much more important for Exxon than it is for Chevron, was flat from the prior quarter and up 1.4% from the prior year. International upstream capex was down 6.5% y/y.

Overall, upstream earnings were $5.7 billion (down 12% y/y), downstream earnings were $1.4 billion (down 67% y/y), chemical earnings were $785 million (up 112% y/y), and specialty products earnings were $761 million (down 2% y/y).

Exxon's free cash flow for the quarter was $10 billion, which was down 12% y/y. With a market capitalization of $469 billion (at $118 per share) and net debt of $5 billion, Exxon's enterprise value is $475 billion, which puts the annualized FCF/EV yield at 8.4%, heaps better than Chevron.

Imperial (release)
First quarter liquids production for IMO (net to them) was 357k barrels per day, down 2% year over year, with upstream capex down 10% y/y for a production shortfall of negative 8%. Once again, Imperial has the best results on the production shortfall metric, and this is understated because XOM/CVX likely have a rising share of lower value NGLs in their U.S. upstream liquids production.

Imperial's upstream earnings were (USD) $407 million (up 69% y/y), downstream earnings were $460 million (down 28% y/y), and chemical earnings were $42 million (flat y/y).

Imperial's $1.1 billion of cash from operations, less $363 million of capital expenditure, gives $737 million of free cash flow for the quarter. That is a yield of 7.2% on the enterprise value of $41 billion.

Imperial share count is down 8.2% y/y, although they did not repurchase any shares during Q1.

CBS Thoughts
Imperial and Exxon seem superior to Chevron at present valuations. Note that Exxon's business will shift more towards shale if (or when) the merger with Pioneer Natural Resources (PXD) closes. Pioneer gives detail of its oil, NGL, and natural gas production volumes. In the fourth quarter of 2023 (release), oil volumes were 381k barrels per day, up 8.5% y/y. Capital expenditures in Q4 2023 were $1.18 billion versus $1.06 billion the year prior; up 11%. So, not too bad of a production shortfall, which is what we found when we were doing the Shale Treadmill research last year.

Exxon Mobil Corporation ($XOM)

We were just noticing in going over earnings releases that good ol' Exxon Mobil is trading at a shareholder yield of 8%. We like doing comparisons over long time frames, and Exxon went into a drawdown in the summer of 2016 that lasted for 6 years on a price basis, until 2022. Let's compare Exxon's results for 2016 and 2023.

In 2016 (10-K), Exxon's upstream segment earned $196 million, the downstream (refining) earned $4.2 billion, and its chemical business earned $4.6 billion. They produced 2.4 million barrels per day of liquids and 4 million BOE/d total. The refinery throughput was 4.3 million barrels per day.

They had 4.2 billion shares outstanding for a market capitalization of about $350 billion, and $81 billion of net liabilities for an enterprise value of $431 billion. Cash from operations was $22 billion and they spent $12.4 billion (net) on capex for a free cash flow of $9.6 billion. (A 2% yield on the enterprise value.)

They paid $12.5 billion in dividends (3.6% yield) and bought back $1 billion of stock, borrowing to pay the difference between the free cash flow and the shareholder returns (which were 3.8% total and not fully earned).

In December 2019, three years later and just prior to covid, shares were about 25% lower. There was a further drawdown with covid.

For 2023 (release), the upstream segment earned $21 billion, the downstream earned $12 billion, the chemicals segment earned $1.6 billion, and specialty products earned $2.7 billion. They produced 2.4 million barrels per day of liquids and 3.7 million BOE/d total. Their refinery throughput was 4.1 million barrels per day.

They now have 4 billion shares outstanding for a market capitalization of $416 billion, and $43 billion of net liabilities for an enterprise value of $459 billion. (Leverage has decreased from 19% of enterprise value in 2016 to only 9% now.) Cash from operations was $55 billion and they spent $21 billion net on capex for a free cash flow of $34 billion. (A 7.4% yield on the enterprise value.)

They paid $15 billion of dividends and bought back $18 billion of stock, which is a shareholder yield of 8% on the current market cap.

So they have kept production and refining capacity flat for seven years, and their earnings per barrel produced and refined have grown significantly. Free cash flow has increased 3.5x but the enterprise value is only 6% higher because of the valuation compression. The FCF/EV yield (valuation) has compressed by almost three-quarters even as the balance sheet has gotten less risky.

The biggest profit center is their non-US upstream. They do not disclose the upstream profits by project, only by U.S. and non-U.S. They are big in offshore, and so far we are finding that offshore is even more front-loaded / inflation protected than the oil sands. They also have an LNG business selling to Asia and Europe. That’s a significant barrier to entry. And again, front loaded cost.  

Exxon is a blue chip so one of the things you wonder is could we see much higher earnings at say $100 oil, plus a revaluation to a shareholder yield of say 4%? That would make it a multibagger, plus an 8% yield along the way.

Earnings Notes (Q4 2023)

Freeport-McMoRan Inc. (FCX)
For Q4 2023, Freeport reported operating cash flow of $1.32 billion and capital expenditures of $1.36 billion, giving a free cash flow for the quarter of negative $42 million. Their quarterly copper production of 1.1 billion pounds was up 2% y/y, at an average realized price of $3.81 per pound. Their guidance for 2024 free cash flow is $1.2 billion (at $3.75 copper), which would be only a 2% yield on the current enterprise value of $57 billion.

FCX’s consolidated operating cash flows are estimated to approximate $5.8 billion (including $0.1 billion of working capital and other sources) for the year 2024, based on current sales volume and cost estimates, and assuming average prices of $3.75 per pound of copper, $2,000 per ounce of gold and $19.00 per pound of molybdenum. The impact of price changes on operating cash flows for the year 2024 would approximate $400 million for each $0.10 per pound change in the average price of copper, $180 million for each $100 per ounce change in the average price of gold and $120 million for each $2 per pound change in the average price of molybdenum.

Capital expenditures are expected to approximate $4.6 billion for the year 2024 (including $2.3 billion for major mining projects and $1.0 billion for the Indonesia smelter projects). Projected capital expenditures for major mining projects include $1.1 billion for planned projects primarily associated with underground mine development in the Grasberg minerals district and potential expansion projects in North America, and $1.2 billion for discretionary growth projects.

FCX’s financial policy is aligned with its strategic objectives of maintaining a strong balance sheet, providing cash returns to shareholders and advancing opportunities for future growth. The policy includes a base dividend and a performance-based payout framework, whereby up to 50% of available cash flows generated after planned capital spending and distributions to noncontrolling interests would be allocated to shareholder returns and the balance to debt reduction and investments in value enhancing growth projects, subject to FCX maintaining its net debt at a level not to exceed the net debt target of $3.0 billion to $4.0 billion (excluding net project debt for the Indonesia smelter projects).

They are quite leveraged to the copper price as you can see: $400 million additional operating cash flow for each ten cent increment in copper price. Yet even $4.75 copper would only give an additional $4 billion of operating cash flow which would be kind of lackluster on the $58 billion EV. They are crazy to be spending money on growth! They should demand contracts in hand for $6/lb before they spend a penny more on capex.

Barrick Gold Corp (GOLD)
For Q4 2023, Barrick reported cash from operations of $1 billion and capital expenditures of $861 million, giving a free cash flow for the quarter of only $136 million on an enterprise value of $25 billion. Gold production was up 1% y/y in Q4. Their cash cost was $982 per oz and their "all-in sustaining cost" was $1,364/oz. 

Like other commodity producers and miners, they are plowing it into capex: They produced 4.05 million ounces of gold in 2023, down from 4.1 million in 2022 and closer to 5 million in 2020. Cash cost has risen from $700/oz in 2020 to $960/oz last year. Operating cash flow for 2020-2023 (four years) totaled $17 billion but they spent $11 billion on capex. So only $6 billion of cumulative free cash flow ($1.5 billion per year) and production is in decline!

Remember that to recover an ounce of gold they have to process 28 tons of ore, and for every ton of ore, they have to also move 6 tons of waste.

Comstock Resources Inc (CRK)
Comstock produces almost 100% natural gas and sells it for the pittance of $2.50/mcf. They reported negative free cash flow for Q4 and FY 2023 yet they grew production 6% y/y. Although they may get some religion about lighting cash on fire now that natural gas is even lower:

"In response to weak natural gas prices, Comstock plans to suspend its quarterly dividend until natural gas prices improve. In addition, the Company plans to reduce the number of operating drilling rigs it is running from seven to five. Two of the five drilling rigs will continue to be deployed in the Company's Western Haynesville play. As a result, Comstock plans to spend approximately $750 million to $850 million in 2024 on its development and exploration projects to drill 46 (35.9 net) operated horizontal wells and to turn 44 (38.2 net) operated wells to sales in 2024. Comstock expects to spend $125 million to $150 million on its Western Haynesville midstream system, which will be funded by its midstream partnership."

Comstock has $3.4 billion of net liabilities and a $2 billion market cap. It is conceivable that the equity here goes to zero.

PrairieSky Royalty Ltd. (PREKF)
PSK reported revenue for 2023 of $380 million, generated $283 million of funds from operations (74% margin). They spend 13% of revenue on income tax, 9% on G&A expense, 3.4% on finance expense (interest), and about 1% each on production taxes and on exploration and evaluation. The $283 million of funds from operations is a 7% shareholder yield on the $4 billion market capitalization. (Based on Q4 would be an 8% yield.)

Horizon Kinetics wrote about PSK in the annual letter for their Inflation Beneficiaries (INFL) ETF:

"With today’s temporarily depressed energy prices, PrairieSky should be able to generate C$1.50 in FFO/share, which equates to a 7.5% yield. This could be viewed as a “base case” minimum return—assuming no improvement in energy prices, production volumes, or Canadian price differentials. Assuming modest improvement here, namely with pricing and volumes, it is reasonable to expect more than C$2.00/share of FFO, or a 10% yield. If prices rebound more fully, and volume grows even moderately, FFO could exceed C$2.50 share, nearly a 12% yield."

One big hope for PSK would be more export of natural gas from Canada. Their share of natural gas production for the quarter was 5.4 million Mcf of gas which was sold for only $2.19 per Mcf.

Intercontinental Exchange Inc. (ICE)
For the full-year 2023, ICE earned $3.05 billion of free cash flow on $8 billion of total revenue (less transaction-based expenses) for a royalty-like 38% free cash flow margin. The current market capitalization is $78 billion the enterprise value is around $100 billion, so at a 3% free cash flow yield, it is not cheap. Something else to note was FCF was flat from 2022 to 2023. Their M&A goals: "deepen moats, gain intellectual property, increase customer wallet-share".

Peabody Energy Corp (BTU)
The market capitalization of Peabody is now $3.35 billion versus $3.3 billion when we wrote about them last quarter. (It was $4 billion when we wrote about them in August 2022.) Total liabilities less current assets are now $335 million, so we would put the enterprise value at $3.7 billion now. For the fourth quarter of 2023, Peabody's adjusted EBITDA was $345 million, up from $270 million in the third quarter. Adjusted EBITDA for the full year 2023 was $1.4 billion which is about equal to the Q4 annualized figure. That puts the EV/EBITDA at 2.7x. Operating cash flow for the quarter was $282 million and $1,036 million for the year. Capital expenditures were $158 million for the quarter and $348 million for the year. So the free cash flow yield on enterprise value is 13% based on the most recent quarter or 19% for the full year.

Thoughts from Coal Trader: "If executed successfully, the Centurion and Shoal Creek organic investments should deliver extremely high IRR's and return significant free cash flow to Peabody in the coming years. Peabody’s team also found a way to further enhance the Centurion investment by acquiring the adjacent Wards Well deposit. These investments will pivot the company more towards the met market where the long term fundamentals are far more favorable compared to thermal. The long term prospects of the company have significantly improved with Centurion being the flagship of their portfolio in the years ahead. The average realizations of the met segment will improve significantly with the addition of Shoal Creek and eventually Centurion. This is probably something that will be overlooked by many analysts, but I believe the 'relativities' in the metallurgical coal market are something the sector if going to have to contend with for far longer than most believe. That is to say, the price spreads between high-quality coking coals relative to lower-quality coking coals may be here to stay..."

Seems cheap and everything, but would rather own coal royalties at current valuations.

Natural Resource Partners, L.P. (NRP)
No year-end results yet, but NRP put out an 8-K in January about a warrant settlement:

On January 29, 2024 (the "exercise date"), holders of Natural Resource Partners L.P.'s (the "Partnership's") warrants to purchase common units ("warrants") exercised 462,165 warrants with a strike price of $34.00. On January 31, 2024, the Partnership settled the warrants on a net basis with $10 million in cash and 198,767 common units. The 15-day VWAP ending on the business day prior to the exercise date was $97.62. Of the originally issued 4.0 million warrants, 1.08 million warrants with an exercise price of $34.00 remain outstanding.

As of the September 30, 2023 quarterly results, NRP had 2,190,000 warrants outstanding. An October purchase (8-K) brought them down to 1.54 million warrants. We had been wondering what they did with their Q4 cash - we won't know for sure for another few weeks until they report earnings, although they did aggressively tackle the warrants. Wonder if they were redeeming the preferred (12% liability) during the fourth quarter?

Exxon Mobil Corp (XOM)
XOM reported cash from operations of $13.7 billion and free cash flow of $8 billion (58% of CFO) for the fourth quarter of 2023. The market capitalization is $400 billion and the enterprise value is $420 billion so the free cash flow yield is 7.6% at current oil (and LNG) price. For the full year of 2023, shareholder distributions were $32.4 billion ($14.9 billion of dividends, and $17.4 billion of share repurchases) which is a 8% shareholder yield.

Imperial Oil Ltd (IMO)
We mentioned IMO last week. Production in the fourth quarter was up 8.5% versus the prior year, while capex for the quarter was down 34% versus the prior year. (See results. Full year capex was down 2% from 2022.) Free cash flow for the quarter was $667 million, which is about an 8.6% yield on the enterprise value. Imperial is a share cannibal. During 2023, they shrank the share count by 8.3%. 

Enbridge Inc (ENB)
Enbridge shares have been really weak, under-performing Enterprise Products, for example. (Also compare with EPD, NTG, and FEI over the past three years.) It's a $70 billion market capitalization company yielding 7.9% (dividend) which is quite high compared to what it has yielded historically. And it is a C-corp so you don't even get the annoying Schedule K-1 that you do from other midstream companies. From the Q4 call:

2023 showcased the predictability of our business amid continued geopolitical instability, persistent inflation and rising interest rates. This is as a result of the 98% of Enbridge's earnings being generated from either cost of service or take-or-pay contract assets. Our debt portfolio is less than 10% exposed to floating rate volatility. Our customer base is over 95% investment grade, and 80% of our EBITDA is earned from assets with protection against inflation. We are rated BBB+ by all rating agencies and remain committed to our long-held leverage target of 4.5x to 5x.

Half of the EBITDA is from their liquids pipelines. They've got the Mainline pipeline from the western Canada oil sands and then the Line 5 that takes it to eastern Canada refiners. The Flanagan South and Seaway can also take that Mainline oil from Canada down to Gulf Coast refiners. ("We transport about 30% of the crude oil produced in North America. We transport about 65% of U.S.-bound Canadian exports.")

A quarter of their EBITDA is gas transmission. They carry from western Canada to export, also to eastern U.S. Connects PA gas to eastern U.S. as well as Gulf Coast. ("Enbridge moves about 20% of the natural gas consumed in the United States. We are the largest natural gas supplier to New England, the Southeast and virtually all of Florida. Our transmission network is also webbed throughout the Gulf Coast. We are also one of the largest offshore natural gas transporters in the Gulf of Mexico.") They are working on LNG export from western Canada, called the Woodfibre LNG project.

Other quarter is gas distribution (utility). ("Enbridge’s gas utility business, Enbridge Gas Inc., becomes the largest by volume in North America—with about 7,000 employees delivering 9.3 billion cubic feet of natural gas per day (Bcf/d) to about 7 million customers.")

Allison Transmission Holdings Inc (ALSN)
We keep noticing ALSN on the daily all-time highs list. Per their website, Allison is the world’s largest manufacturer of fully automatic transmissions and hybrid propulsion systems for commercial-duty vehicles. 

On fourth quarter sales of $775 million, they did $170 million of net income and $186 million of adjusted free cash flow (24% free cash flow margin). On full year sales of $3 billion, they did $659 million of adjusted free cash flow (22% FCF margin). Revenue for the year was up 10% for 2022 and adjusted free cash flow was up 37%. They repurchasing $260 million of shares during 2023 (6 percent of outstanding). The market capitalization is $6.25 billion and the enterprise value is $8 billion, so the FCF yield is 8%.

Penske Automotive Group, Inc. (PAG)
Highlight from fourth quarter results:

For the three months ended December 31, 2023, total new and used units delivered increased 8% to nearly 117,400, and total retail automotive revenue increased 5% to $6.2 billion. Same-store new and used units delivered increased 9% to nearly 116,700, and same-store revenue increased 4%, including a 7% increase in service and parts revenue. Total retail automotive gross profit decreased 1% to $1.0 billion, including a 1% decrease on a same-store basis. Same-store service and parts gross profit increased 7%.

Revenue for the fourth quarter was $7.3 billion, gross profit was $1.2 billion, EBITDA was $357 million, and capital expenditures were $103 million. The current market capitalization is $10 billion. Net income was $190 million for the quarter and $1 billion for the full year.

AutoNation Inc (AN)
Highlight from fourth quarter results:

New Vehicle Gross Profit - Decreased $102 million reflecting gross profit per vehicle retailed of $3,653, compared to $5,633 a year ago, partially offset by an 8% increase in unit sales. Used Vehicle Gross Profit - Decreased $27 million reflecting gross profit per vehicle retailed of $1,455, compared to $1,847 a year ago and a 4% decrease in unit sales. After-Sales Gross Profit - $540 million, an increase of $61 million or 13% from a year ago.

Revenue for the fourth quarter was $6.8 billion, gross profit was $1.2 billion, and net income was $216 million. During the quarter, AutoNation repurchased 1.15 million shares of common stock (3% of shares outstanding at start of quarter) for an aggregate purchase price of $151 million. The current market capitalization is $6 billion. Net income was $1 billion for the full year.

Enterprise Products Partners LP (EPD)
Highlights from fourth quarter results:

Enterprise reported net income attributable to common unitholders of $5.5 billion, or $2.52 per common unit on a fully diluted basis, for 2023 compared to $5.5 billion, or $2.50 per common unit on a fully diluted basis, for 2022. Operational DCF was $7.5 billion for 2023 compared to $7.6 billion for 2022. DCF provided 1.7 times coverage of the distributions declared with respect to 2023. Enterprise retained $3.2 billion of DCF in 2023 to reinvest in the partnership, repurchase partnership common units, and reduce debt. Distributions declared with regard to 2023 increased 5.3 percent compared to those declared for 2022 and marked Enterprise’s 25^th consecutive year of distribution growth.

Steady as she goes. The real question will be, do the growth investments pay off? If so, earnings will rise and capex will go down, resulting in a lot more cash for distributions. (As we pointed out in October, the free cash flow per unit of Enterprise has grown substantially (3.3x) over the past five years.)

Altria, Inc (MO)
Highlight from fourth quarter results:

Smokeable products segment reported domestic cigarette shipment volume decreased 7.6%, primarily driven by the industry’s decline rate (impacted by macroeconomic pressures on ATC disposable income and the growth of illicit e-vapor products) and retail share losses, partially offset by trade inventory movements. When adjusted for trade inventory movements, smokeable products segment domestic cigarette shipment volume decreased by an estimated 9%.

Cigarettes volumes down 9%. Cigarette revenues down 2.4% y/y net of excise tax. They are not able to raise price of pack enough to maintain flat revenue. Operating income from cigarettes down 1.3% y/y.

Chipotle (CMG)
Highlights from fourth quarter results:

Total revenue increased 15.4% to $2.5 billion. Comparable restaurant sales increased 8.4%. Operating margin was 14.4%, an increase from 13.6%. Restaurant level operating margin was 25.4%, an increase of 140 basis points.

Market capitalization is $70 billion, they earned $282 million in Q4 on sales of $2.5 billion. Sixty times earnings is steep! Net income for fourth quarter was up 11% year-over-year.

Marathon Petroleum (MPC)
This Marathon is the refiner, not the E&P company (MRO). They refine almost 3 million barrels per day, which is the most in the U.S., followed by Valero (VLO) and ExxonMobil, each with about 2 million barrels per day. Highlight from fourth quarter results:

“In 2023, the business generated $14.1 billion of net cash from operations, driven by strong operational performance and commercial execution,” said Chief Executive Officer Michael J. Hennigan. “This enabled the return of $12.8 billion of capital to shareholders. We believe MPC is positioned to generate strong through-cycle cash flow with the ability to deliver superior returns to our shareholders.”

That's on a market capitalization of $63 billion. 

Marriott International, Inc. (MAR)
We wrote about Marriott in November as a royalty-like business. Highlights from Q4 results:

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) totaled $1,197 million in the 2023 fourth quarter, a 10 percent increase compared to fourth quarter 2022 adjusted EBITDA of $1,090 million. The company repurchased 4.7 million shares of common stock in the 2023 fourth quarter for $965 million. For full year 2023, Marriott repurchased 21.5 million shares for $3.9 billion. 

In 2024, we expect another year of solid growth and significant shareholder returns. With normalizing RevPAR growth around the world, we anticipate a worldwide full year RevPAR increase of 3 to 5 percent and net rooms growth of 5.5 to 6 percent. We expect this should yield adjusted EBITDA of approximately $4.9 billion to $5.0 billion for the year and enable us to return $4.1 billion to $4.3 billion to shareholders after factoring in $500 million to purchase the Sheraton Grand Chicago.

That would be quite a nice shareholder return on the current market capitalization of $69 billion.

Warrior Met Coal Inc. (HCC)
The market capitalization of Warrior is now $3.2 billion. Their current assets net of all liabilities (ignoring deferred income taxes) are $660 million, so the enterprise value is $2.5 billion. For the fourth quarter of 2023 (release), Warrior's adjusted EBITDA was $164 million, up from $148 million the prior year. For the full year (2023), adjusted EBITDA was $700 million, down from $1 billion in 2022. That puts the EV/EBITDA at 3.8x using the fourth quarter (annualized) or 3.6x using the entire year.

They sold 1.53 million tons versus 1.45 million the prior year. The average price was $234/t and the average cash cost was $121/t. Cash from operations was $245 million for the quarter and they spent $182 million on capital expenditures. 

For the full year 2023, $700 million of cash from operations, but they spent $525 million on capex. No share repurchases, even though the stock was trading for 1.2x EBITDA earlier last year.

The price per ton of met coal averaged $219 in 2023 vs $304 in 2022. It seems insane to invest so much (~$1 billion for the new Blue Creek mine) in producing more of a commodity that does not have a firm price. There are some good pictures of it in the new investor presentation though.

Coal Trader tweeted: "It seems like they’re really struggling to move this coal. Maybe the transition to more HVA is hurting more than I figured, or maybe the spreads in the Atlantic basin are making it more difficult than I assumed. Prices in Q4 were terrible, and inventories increased A LOT."

That's so brutal. There really shouldn't be any question of being able to move the product if you are expanding production.

Occidental Petroleum Corporation (OXY)
From Q4 results, Occidental's oil volume (total U.S.) was down 2.2% in the fourth quarter (year/year). Their total U.S. production in BOEs though was up 1.3%. In the Permian specifically, oil was flat and natural gas was up 14%. The wells are getting gassier!

Total oil and gas capex in the second half of the year was up 4.5% versus the second half of 2022, but in the Permian was actually down 20%. (They really slashed Permian capex in Q4... in Q3 it was up 8% y/y so maybe we'll see volumes fall off more in Q1 2024.)

Their operating cash flow in Q4 was $2.5 billion with capex of $1.4 billion, giving free cash flow of only $1.1 billion. Market cap is $50 billion and the enterprise value is $80 billion. So EV/FCF is only 5.5%.

Truly no idea what Buffett sees here. 

 

Royal Gold Inc. (RGLD)
Reported results: cash from operations was $101 million for Q4 2023 and $416 million for the full year 2023, virtually the same as Q4 2022 and the FY 2022. There were no capital expenditures in Q4 and only $2.7 million for the full year. They spent $325 million on debt repayment and $100 million on dividends. So the shareholder yield is 5.8% on the $7 billion market capitalization. (Net debt is down to $151 million.)

Kraft Heinz Company (KHC)
Noticing from Q4 results that Kraft's North American volumes were down 5.5% despite 2.5% price increase, resulting in fourth quarter sales down 3%. (They're calling this "headwinds that were driven by ongoing consumer pressure".)

 

The market capitalization is $42 billion and the enterprise value $63 billion. Cash from operations for the full year was $4 billion; surprisingly they actually have $1 billion of capital expenditures, so free cash flow is only $3 billion. They spent $191 million on debt repayment, $2 billion on dividends, and $455 million on share repurchases.

"Big Oil" Earnings - Q2 2023 ($XOM $CVX)

We are watching the Shale Treadmill at oil and gas producers this quarter, starting with two of the supermajor integrated oil companies, ExxonMobil and Chevron. (See last quarter's notes.)

Exxon reports that its worldwide production of liquids was 2.35 million barrels per day, which was down 5.7% from the first quarter and up 2% versus the second quarter of 2022. Total hydrocarbon production (including natural gas) was 3.6 million barrels of oil equivalent per day, down 5.8% from the first quarter and down 3.3% from the second quarter of 2022.

Upstream capital expenditures were $4.6 billion in the second quarter versus $4.6 billion in the first quarter (so, flat) and $3.6 billion in the second quarter of 2022 (up 27% year-over-year). So with flat capex, production declined almost six percent. 

Exxon drills wells in shale basins like the Permian, but they also have significant conventional production, so they are not on as bad of a capital expenditure treadmill as the pure-play shale producers.

Chevron reports that its worldwide production of liquids was 1.7 million barrels per day, which was up 1% from the first quarter and up 3% from the second quarter of 2022. Total hydrocarbon production (including natural gas) was 3 million barrels of oil equivalent per day, flat from the first quarter and up 2% from the second quarter of 2022.

Upstream capital expenditures were $3.2 billion in the second quarter versus $2.6 billion in the first quarter (up 23%) and $2.2 billion in the second quarter of 2022 (up 49% year-over-year). Chevron is spending huge incremental amounts on capex to keep production barely flat.

Remember that Chevron also agreed to buy PDC Energy, Inc. and that deal is supposed to be closing this quarter. PDCE was one of the worst producers in our Shale Treadmill study, with capex was up 94% year-over-year in the first quarter but delivering total production was down 3.3% with oil production down 6%.

Upcoming earnings reports for other producers:

• August 1 (Tuesday) - PXD
• August 2 (Wednesday) - PDCE, CHRD, MRO, OXY
• August 3 (Thursday) - SU, CNQ, COP
  

"Big Oil" Earnings ($XOM $CVX)

Looking at some earnings reports from oil producers. We still haven't heard from Marathon Oil, Canadian Natural Resources, or Suncor. (Although Suncor did announce that they bought out the woke French supermajor oil company from its joint ventures.)

Let's start with the biggest U.S. energy company, Exxon, which is now the 11th largest public company in the U.S. by market capitalization. (It is still about 10% smaller than Tesla's market capitalization!) Shares of XOM recently hit an all time high.

The current market cap of Exxon is $480 billion and their enterprise value is $495 billion. (Exxon's net debt is lower than it has been in a long time.) For the first quarter, they reported earnings of $11.4 billion, for an annualized P/E of just over 10x.

Cash flow from operations was $16.3 billion and their measure of free cash flow was $11.4 billion for the quarter. They returned $8.1 billion to shareholders during the quarter, which included $4.3 billion of share repurchases. (So shareholder returns were half of CFO and 71% of FCF.) The shareholder yield is 6.8% and the FCF/EV is 9% (both annualized).

Earnings breakdown: the Upstream segment $6.5 billion, from 3.8 million boe/d of production, a 4% year-over-year increase. (Capex was up 30%.) The Energy Products segment earned $4.2 billion. Combined, the Chemical Products and Specialty Products segments earned $1.15 billion. They get about half of their production from the Permian and the rest is very geographically diversified, all over the world.

Exxon had 7.2 billion barrels of proved crude oil reserves at the end of 2022 and 17.7 billion total BOEs of reserves. They also have 4.6 million bbl/day of refining capacity: 1.8 million bbl/day in the U.S. and 1.3 million bbl/d in Europe. That's an EV/bbl (crude only) of almost $70, which ignores the natural gas as well as refining and other operations (all very valuable), but shows you that you're not buying crude oil in the ground dirt cheap the way you do with Suncor. 

The topic of replacing reserves was discussed on the conference call for Q1:

We're always looking for an opportunity for an acquisition and one that grows value and it's got to be value-accretive. It's got to be one where what ExxonMobil brings to the table actually increases what either company would do independent of one another. And so, that's kind of, I'd say, the underlying approach.

While we're in a depletion business and, you know, we've got to work real hard to continue to bring volume on, we're not actually in the market to find volume. We're in the market to find value, and we're willing to kind of let volumes do what they will do in the search for making sure that anything that we bring into the portfolio is accretive and is a unique value contribution for the shareholders.

It is great to hear an oil producer say that they are willing to let production volumes decline. That is the capital expenditure discipline that we need from the industry.

You could look at Exxon as: big, blue chip, high name recognition, not deep value priced, integrated and geographically diversified.

Chevron (previously) is the 19th largest public company in the U.S. by market cap and the second largest energy company, with a market capitalization of $320 billion and an enterprise value of $325 billion. For the first quarter, they reported earnings of $6.6 billion, for an annualized P/E of just over 12x.

Cash flow from operations was $9 billion (excluding working capital changes) and their measure of free cash flow was $4.2 billion for the quarter. They returned $6.6 billion to shareholders during the quarter, which included $3.75 billion of share repurchases. (So shareholder returns were 73% of CFO and more than 100% of FCF.) The shareholder yield is 8.3% and the FCF/EV is 5% (both annualized). 

Chevron's capex in the first three months of 2023 was up 55 percent from the year ago quarter, "primarily due to higher investment in the United States." Despite that capex increase, liquids production was flat, and total BOE production (including natural gas) was down 1%. And there was really no discussion of this on the conference call!

They had 5 billion barrels of proved crude oil reserves at the end of 2022 and 11 billion total BOEs of reserves. They also have 1.8 million bbl/day of refining capacity including 1.1 million bbl/day in the U.S. That's an EV/bbl (crude only) of almost $65, which ignores the natural gas and other operations.

Big takeaways - Exxon and Chevron are both nearly debt free, and it sounds like they are both going to make acquisitions instead of investing in increasing production. 

But notice the big increases in capex (+30% and +55% y/y) and low-to-no production growth (+4% and -1%) at both companies. This is why we were interested in the one type of oil producer that has both very long reserve life and front-loaded costs: the Canadian oil sands majors. (It is also why we are interested in royalties on petroleum production.)

Sector Rotation Value Strategy

I've been thinking about how our value vs growth trade has led us to own tobacco, hydrocarbons, pipelines (among other things) and how we might be able to make this a repeatable strategy. I think we are looking for two things:

• Capital expenditures in the sector are low (at a local minimum, nadir), while at the same time
• Cash being generated, and returned to investors (dividends, debt reduction, share buybacks) are high relative to enterprise value and market capitalization.
  

The reason that the first point is important is because investment (or dis-investment) from capacity has predictable effects on profits:

• Over-investment -> low profits and bad times
• Low profits and bad times -> under-investment
• Under-investment -> high profits and good times
• High profits and good times -> over-investment
  

Take a look at recent capital expenditure levels in the oil and gas industry. The first chart below is capex in Canadian oil and gas. The second chart shows the combined quarterly capex of four oil majors (XOM, CVX, COP, and EOG) with the individual companies in green and the combined totals in pink.

The combined capital expenditure at the four largest integrated oil companies dropped 80% from peak levels. The last oil price shock (high prices and good times) led to undisciplined capital allocation in the energy industry. That in turn led to low profits, bad times, and bankruptcies. Over the past couple years we have had under-investment. Since the marginal production comes from fast-declining wells, it falls off fast when there is under-investment.

 

Meanwhile, demand is growing. Even if you doubt it will grow in the U.S., it will grow in the rest of the world.

The stage is set for high profits and good times. Not for nothing, valuations are low in energy. This is important because scarce capital is consistent with under-investment, and low valuations are the second point that we are looking for in this two prong investing approach.

Let's look at a contrasting example. We all know that Costco is a fantastic company. Earnings have been steadily rising the past decade.

The concern is that they may be over-earning - so much of their revenue is from yuppie impulse purchases that are cyclical - and the cycle high earnings are being capitalized at a record high PE multiple. Once you start looking for the double-counting pattern, you see it everywhere.

The industries with the worst trailing 10 year returns (all negative) are: metals and mining, oil, gas & consumable fuels, and energy equipment & services. If this theory is right, there should be mean reversion for them. The rising profits will attract people who will pay higher multiples - double counting.

Meanwhile, the sectors that have been enjoying high profits and good times will have been over-investing. The NASDAQ earnings peak is already in the rear view mirror. As Lyall points out,

Interestingly, earnings have been falling since 2018 and are actually (1) down about 25% from their 2018 peak; and (2) currently slightly below 2016 levels. This is actually not atypical late in a boom/bubble. The flood of capital into an industry usually drives down returns.  Often that's ignored because people are focusing on the growth narrative/top line instead of earnings & returns on capital. Eventually earnings matter though. It goes without saying that the consensus earnings estimates shown in light shade are likely to prove fairly delusional. I think we are most likely to see a continuing downward trend in earnings from here until we have a 2000-style bust & resultant industry capital rationing. If earnings stabilize out at about 150 and the P/E falls to 20x the NASDAQ will fall about 75%. I suspect earnings will probably fare quite a bit worse than that in a legit downturn though. Earnings have already fallen 25% even with extremely favourable top-line conditions. People will argue "but you need to exclude stock comp". The unfortunate reality is that the amount of stock dilution actually significantly increases as share prices fall. You have to issue twice as many shares if the price is 50% lower to give people the same comp package.

Remember that Chipotle spends 60% of revenue on labor and food. Their operating profit margin is just under 5%. As Chipotle's food and ingredient costs rise, they can try to pass it on through higher prices but at a certain point this is limited by hurting sales volumes. Then the margins will just be reduced.

Falling margins at constant revenue will mean falling profits. At that point, the stock could re-rate from 114 times earnings to one-tenth of that multiple. Profound overvaluation can result in some cost inflation causing a 95% share decline in a decent business.

Energy Stocks Are Still Overpriced

Green curve above shows the WTI oil futures curve at the market peak on February 19th, orange curve shows what it looks like today.

Ignoring the debacle in the front month (May and June) contracts, the July oil is trading for $20/bbl which is down 66% from the 2019 year-end price of $59/bbl. The out-year contracts are now converging on $40 which is down by 33% from the 2019 year-end price.

Meanwhile, Exxon is down 40% year-to-date and the XOP fund is down by about half. The equities have fallen by slightly more than the commodity price, but there are two problems with that:

1. Equities should fall by more than the commodity price because of operating and financial leverage
2. Energy stocks were overpriced to begin with

The leverage should be obvious. If your oil costs $15 per barrel to produce, a price decline from $60 to $40 (-33%) lowers your profit per barrel from $45 to $25, a 45% decline. Having debt also leverages the enterprise value decline impact on the equity. 

I have been watching Exxon for years trying to justify owning it. My clients would be a lot happier owning a "blue chip" selling dinosaur juice than sitting in T-bills. Here are my notes from June 2016:

They had net income of $1.8 billion in the first quarter. The upstream lost a little bit of money, but downstream and chemical made money. If you value those two segments at 15x Q1 annualized net income, they're worth $135 billion. (That would be in the top few dozen of the S&P 500.) The enterprise value of XOM is $400 billion, so you're paying $265 billion for the oil and gas reserves. The PV-10 was $208 billion at the end of 2014, down to $71 billion at the end of 2015.

Can also think in terms of a very attractive price to pay for XOM. Let's say $135B for the two segments and then $100B for the oil. That's $235B EV, which is $165B less than current EV. Means 45% lower stock price - $40. 

The stock was trading at $90 then and now it's at... $40. Oil was at $50 then, now the weighted average from a DCF valuation would be in the high $30s. Again, that 20% commodity price decline should be magnified by the operating and financial leverage into an even bigger share price decline.

This pattern exists at every energy company I have looked at recently. At least Exxon makes money - so many companies in the industry do not, and did not even at higher prices. Last fall I asked, "What happens to oil prices when producers have to be profitable?" One reason I have had to hide out in cash this cycle is that when people are too optimistic (delusional), no one can make money investing. Either the business operators are overfunded and compete all the profits away (energy, startup sector, "disruptors," Netflix, Amazon) or investors are too optimistic and pay prices for share interests that almost guarantee losses. The willingness to pay high multiples for hypothetical future earnings is an extreme example of double counting. (The Nifty 50 were expensive but they all made money.)

The most popular stock on retail brokerage (bucket shop?) Robinhood during the historic oil futures decline to negative prices this week was the United States Oil Fund ETF. What they don't seem to realize is that USO is not a tank farm full of cheap oil that is going to bounce back in value. It is just an entity that buys front month oil futures contracts and rolls them over. It is getting chewed up by the contango (having to sell the future low and buy a higher priced one to roll over) and will probably go to zero this summer.

This bear market should give a final washout of the energy sector. There will be lots of bankruptcies with equity wipeouts and very low creditor recoveries. As long as the profitability-indifferent investors are scared away, the survivors would be able to consolidate the remaining properties, develop them rationally, and make money.

Out of the Money Puts?

Ridiculously overpriced garbage that might be worth owning puts on:

• TLT
• FB
• TSLA
• NFLX
• XOM