From GS this weekend,
Published June 27, 2010
What's changed
ExxonMobil completed the all-stock acquisition of XTO Energy on June 25. We have lowered our 2010-2013 EPS estimates to $5.80/$7.70/$9.00/$7.80 from $6.10/$8.05/$9.50/$8.35 to reflect the inclusion of XTO into our model, equating to about 5% per annum EPS dilution from the deal.
Implications
The Exxon/XTO transaction in our view casts doubt on the sustainability of Exxon’s historical return on capital advantage. Using a $5-$8/MMBtu Henry Hub natural gas price range, we estimate that the acquisition yields an IRR of 6%-14%. Using Exxon’s preferred returns metric, we estimate XTO will earn a minimal 3%-8% ROCE in 2012 using $5-$8/MMBtu gas prices, well below Exxon’s more robust average ROCE of 28% over the last decade. As such, we think the deal is unlikely to live up to what investors have come to expect from Exxon in terms of project returns and the rigorous returns-focused standards to which Exxon has long held itself.
In addition, Exxon has now raised questions as to whether the deal signals a less attractive legacy resource base than previously assumed. Given the company’s commendable long-term track record of disciplined capital spending and best-in-class ROCE, we struggle to understand why Exxon would allocate $34.6 billion of capital for a very modest return if its organic resource base offered more enticing potential. Though its shares are inexpensive on an absolute basis, we see the potential for further erosion in its relative valuation versus peers and remain Neutral-rated.
Valuation
We see 13% upside to our revised $65 ($70 before) 6-month target price, based on asset value and cash flow valuation analyses. Our lower target price is consistent with our reduced EPS and returns expectations.
