Losing Triple A Credit Rating

Losing Triple A Credit Rating

ExxonMobil Corp. had the honor and distinction of having a gold-plated AAA credit rating since the post WWII period. However, fortunes can change abruptly when one is trading products of mother nature. Last week, Standard & Poor’s (S&P) downgraded Exxon Mobil’s credit rating for the first time in almost 70 years from the coveted “AAA” rating to a “AA+” rating citing expectations of continuing low oil prices. ExxonMobil joins two other US companies with S&P AA+ credit ratings; General Electric Co. and Apple Inc. The two remaining US companies with the highest possible corporate AAA debt ratings are Johnson & Johnson and Microsoft Corp.

Exxon Mobil History

ExxonMobil is an American multinational oil and gas company based in Texas. It is the largest direct descendant of John D. Rockefeller’s Standard Oil Company. Exxon Mobil was formed in 1999 by the merger of Exxon (formerly Standard Oil Company of New Jersey) and Mobil (formerly the Standard Oil Company of New York). ExxonMobil is also the Fifth largest publicly traded company by market capitalization. ExxonMobil was the second most profitable company in 2014.

Downgrade Reasons

S&P stated that the “company’s debt level has more than doubled in the recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow.”

S&P also said that while Exxon made efforts to reduce capital spending, the maintenance of production and replacing reserves will ultimately require the company to spend more. Because the company is returning cash to shareholders, instead of building cash or reducing its debt, the company faces limits on credit improvements even when oil prices recover.

S&P cautioned that it could further lower its rating on Exxon if the company is unable to sufficiently adapt to a prolonged period of low commodity prices. The downgrade is not a complete surprise. In February, S&P downgraded rival Chevron Corp and warned that such a move was also possible for Exxon.

Shareholder Payments

ExxonMobil paid out $325 billion as dividend and share repurchases over the last 11 years which exceeded its outlays for new property, plant and equipment of $272 billion over the same period. During the fourth quarter of 2015, the company paid out $3.6 billion in dividends and share repurchases, which is more than it earned in that quarter.

In February, Exxon Mobil changed its strategy and declared that it would only repurchase shares to offset dilution, and not pay back cash as dividend.  

Why Repurchase Over Dividend

Many companies prefer stock repurchase over dividends. One explanation is accounting based therefore cosmetic and the second explanation is more economic.

Investors tend to focus on accounting earnings, mostly earnings per share (EPS), which is computed as net income divided by number of shares outstanding. When a company buys back (repurchases) its own stock, it reduces the shares outstanding and thereby increases its EPS. This type of an increase in reported EPS is cosmetic (nip and tuck). Shareholders care about the pie (earnings) and not how the pie is being shared (EPS). So stock buyback initiated to increase EPS is a akin to a magician’s show intended to circumvent reality.

The advantage of stock buyback is that it is a one-time cash payout unless the company elects to announce future buybacks. Dividends, on the other hand, are more permanent in nature and investors expect continuation of dividend payments when one is announced. Therefore, companies wanting to preserve future cash prefer stock buyback over dividend.

ExxonMobil wants to buyback stock to offset the stock price decline from declining oil prices. Given the low oil prices, it has cut back on its planned investments or production capacity. However, when oil prices bound back, it wants to preserve cash to fund its future growth which is why it prefers stock buyback over dividend.

Stock Price

ExxonMobil’s stock price went down from a high of around $103 in 2014 to a low of $72 in 2015. The stock is back at around $90. With oil prices trending up, we can only expect ExxonMobil’s stock price to continue its upward trajectory.

Chatham; June 11, 2.11P


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