Dear Daily Crux reader, –––––––––––––––––––––––––––––––––––––––––– The Daily Crux: Dan, you recently caused a stir by saying that Jim Chanos – the legendary short-seller – is wrong about his latest short position in ExxonMobil. Can you explain?
By now, most of our readers know our colleague Dan Ferris is a huge fan of buying shares of companies he calls "World Dominators."
As the editor of Extreme Value, Dan has one of the most impressive track records in the industry. He's an expert at finding some of the world's safest, highest returning stocks… so when Dan makes a strong recommendation, we always listen.
Recently, one of the world's top "short sellers" – traders who bet on stocks falling – took a bearish stance on one of Dan's favorite World Dominator stocks. In this week's interview, Dan offers his opinion on why this trader is wrong… and why some folks are missing out on a huge opportunity .
Read on to get the details.
Good investing,
Justin Brill
Managing Editor, The Daily Crux
www.thedailycrux.com
The Daily Crux Sunday Interview
This world famous investor is wrong
Dan Ferris: Well, let me start by saying that I have nothing but respect for Jim Chanos. He figured out the troubles at Enron before anyone else knew what was going on. He shorted the company from about $90 all the way down to $1. He's truly one of the world's best at what he does.
But I think he's totally wrong about ExxonMobil (NYSE: XOM).
Crux: That's quite a statement. What makes you think so?
Ferris: Well, my readers know I think Exxon is one of the world's best-run companies... and one of the world's greatest long-term investments. I consider the company a World Dominator.
Obviously, I'm not impartial. But I can explain exactly why I think Chanos is wrong.
His thesis is that ExxonMobil is in liquidation... meaning the company is selling off its assets... and investors simply don't realize it. This thesis is based on several arguments, but it basically boils down to this: Chanos thinks the company is selling more of its oil and gas reserves than it's replacing, and says the company is earning less money each year. If true, this means the company is on a long, slow decline to zero.
Now, I've spent a lot of time looking at this... and it's just not true.
First, let's talk about reserves.
The details are too technical to get into here... but I break down all the facts in my latest issue. The bottom line is that Exxon has been replacing reserves. In fact, it's been growing reserves. Going back to 1999, we can see that while it hasn't grown reserves every single year, the trend is clearly up. It had more reserves in 2009 than in 1999.
Even better, the company is strongly growing reserves per share. This is due to the combination of growing total reserves and a large share buy-back effort.
And on average, the company has replaced 114% of production for the past five years... meaning they've added 14% more reserves than they've produced and sold.
No matter how you look at it, ExxonMobil's reserves are growing. I don't know what company Chanos is looking at, but it doesn't appear to be this one.
His second basic argument is that revenues haven't increased in years... and again it just isn't the case. When you look at the company's annual revenues over the past 10 years, it's clear to me that its revenues go up when oil prices rise, and fall when prices fall. But this isn't unexpected... it's a commodity company after all. That's how it works.
So while it's true ExxonMobil's revenues fell last year compared to 2008, it's because oil prices plummeted during that same period. But again, the overall trend in revenues is up over the past 10 years.
Fortunately, ExxonMobil isn't dependent on high energy prices to grow shareholder value. The company has steadily increased revenue per share – just like it's increased reserves per share – thanks to its buy-back program.
Crux: Can you explain how that works and why it's such a great thing?
Ferris: A share buy-back or repurchase program is exactly like it sounds.... the company uses its huge cash hoard to buy back its own shares from the open market. This reduces the number of shares outstanding, increasing the value of each remaining share.
ExxonMobil is one of the best share repurchasers of all-time... no other company in the industry can match it. Since 2000, it's reduced the number of shares outstanding by 34%. During the same period, BP lowered its count by just 17%, and Chevron and Royal Dutch Shell increased their share count.
ExxonMobil was one of the few companies to buy back shares during the market crash in 2008 and 2009. While many companies were panicking, ExxonMobil loaded up as its stock fell from $96 to around $60.
The company bought back about $35 billion in 2008 and $20 billion in 2009. It reduced share count by 12%, while share counts at BP, Chevron, and Royal Dutch all increased during that time.
Why is this a great thing?
This move was essentially a massive wealth transfer from sellers to its remaining shareholders.
Like I mentioned before, ExxonMobil is in a highly cyclical industry... its revenues are dependent on the price of oil. When oil prices rise, like they did for most of the past decade, the company makes record profits and generates huge amounts of cash. That's exactly what we saw.
But it makes no sense to plow those record cash flows back into the oil market while prices are at extremes. Prices are too high to find much value. Instead the company buys back shares, which reduces the amount of capital the company has at risk while waiting for the end of the boom cycle.
The buybacks also keep reserves per share steadily rising, even in years where total reserves don't increase by much. They also help to keep revenues per share increasing, by offsetting the loss of revenue from lower oil prices.
Crux: That's a solid argument... But if Chanos is wrong, why has the stock fallen nearly 20% this year while crude oil has held up fairly well?
Ferris: Well, you can never really know what Mr. Market is thinking, but I think I know what's going on here.
The company recently closed its deal to merge with XTO Energy. The deal adds 45 trillion cubic feet of natural gas reserves from every major North American shale discovery to ExxonMobil's reserves. The company's new reserves will be about 45% natural gas.
This is great news... natural gas is the fossil fuel of the future. It's cleaner than coal, more politically feasible than nuclear, and cheaper than solar and wind.
But the company stopped share repurchases to complete the merger. And this is likely what's helped depress its share price, along with the general fear and uncertainty surrounding the entire industry thanks to the Gulf oil disaster.
So I think Mr. Market has given us a fantastic opportunity. Like I often mention to readers, the average holding period for a NYSE-traded stock today is only six months. But ExxonMobil is a long-term investor. That's the only way to succeed in the oil and gas business, and ExxonMobil is the best in the business.
The negative news will pass. Eventually investors will realize that the Gulf spill will have very little impact on ExxonMobil's business, and the company will begin buying back shares again now that the XTO deal is done.
Crux: Great points. Any closing thoughts?
Ferris: Chanos often mentions his four favorite characteristics of great short-sells: debt-fueled booms that go bust, consumer fads, bad accounting, and technology that's become obsolete.
Not a single one of those applies to ExxonMobil.
Chanos may have made the mistake of confusing a highly cyclical business for something it's not. Or maybe he's just looking to play the downside of this cycle. We can't know for sure.
I know it's difficult to own a stock when a famous investor is short. But in Extreme Value we don't base our decisions on what other investors are doing. We do the research, get all the facts, and make our own decisions.
This strategy has been hugely successful for us, and everything I've found tells me ExxonMobil is still a fantastic long-term investment.
Crux: Thanks for talking with us, Dan.
Ferris: You're welcome.
Editor's Note: ExxonMobil is just one of several stocks Dan calls "World Dominators." Dan recently told us that he's making it his mission in life to teach as many people as possible about these stocks, so they'll buy them for their own accounts.
He says that in all his years analyzing stocks, he's never found a surer way to make big, safe returns than buying World Dominator stocks at the right price. To access the complete list of Extreme Value World Dominators, along with everything you need to know to profit from them, click here.
Sunday, 11 July 2010
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