It took less than two years for Berkshire Hathaway, Warren Buffett’s storied investment vehicle, to buy and sell a big stake in ExxonMobil. For an investor famous for holding investments for ‘forever’, this is a significant move and vote of no confidence in the world’s largest listed oil producer.
Buffett himself is at pains to point out he sold his US$4bn stake to fund other investments and that Exxon remains – in his words – ‘a wonderful company’. Let’s leave aside the fact that Berkshire has plenty of cash and didn’t need to sell its stake to raise more. What spooked Buffett?
Jim Chanos has, for at least as long as Buffett has been buying, argued that Exxon and other ‘supermajors’ are value traps in terminal decline.
Buffett likes the actions of management, who have been furiously buying back shares and paying dividends; Chanos sees those actions as covering up failure.
Even before the oil price slump, Exxon’s operating cash flow was deteriorating and capital expenditure increasing; free cash flow has fallen from US$22bn in 2010 to US$13bn last year. This year, when lower oil prices bite, free cash flow will be sharply lower again.
Yet rather than adapt to lower profitability, Exxon has stubbornly been buying shares and paying dividends it can’t afford. Buybacks and dividends are 15% higher today than in 2010 despite free cash flow being 40% lower.
The business is, in effect, taking on debt and selling assets in a desperate attempt to pay shareholders. Chanos likens it to a liquidating trust.
Replenishing reserves has become so costly and difficult that Exxon has had to look to gas, buying one of the largest shale gas businesses in North America, XTO, for US$31bn in 2009.
Exxon’s aggregate reserves have certainly grown but, take XTO’s gassy contribution away and Exxon resource base actually has been dwindling. Despite higher oil prices since the acquisition, returns on capital have slumped by a third as highly profitable reserves are replaced by less profitable ones.
Exxon still generates returns on capital of almost 20% but, at the margin, profitability is declining and the actions of management haven’t adjusted to the new reality. It’s hard to see how the decline of the supermajors will be arrested.
In the battle of Chanos vs Buffett, it’s Chanos up by one.