ExxonMobil Corp (XOM) stock ended 2023 just below $100 at $99.98 per share. But XOM looks cheap here with a forward P/E of 10.9x and a 3.80% dividend yield. Moreover, with $40 billion in free cash flow (FCF), XOM stock is worth considerably more than its present valuation.
The stock is near a trough now, having fallen from almost $120 per share at the end of Sept. Ever since the company announced on Oct. 11 its merger bid for Pioneer Natural Resources (PXD) and lots Q3 earnings on Oct. 27, XOM stock has been on a slide.
But that does not take away from the huge amount of free cash flow the company generates.
Massive FCF Could Lead the Stock Higher
For example, the oil and gas company generated $11.7 billion in FCF last quarter, $6.7 billion more than the $5.0 billion it made in Q2. YTD Exxon has produced $28.13 billion in FCF and could easily generate $40 billion by the end of 2023.
Moreover, if the merger with Pioneer goes through during the first half of 2024 as the company projects, its 2024 and 2025 FCF generation could soar even higher. I described this in my article on Oct. 24, “Exxon Stock Is Off Its Highs Ahead of Earnings But Investors Are Bullish.”
For example, Pioneer generated $1.2 billion in FCF during Q3 as well as $742 million in Q2, and $948 million in Q1. That makes $2.89 billion YTD, and it's likely the company will generate close to $4 billion for all of 2023.
If that occurs, this will be an additional 10% increase in the $40 billion that Exxon generates each year. And that is before any scalar savings between the two companies. In short, it might not be out of the question that the combined company could produce $45 billion to $50 billion in FCF.
XOM Target Price
This means that XOM stock is severely undervalued.
For example, using an 8% FCF yield metric, we can estimate that its market cap could rise to $562 billion (i.e., $45b/0.08=$562.5 billion). That is $162.5 billion higher than its present $400 billion market capitalization, or 40.6% higher.
In other words, XOM stock could be worth 40% more, or $140 per share (i.e., $100 x 1.40). That makes it very cheap here.
One way for existing shareholders to play this is to short out-of-the-money (OTM) put options. That will create extra income while they wait for the stock to rise.
Shorting XOM OTM Puts for Income
For example, look at the Jan. 19 expiration period for XOM puts, which is 3 weeks away from today. It shows that the $95.00 strike price, which is about 5% below today's price (i.e., out-of-the-money), trades for 44 cents on the bid side.
That means that anyone who shorts this put, with just 3 weeks until expiration, makes an immediate yield of 0.463% (i.e., $0.44/$95.00).
That means that if the investor can repeat this trade every 3 weeks for a year, the expected return (ER) is 7.87%. That is because there are 17 periods of 3 weeks in a year and 17x0.463% equals 7.87%.
This trade won't work every time and there is downside risk. But the worst that will happen is that the investor will have to buy more shares at $95.00 per share.
Given the $3.80 dividend, that means the investor will have a 4.0% dividend yield (i.e., $3.80/$95.00) on that tranche, even if it results in an unrealized loss. That makes this a very attractive way to play XOM stock while waiting for it to hit the much higher target price.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
