U.S. oil majors Exxon Mobil and Chevron are good at squeezing hydrocarbons out of the ground. Digging for extra Brownie points from investors has been tougher.
The companies have tried hard to be attractive, first by continuously demonstrating spending discipline and consistently doling out generous shareholder returns. Most recently, both announced mega acquisitions at reasonable prices.
Exxon just acquired some of the best acreage in the prolific Permian Basin, paying a 9% premium on Pioneer Natural Resources' 30-day volume-weighted average price as of Oct. 5. Chevron, meanwhile, added some valuable Guyana exposure , paying a 10.3% premium on Hess's 20-day average price on Oct 20. With these acquisitions, research firm Wood Mackenzie estimates that the two U.S. oil majors combined will generate more than half of the total free cash flow of the seven major oil companies by the mid-2030s in its base case oil-price scenario.
On Friday, Exxon announced a 4% dividend increase—more generous than last year's hike of 3%. Both are still generating a lot of free cash flow and returning a good amount of it to shareholders: Exxon and Chevron have paid out $24 billion and $20 billion, respectively, in dividends and buybacks year to date.
But both companies saw their share prices slip since announcing their megadeals. On Friday after both released quarterly results, their shares took a further leg down—Chevron by 6.7% and Exxon by 1.9%. Exxon is down 4.2% since its deal announcement, while Chevron is down 12% since news broke of its acquisition.
Lukewarm results deserve some of the blame. Exxon's net income in the third quarter fell 54% from a year earlier to $9.1 billion, a slightly worse result than Wall Street expectations of a 52% decline. Chevron's net profit was 42% lower, worse than the 38% decline that analysts had estimated.
Exxon said its energy-products segment was negatively affected by unfavorable timing of its hedges, which will unwind over time. Its chemicals segment, meanwhile, succumbed to compressed industry margins. Chevron reported worse-than-expected international downstream results, which were affected by lower margins on refined-product sales and lower refinery runs because of planned shutdowns.
The two companies might have unwittingly signaled less confidence to the market by using their stock as currency for their deals. For one, it demonstrates that they believe their shares are fully valued. Furthermore, growth by acquisition telegraphs slightly less confidence in oil's longevity—a truly bullish move would be to devote resources to entirely new production.
Investors have expressed doubts about Exxon's claim that it can produce more out of its and Pioneer's combined acreage than the companies would have individually, all while reducing costs. In the earnings call on Friday, Exxon gave more color, saying that its method—known as cube development—delivers similar recovery on its own acreage as Pioneer's, even though Pioneer acreage is higher quality. Cube development allows Exxon to drill multiple horizontal wells in stacked intervals from a single surface location—a method that helps maximize recovery while reducing costs, according to the company's website.
Meanwhile, Chevron faced multiple questions on its earnings call on Friday about its ability to execute its projects on time and on budget following delays and cost overruns on its joint-venture expansion project in the Tengiz Field in Kazakhstan. Chevron said Friday that the project is expected to cost between 3% and 5% more than the initial plan. Chief Executive Mike Wirth said that the project has had unique issues and that remaining projects in its pipeline are less complex.
One read of the reaction so far could be that investors fundamentally aren't willing to assign much more value to energy companies, even the largest ones with huge cash-flow potential. Another explanation is that investors simply need to see more evidence of synergy and cash-flow potential before getting excited about the announced deals.
Negotiating a megadeal is one thing. Convincing investors of its value is another matter.