The fallout from diminishing oil prices has hit companies small and large. Numerous small players have been wiped off the map while bigger companies have felt the pinch in the form of depressed earnings. But, on April 25, Exxon Mobil got ‘kicked while it was down’ when Standard & Poor’s lowered their corporate credit and long-term debt ratings stripping the oil giant of its pristine AAA classification.
Exxon traces its roots back to the days when kerosene competed with whale oil as a household lamp fuel, and it’s been the proud holder of the coveted AAA credit rating since 1949. But, Standard & Poor’s didn’t look well on Exxon’s huge debt level, coupled with seriously dented cash flows (related to lower oil prices). The concern is that Exxon is less than ideally situated to cover debt and interest payments, as well as strapped for investment in new discoveries.
As the price of oil tumbled, Exxon issued debt rapidly to fund its dividend program and capital spending. Last year, Exxon reported an annual profit of $16.2 billion, a 64% drop from the year before, but its long-term debt has nearly doubled to 20 billion. The company also slashed its capital expenditures by 29% in the fourth quarter of 2015 to $7.4 billion, reflecting the industry’s sweeping withdrawal amid oil’s decline.
Exxon’s rising debt burden and diminishing returns, coupled with its inexorable increase in its dividend payments, resulted in a return on invested capital (ROIC) of just 5.2% in 2015; the lowest it’s been since the merger with Mobil in 1999. As a result, Exxon was bumped down to ‘AA+’.
What Does a Downgrade Mean?
In reality, a small rating downgrade probably won’t have too much effect on Exxon. First of all, Standard & Poor’s and other ratings agencies are not the be-all end-all when it comes to indicating a company’s strength.
Second, the market seems to have already shrugged off the ratings downgrade. While the stock price declined by as much as 25% in early fall of last year to around $72 a share, the stock price is already back to ~$90 as of this writing.
In terms of reputation, this could be a slight setback as the AAA credit rating was a key selling point for Exxon while conducting business in foreign markets. To some extent, this also impacts the company’s marginal cost of debt capital, which is especially important in a capital intensive business. The downgrade in ratings may increase borrowing costs and can make acquisitions more expensive.
Bottom Line for Investors
Though a downgrade looks bad on paper, it’s not really as bad as it sounds—especially if the company is going from AAA to AA+. An investor might look at it as nothing more than a gentle alert about a company feeling some pressure in a sector that’s widely known to be under duress. Exxon should be just fine and have no trouble surviving this period, remaining perhaps the strongest player in the oil space.
For investors adamant about ratings and highest quality possible, there are now only two U.S. non-financial companies with the highest possible rating on their debt: Johnson & Johnson and Microsoft Corp. It doesn’t necessarily mean they’re the safest stocks—all stocks are inherently risky—but you might look to them for added peace of mind.
Disclosure