BIG BAD OIL

The highly publicized and politicized outcry over increasing gasoline prices reached a crescendo in April when Exxon Mobil announced the fifth largest quarterly profit in history for a publicly traded company, bottom-lining more than $8 billion for the first quarter of 2006.

This came on the heels of early April news that former Exxon Mobil Chairman Lee Raymond sailed into his January retirement with a package approaching $400 million, including a lump sum payment of more than $98 million, according to SEC filings. As crude oil soared past $70 per barrel, and gasoline topped $3 per gallon, Raymond’s package added fuel to an already hot public relations fire.

Judging by the drubbing Big Oil took in the media, on the House and Senate Floors, and in countless bar rooms, barber shops and around dinner tables across the country, you’d have thought that $3 gas meant insanely high profit margins for Big Oil companies. Some Senators suggested kicking back $100 to every taxpayer to cushion the blow of increased commuting costs; one Senator, presumably in the guise of a modern-day trust busting-Teddy Roosevelt, brought forth the notion of breaking up the big oil companies altogether.

With all the scrutiny and bad feeling around the issue, some commentary on the fundamentals of Big Oil, Exxon Mobil in particular, should be devoted, especially in regards to how current sales and profit figures compare to prior years. Comparisons to a few other companies outside the oil industry for perspective are also in order.

The Top Line

Starting with sales figures, Exxon dwarfs the rest, by a large margin:

Sales ($millions)

2005 2004 2003 2002 2001

Exxon 358,955 291,252 237,054 200,949 208,715

Microsoft 39,788 36,835 32,187 28,365 25,296

Merck 22,012 22,939 22,486 21,446 21,999

Hershey 4,836 4,429 4,173 4,120 4,137

Sources: Bloomberg, Multex

In terms of sales growth, Exxon is also the clear winner for 2005, growing the top line at 23%. For the four-year period 2001-2005, Exxon again comes out on top, with four-year growth of 72%, or a compounded annual growth rate of 14.85%. Microsoft finished second with 57.2% and a CAGR of 12%. Not very comforting to the general public, no doubt, who are still trying to get used to paying $3-plus for a gallon of gas.

It comes as no surprise that Exxon’s net income is also substantially greater than the rest. In fact, it is considerably more than the other three companies’ combined 2005 net income.

Net Income ($millions)

2005 2004 2003 2002 2001

Exxon 36,130 25,342 21,510 11,460 15,320

Microsoft 12,254 8,168 7,531 5,355 7,346

Merck 4,631 5,813 6,795 7,053 7,192

Hershey 493 591 458 403 207

Sources: Bloomberg, Multex

For more perspective on the magnitude of what $36 billion represents, consider that Exxon’s 2005 net income is very close to Microsoft’s 2005 total revenue. In terms of net income growth, Exxon’s was the most robust, up 233% during the four-year period for a compound annual growth rate of 23.6%. None of the other companies came close to Exxon in this department, and Merck was in negative territory, with profits sliding each year.

Despite Exxon’s strong sales and earnings growth, despite earning more in one year (2005) than any other publicly traded company in the history of the world, the company’s net profit margins just barely break into double-digit territory. Microsoft earns more than three times as much per dollar of sales than Exxon does. Even Hershey’s net margin is superior to Exxon’s, essentially making chocolate more profitable on a relative basis than oil.

Profit Margin

2005 2004 2003 2002 2001

Exxon 10.07% 8.70% 9.07% 5.70% 7.34%

Microsoft 30.80% 22.17% 23.40% 27.77% 29.04%

Merck 21.96% 25.34% 30.37% 33.54% 33.10%

Hershey 10.19% 13.05% 10.59% 9.81% 5.00%

Source: Bloomberg, Multex

Judging by analyst estimates for the next three years, there won’t be a great deal of revenue growth or margin expansion for Exxon Mobil. In fact, analysts estimate a fairly sharp revenue drop by 2008, indicating their current belief that oil prices will fall over the next couple of years.

Exxon Mobil Estimates

2006 2007 2008

Revenue 381,219 351,314 275,247

Net Income 36,053 31,409 27,086

Profit Margin 9.46% 8.94% 9.84%

Source: Multex

In terms of margin expansions for the other three companies, the estimated outlook appears brightest for Hershey. While analysts still estimate healthy 20-plus percent margins for Merck and Microsoft, these are leveling off, or declining.

Profit Margin Estimates

2006 2007 2008

Microsoft 29.30% 28.72% 29.43%

Merck 22.30% 22% 21.95%

Hershey 12.20% 13.08% 13.95%

Source: Multex

There’s no doubt that the preceding analysis was an apples-to-oranges comparison in terms of industries and companies. The point of this illustration, however, was not to suggest comparability between these companies, but rather to put big oil numbers into perspective. The oil industry is highly competitive, highly regulated, dependent on the price of a commodity of which there is both a declining supply and increasing demand, and subject to severe supply disruptions. Furthermore, it is capital-intensive, requiring substantial research and development efforts, especially as oil reserves become harder to locate and tap. So from a risk/reward standpoint, relatively high profit margins would seem to be a deserved outcome.

There’s no doubt that rising gas prices are an emotional issue. Psychologically, consumers have a difficult time paying $3 and up at the pump and the very notion that Big Oil companies generate billions in income, while consumer commuting costs rise, is simply not palatable to many. This in turn makes oil companies an easy target for politicians, especially as elections approach. Huge payouts to retiring executives don’t help matters.

But the numbers don’t lie. While oil company profits are huge in absolute terms, profit margins tell a somewhat different story that will probably never get into public consciousness at the same level as the revenue and profit numbers.