So far in this series of commentaries on the Dow Jones Industrial Average (INDEX: ^DJI) component stocks that are in each S&P 500 sector, we have looked at the telecommunications, financial, consumer discretionary, consumer staples, and health care sectors. I reviewed each sector in the order of their returns year to date. Interestingly, since August we have seen some shifting occur so that as of this commentary the financial sector has the highest year-to-date return at 30.65%, including dividend yields; consumer discretionary ranks second at 26.23%; telecommunications has dropped to third with a return of 24.13% YTD; health care ranks fourth at 15.82%; and consumer staples is now fifth at 15.05%. Our next sector under review, energy, is comprised of only ExxonMobil (NYS: XOM) and Chevron (NYS: CVX) . Let's see how they have done so far this year.
Total Return YTD
Price/Earnings Ratio LTM
Earnings Quality Score
Source: S&P Capital IQ.
In the past, my research has incorporated a Motley Fool Earnings Quality Score that taps into a database that ranks individual stocks. The database designates an A through F weekly ranking, based on price, cash flow, revenue, and relative strength, among other things. Stocks with poor earnings quality tend to underperform, so we look for trends that might predict future outcomes.
For its last quarter, ExxonMobil -- the world's largest publicly traded oil company -- reported lower revenue year over year. Despite lower revenue, operating income and net income were up 41% and 49% year over year, respectively.
Metric (millions except per-share data)
June 30, 2012
June 30, 2011
June 30, 2010
Earnings per Share
Operating Cash Flow
Source: S&P Capital IQ.
As a trend, costs as a percentage of revenue have crept higher. The net profit margin, however, jumped from 9% to 15%. The operating cash flow margin -- last 12 months -- is a healthy and stable 13%. Free cash flow was negative at -$4,861 billion, but is likely a statistical outlier.
Despite strong operating cash flow, ExxonMobil's earnings quality has been hurt by its carrying a higher payables balance than receivables, and also taking longer to pay. Days sales outstanding -- a measure of receivables management efficiency -- were 29 days most recently ,while days payable outstanding were at 62 days, down from 66 days last year and 72 days two years ago. Receivables as a percentage of revenue were steady at 32%, while payables were at 49%.
Days in inventory -- the days needed to complete an inventory cycle -- were at 18 days, but down from 22 days last year. Inventory levels are also down from $19.048 billion last year to $15.158. Combined with the lower revenue, this suggests that ExxonMobil has pared back production and is managing inventory more efficiently. Higher prices at the pumps have hurt demand.
ExxonMobil has steadily worked down its debt position over the last two years, and has also spent $10.63 billion net to repurchase shares. Fewer shares boost earnings per share, but when Exxon reports on Oct. 31, analysts expect $1.94 earnings on $111.12 billion revenue, down 8.92% for earnings and down 11.34% for revenue year over year. More important, average fourth-quarter year-over-year revenue growth will drop to 1.5% from 28%, a huge swing.
ExxonMobil's cost of goods sold has increased from 69% to 71%-73% of revenue year over year since 2010, which could mean that it can't pass these costs on to consumers via higher prices due to less demand. There are likely other oil companies that might provide better returns, but they are not part of the Dow. With its 2.5% dividend yield, XOM is a hold.
Chevron recently warned investors that it expects third-quarter earnings to be "substantially lower" than in the second quarter, when it made $3.66 a share, sending the stock down more than 4%. Diluted earnings in the same quarter last year were $3.92, and analysts expect $2.96 a share from Chevron when it reports on Nov. 2. More important, revenue is estimated at $64 billion, up 7.95% over last year's $59.287 billion.
Like its larger Dow cousin, Exxon, Chevron's costs have been rising slightly faster than revenue and show weak demand for economic reasons. Revenue continues to grow but at a slower rate of growth. Chevron actually enjoys higher operating cash flow margins than Exxon, and operating cash flow continues to average nearly $10 billion a quarter. The point is that many of these metrics are trending negatively. According to news reports, some of Chevron's problems are specific to the company -- a fire at a refinery is one example. These events tend to cloud the longer-term picture which is generally not as bad as the short-term.
Foolish bottom line
Historically, both companies have shown strong growth and good returns for shareholders, and winners are likely to continue winning. Aside from supply and demand issues that have affected both companies, the fundamentals indicate they are dealing with rising costs and can't pass all of this back to consumers. Will this trend continue? Foolish readers should base investment decisions on earnings quality.
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The article Even These Dow Stocks Are Slowing Down originally appeared on Fool.com.
John Del Vecchio has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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