ESG, which stands for Environmental, Social, and Governance, is a movement that has gained a significant amount of steam over the past few years. According to Morningstar, a surge of investment inflows to sustainable funds helped them reach a new record of $20 billion in 2019. A CNBC report that was released this week stated that analysts predict the total amount in ESG-related investments is expected to double this year. While a number of well-known ESG companies certainly come to mind, with renewable energy company NextEra Energy (NYSE:NEE) being one of them, I can think of an equal number of companies that don’t necessarily fit the ESG bill.
The three stocks that I have for you today, Exxon Mobil (NYSE:XOM), Philip Morris International (NYSE:PM), and Wells Fargo (NYSE:WFC), can be considered by many to be “non-ESG” companies. However, as there are two sides to every coin, I believe that painting these companies with a broad brush is akin to dwelling on the past while ignoring the present. In addition, I believe an investment in each of these three companies provides an attractive risk reward ratio at today’s valuations, so let’s get started!
Exxon Mobil: The Environmental Factor in Non-ESG
Exxon Mobil is the world’s second largest energy company, sitting just behind Saudi Aramco, which is still majority state-owned by the Saudi government. While most people know the company for its exploration, production, and refinement of oil and natural gas, Exxon also has a robust chemicals business. When someone drives a combustion engine or electric motor vehicle, or takes public transportation, they are travelling on roads paved with asphalt, which is produced from petroleum. In addition, as electric vehicles gain popularity, demand for plastics (which is produced from oil and natural gas) rises incrementally, too. That’s because plastics are lighter than steel, thereby enabling electric vehicles to travel farther on single charge.
Exxon is also exploring the potential use of algae as an alternative clean fuel source and has a partnership with FuelCell Energy (NASDAQ:FCEL) to develop carbon capture technologies with the potential for large-scale power utility and industrial applications. As a sign of its commitment to cleaner energy, Exxon’s stated goal is to produce 10,000 barrels of algae biofuel per day by 2025.
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To be clear, Exxon Mobil’s fortunes today are still very much tied to fossil fuels, in which it has many competitive advantages as an integrated oil and gas company. It has plans to sell $25 billion of non-core assets in Europe, Asia, and Africa so that it can focus more resources on the Permian Basin and Guyana. I like this plan, as the company has a number of operational efficiencies that allow it to drill for oil at a lower cost per barrel in these two areas compared to what it can achieve anywhere else at the moment. This is what CEO Darren Woods had to say about the Permian Basin in late May during the company’s annual shareholder meeting:
We’re fully leveraging this integrated capability in the Permian, beginning with the production of oil and gas in New Mexico and West Texas through our gathering systems, terminals and pipelines, all the way to our Gulf Coast refining and chemicals complexes, providing unconstrained market access to the upstream and advantage feed stocks for our manufacturing facilities.
Over the past two years, this approach has generated $1 billion of incremental value. The collective experience of our global organization operating over decades has resulted in deep knowledge and critical disciplines and execution capabilities. We refer to this as functional excellence, which manifests itself in all of our work. A particular importance is how we develop and execute projects.
Keeping in mind that the Guyana assets were discovered just five years ago, I’m impressed by how quickly Exxon has ramped up its operations there. It appears that Guyana will begin contributing to the company’s bottom line this year. This is what Darren Woods had to say about Guyana during the annual meeting:
We leveraged our project management expertise in the Liza Phase 1 development Offshore Guyana, last year bringing production online under budget and ahead of schedule, less than five years from discovery, which is about twice as fast as the industry’s average for a project of this scale, and we did this with leading safety and environmental performance.
We enhanced our capabilities in this area when we formed our new global projects organization in April of last year, integrating decades of project management experience, deep technical knowledge and commercial capabilities from our upstream, refining and chemical businesses and the one global team, excluding projects across our entire corporation. This new organization is already delivering significant value, and is playing a critical role in managing our response to COVID-19.
While the current COVID environment has proved challenging, management has proved its willingness to adapt as it cut $10 billion from its 2020 capex budget. One key factor that investors should pay attention to is its Net Debt balance, which, as of March 31st, had risen by 38% since 2015. In addition, it raised an additional $9.5 billion worth of debt in April. I view this as more of a precautionary measure to boost liquidity during the crisis, as many companies have done.
(Source: Created by author based on company financials)
I’m not too concerned by the increase in debt, as the company has a promising outlook in the Permian and Guyana, which could significantly boost cash flows and allow the company to again cover the dividend and reduce its debt balance. As of now, its debt-to-capital ratio still stands at a safe 13%, and it maintains an AA credit rating from S&P.
I also find the 8% dividend yield to be attractive. Although it is not currently covered by cash flows, I expect it to be covered in the future as this company is not managed on a quarter-by-quarter basis, but rather with a longer-term basis in mind.
I have a Buy rating on shares at the current price of $43.62 and a P/EBITDA ratio of 7.5. I have a one-year price target of $60 with the expectation that the economy will return to normal with an eventual easing of the pandemic and a ramp-up of its Permian and Guyana operations.
(Source: F.A.S.T. Graphs)
Philip Morris International: The Social Factor in Non-ESG
Philip Morris is perhaps one of those companies that doesn’t need an introduction. Since being spun off from Altria (NYSE:MO) in 2008, it sells tobacco products outside of the United States. It holds a strong 25% market share in cigarettes alone, led by its signature Marlboro brand. Perhaps what’s most exciting about Philip Morris is the iQOS heat-not-burn tobacco product that the company introduced in 2014. I recall a few years ago, at a business software conference, during which I struck up a conversation with a couple of fellow attendees that happened to work for Philip Morris. They told me that their CEO had a vision for generating over half of its revenues from its smoke-free product, iQOS. I hadn’t heard much about iQOS at that time, and remember feeling impressed at what seemed to be an audacious goal.
Based on the latest results, it seems the company is well on its way. iQOS is now the third largest tobacco brand in the markets where it is sold, holding a 6.6% share, and only sitting behind the Marlboro and Winston brands.
(Source: Company Investor Presentation)
iQOS already represents 10% of total combined cigarettes and heated tobacco volume for the company and is growing at a 7% to 10% annual rate, as reflected by the graph above. I believe a net positive for Philip Morris will be the continued roll-out of iQOS in the United States, in which it has licensed the sale and marketing of iQOS to its former parent company, Altria. The United States represents an attractive tobacco market, and I see much incremental revenue potential for Philip Morris as smokers are converted to the iQOS platform. I see another positive in that governments around the world may not choose to tax iQOS in the same manner as cigarettes, which could make iQOS margins more favorable compared to those of cigarettes.
While currency risk will always be an overhang for Philip Morris, this risk is somewhat mitigated by the record amount of stimulus that has been introduced to the U.S. economy, which could result in a dollar devaluation. This could provide a favorable tailwind as its international income is converted to U.S. dollars.
I find the 6.8% dividend yield to be attractive, as it remains safe at a 78% cash payout ratio over the trailing 12 months. Although the 3.6% annual dividend growth rate over the past five years hasn’t been too impressive, I expect a faster growth rate going forward with reduced iQOS-related R&D spend, and potential currency tailwinds and higher iQOS margins.
I have a Buy rating on shares at the current price of $68.87 and PE ratio of 14.5. I have a one-year price target of $90, which I find reasonable given the promising growth trajectory of iQOS globally and in the potential it holds in the United States.(Source: F.A.S.T. Graphs)
Wells Fargo: The Governance Factor in Non-ESG
Wells Fargo has been no stranger to controversy in the past few years after it admitted in September 2016 that as many as 2 million fake accounts were opened from 2002 to 2016. Besides the reputational damage this had caused, Wells Fargo was hit with civil and criminal investigations, which it only recently settled in February of this year for $3 billion.
While poor governance and oversight undoubtedly led to the scandal, the company has made a number of changes since when the scandal first broke. Among the top officers to have exited the company include the former CEO John Stumpf, who presided over the bank when the scandal broke, and his successor Tim Sloan, who was unable to convince regulators of the changes the bank had made. In addition, the company has clawed back $75 million in compensation given to John Stumpf and former head of community banking Carrie Tolstedt for their negligence.
In addition, I find it encouraging that the new Wells Fargo CEO, Charles Scharf, is an experienced outside hire who had previously served as CEO of Visa (NYSE:V) and BNY Mellon (NYSE:BK). I also like the fact that he sees a lot of strengths in the strong branch network and opportunities to make the company better, all while addressing the need for proper risk governance as he remarked during a May 2020 industry conference:
As I said, the franchise quality is extraordinary. And the community-oriented culture not just within the company, but what we do market-by-market community-by-community really is a driving force in how the company thinks.
The other side of that the way the company was run is just not what is going to be able to make us successful for the long-term. Part of the culture while you could look at it and say it’s positive, it’s a very nice place, not demanding enough way too insular, both in terms of how we thought of ourselves but also our willingness to be curious and look outside the company at others who are extremely successful. And the autonomy that existed within the company under the right model is a good thing, but where we had gotten had become a very bad thing.
And then I think last, but probably most important given the issues that we have, is just — there’s just this not this sense of urgency and set of skills around executing things that are operational specifically for us building the infrastructure on the risk and regulatory side.
With a new outside CEO and a strong retail branch network, I believe the bank can finally move past its past struggles. While COVID presents a new set of challenges, I see opportunity for the embattled bank to prove itself as it successfully got the Federal Reserve to temporarily lift its asset cap. The bank has also prudently reserved $3.1 billion to act as a buffer against the impacts of the virus.
One key risk for dividend investors is that further deterioration in the economy could cause the Federal Reserve to force banks to suspend or cut dividends, as it has already capped dividends at their current level. With that in mind, I do find the 8.05% dividend yield to be attractive, as it is currently sitting in a historically high range. It has a five-year annual dividend growth rate of 7.3% and the cash payout ratio on a trailing 12-month basis remains safe at 55%, although I expect it to tick higher with anticipated loan losses.
I have a Buy rating on shares at the current price of $25.34 and a PE ratio of 10. I have a one-year price target of $40, which I believe is reasonable with the expectation that the pandemic will ease by the end of this year or early next year. In addition, I believe the record amount of stimulus payments will eventually find its way around the economy and benefit the big banks.
(Source: F.A.S.T. Graphs)
I hope you enjoyed my article about Exxon Mobil, Philip Morris International, and Wells Fargo. The point of my article was to show that companies that don’t fit the classic definition of “ESG” can reflect positive characteristics. When that is combined with an attractive valuation, they can prove to be rewarding investments.
Disclosure: I am/we are long XOM, PM, MO, WFC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.