Exxon Mobil is being removed the DJIA after 92 years in the index.
The energy giant has failed to reward shareholders for over a decade due to irresponsible investing plans leading to higher debt levels.
Stocks removed from major indexes tend to outperform in the year following index removal.
The stock is set up for a tradable bounce after removal on August 31 followed by a sustainable rally, if the index removal is a catalyst for corporate change.
After a decade of failure for Exxon Mobil (NYSE:XOM) shareholders, the Dow Jones Industrial Average announced the ultimate insult. The one positive of the removal from a major stock index is the potential for the move to light a fire under management for change. My investment thesis isn’t ready to turn ultra-bullish on the stock, but any large sell-off could indeed generate a tradable bottom next week.
Image Sources: Exxon Mobil website
Index Removal Positives
On August 24, the DJIA announced the removal of three stocks from the index effective August 31 in a major shakeup for the index of 30 leading stocks. The index will remove Exxon Mobil, Pfizer (PFE) and Raytheon Technologies (RTX) in favor of Salesforce.com (CRM), Amgen (AMGN), and Honeywell International (HON).
As usual, the move is precarious as a stock like Salesforce has risen enormously recently with the 26% surge on Wednesday following strong earnings. At the same time, Exxon Mobil is down nearly 40% for the year, and Raytheon has collapsed 50% this year as well. In aggregate, one can see a vast divergence between the performance of the related stocks over the last three years led by the nearly 200% gains of Salesforce and the nearly 50% loss of Exxon Mobil.
One seeing such moves in highly respected companies has to normally look at taking the contain few of the trade. Is Amgen really the preferred biopharma over Pfizer now, and is Salesforce a Buy after those big gains?
A lot of research has shown that stocks removed from major indexes tend to outperform over the next year or so. The evidence shows that indexes strip stocks out after periods of underperformance followed by another final sell-off when tracking funds are required to dump the stock. The move creates a tradable bottom in a lot of cases.
Research from WSJ Market Data Group back in 2018 highlighted how stocks removed from the DJIA tended to outperform the additions over the first year. The research group found the 17 stocks leaving the index since 1999 have seen far smaller losses over the first year of 0.6% versus the large 8.0% loss of those joining the index.
The most recent five changes prior to 2018 are up an absurd 43%, while the additions only saw meager 3% gains. The recent addition of Walgreens Boots Alliance (WBA) and General Electric (GE) were headed down a similar path, with GE up for the year until the coronavirus upset the apple cart.
Exxon Mobil has already dipped to $40 on the news and concerns of Gulf of Mexico oil production disruption by Hurricane Laura isn’t helping the stock. The energy giant was in the index for 92 years and has failed miserably over the last decade leading to the ouster from the S&P 500 on August 31.
Catalyst For Change
My previous research highlighted the case for cutting the dividend, and shareholders should consider all options on the table now after this historic insult by the S&P Dow Jones Indices. The recent decisions to focus on maintaining the dividend at all costs while cutting investments have clearly failed to reward investors and attract capital.
The recent 50% dividend cut by BP p.l.c. (BP) could alter the thinking of Exxon Mobil. The company has built up a large debt level over the last decade in part causing the negative stock returns. As of Q2, Exxon Mobil has $57 billion in net debt with low energy prices and high dividend payouts only leading to more borrowing in the near term.
While the company has built up debt, the return on invested capital (or ROIC) has slumped. Another catalyst for change is the company and the industry altering investment decisions that only achieve lower energy prices. Exxon Mobil has to start chasing projects that lead to higher values for existing assets versus the constant race to the bottom inherent in shale drilling.
If the company can alter capital decisions to focus on better outcomes for shareholders, the stock will finally have some upside. The removal from the key DJIA and a decade of failure should lead to changes.
With analyst opinions so negative on the stock, Exxon Mobil has the fewest Bulls on the stock now of the last five years. Analysts actually have more bearish ratings at 5 versus only 3 bullish ratings. Again, this is another sign of an extremely beaten down stock ready for a catalyst for a rally.
Source: Seeking Alpha ratings
The key investor takeaway is, Exxon Mobil is a very beaten stock having the worst recent returns of the stocks being removed from the DJIA. The energy giant is poised here to make the typical tradable bounce as most stocks removed from the index have over the last 20 years.
The real catalyst for better shareholder returns is changes by the company in how they invest and return capital to shareholders. Until actual corporate change occurs, the stock is only a Buy for a trade after a further dip into the high $30s when the removal from the index occurs on Monday, August 31.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.
Originally published on Seeking Alpha