In 2015, famed investor and Chief Executive Officer of Berkshire Hathaway (NYSE:BRK-A) Berkshire (NYSE:BRK-B) disposed his entire $3.7 billion stake in integrated oil and gas giant Exxon Mobil Corporation (NYSE:XOM). 

There was speculation about the main rationale behind the liquidation of Berkshire’s holdings in the oil giant. One of the obvious reasons is that the prospects of the company over the next few years remain uncertain, considering the continued slump in oil prices. Further, it did not help that the company announced that it would cut down on its spending to preserve its cash flow amid continued low prices. This short-term capital allocation strategy is also in line with industry norms.

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It was only in a subsequent interview that Warren Buffett explained his reason for selling shares in the company. He still believes that the company remains a solid investment in the long-term despite the near-term blips in its profitability due to the oil price slump. However, Mr. Warren Buffett said that he might have other uses for the money, which would have a better risk-adjusted return on investment.

Exxon Mobil Is the “Steady Eddie” of Oil Giants

The company has one of the strongest historical track records in profitability and cash flow generation. It should also be noted that the company possesses a pristine balance sheet that allows it to be flexible during a crisis. Exxon has also handsomely rewarded investors in terms of gains, notwithstanding the consistent dividend payout.

However, these factors have not calmed the markets, as Exxon has continued to post lower revenue and profitability figures in the recent five fiscal years. From 2011 to 2015, sales have declined from $467 billion to $259 billion. Consequently, earnings per share have been sliced in half from $8.43 in 2011 to $3.85 in 2015. These figures were  mainly driven by lower oil prices in the recent years.

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(Source: Exxon Mobile 2015 Annual Report)

Since Mr. Warren Buffett’s time horizon is longer than the average investor, the investment thesis to repurchase the shares remains the same. In a longer time frame, Exxon Mobil will continue to be the major player in the oil industry, and oil prices are expected to trade higher over the next 5 to 10 years. While forecasts could be far from accurate, there have been wild speculations that oil price could reach $100 per barrel levels again as early as 2018.

Of course, this seems like a wild guesstimate on the future of oil prices. But the idea that demand will continue to grow at a steady pace over the next 10 years seems reasonable. And the major oil player to survive in a stressed oil environment will definitely be Exxon Mobil. Its enduring competitive advantage is its size and its deep pockets, based on which it commands bargaining powers within its value chain.

Acquisitions Will Cement Its Competitive Advantage

Exxon’s acquisition strategy appears reasonable. It was not in a hurry to scoop up oil companies in a depressed oil price environment; acquisitions need to be value-accretive to the Group. For instance, Exxon has recently paid more than $2.5 billion for InterOil, which will complement its solid operations in Papua New Guinea. Obviously, Exxon Mobil was looking at InterOil’s resources rather than its income statement, as InterOil has incurred losses over the last few years.

The transaction is considered as the first of the many planned asset acquisitions by the Group. It is also to be noted that Exxon has ceased its share repurchase to focus on mergers and acquisitions. Its financial position remains solid with total debt remaining minimal compared to its equity size. This implies that it could further raise money in the financial markets to accommodate this strategy. Exxon Mobil has the necessary resources to convert the acquired assets into profitable ventures with its experience, which could produce shareholder gains in the coming years.

Finally, Berkshire should take note that Exxon’s normalized 5-year price earnings ratio appears absolutely cheap at 11 times earnings, combined with dividend distributions of around $3 per share or yield of 3%. Hence, Exxon Mobil shares could be a better use of Berkshire’s money after all.