Friday, April 25, 2008

The $40 billion question

Barack Obama (and various other politicians) have often cited ExxonMobil's $40 billion in profits earned in 2007 as a bad thing. For instance, after winning one of his primaries, Barack Obama said, "I know that it won't be easy to change our energy policy. Exxon Mobil made $11 billion last quarter. They don't want to give those profits up easily."

Now, a few bloggers have remarked that Exxon actually paid taxes of 41%, and over the past few years, Exxon has paid an average of $27 billion per year in taxes.

However, I'd like to explore a different question: is Exxon Mobile really making huge profits? Now granted, the numbers are huge, but Exxon Mobil has to sell a lot to make that profit. Therefore, it's better to look at the percentage profit than the actual figure.

But in finance, it's not just the net after-tax profit figure that you should look at, but you should examine other indicators of profitablity as well. First, there's the issue of taxes. Corporations deploy legions of accountants, lawyers, etc. to delay paying taxes, and to shift money around to avoid certain taxes. So companies may pay high taxes one year and low taxes another year, so when comparing firms to each other, it's sometimes best to use pre-tax profits.

But there's another wrinkle: interest. Suppose you had two firms that were exactly the same, except the first paid dividends of its excess cash each year and the other one did not. The second firm would earn interest on its cash balance. Alternatively, one firm could have sold shares to the public to get its start up funds, while the second could have taken on debt, which comes with interest. So taking interest out of the equation also helps compare firms' profits to each other.

Finally, there's depreciation and amortization. When a firm buys equipment, it has to expense that over several years -- this is called depreciation. When a firm buys another firm, it has to amortize part of the cost of buying that firm over several years (namely, the amount that it paid above and beyond the net value of the assets acquired).

If you exclude amortization, depreciation, interest and taxes you get what's termed in the financial world as "EBITDA": Earnings before interest, taxes, depreciation and amortization.

It's also best to look not just at a single quarter, but a full year. This avoids the problem of one firm having a really good quarter or really bad quarter.

Here is a brief summary of how various other international oil companies have performed during the past 12 months, according to Yahoo finance:

CompanySales ($B)EBITDA ($B)EBITDA %Net IncomeNet Income %
Exxon Mobil $361.71 $73.01 20.18% $40.61 11.23%
BP PLC $284.37 $36.74 12.92% $20.84 7.33%
Chevron Corp $208.11 $38.48 18.49% $18.69 8.98%
Conoco Phillips $171.50 $35.17 20.51% $11.89 6.93%
Eni SpA $139.76 $41.06 29.38% $15.91 11.38%
Hess Corp $31.65 $5.30 16.75% $1.83 5.78%
Marathon $59.39 $7.60 12.80% $3.95 6.65%
Respol YPF $82.81 $8.14 9.83% $5.07 6.12%
Royal Dutch Shell $355.78 $53.77 15.11% $31.33 8.81%
Total SA $217.94 $49.67 22.79% $20.95 9.61%

By examining the above, it's clear that versus other large, integrated oil companies, Exxon Mobil's after tax profits and its EBITDA are a little higher than other companies. However, this is due to it having a more efficient cost structure: if it charged much more than its competitors for oil, people would purchase oil from the competitors. Also note that the above revenue figures do not include sales taxes collected. Since sales taxes are included in the price of gasoline, they are sometimes included in companies' reported revenues.

Now, let's take a closer look at Exxon Mobil's profits:

Exxon Mobil splits its net income across three segments: upstream, downstream and chemicals, and it separates each of these according to US and non-US. Here is how Exxon Mobil's profits break out:

Division US Non-US Total
Upstream $4,870 $21,627 $26,497
Downstream $4,120 $5,453 $9,573
Chemical $1,181 $3,382 $4,563
Total $10,171 $30,462 $40,633
Upstream 12.0% 53.2% 65.2%
Downstream 10.1%13.4% 23.6%
Chemical 2.9% 8.3% 11.2%
Total 25.0% 75.0% 100.0%

(The above excludes a cost of $0.23 billion used for corporate overhead purposes)

Thus, 75% of Exxon Mobil's profits were earned outside of the United States, and only 25% -- $10.2 billion -- were earned in the United States. Now, Exxon Mobil is a huge company, and its lawyers and accountants almost certainly devise methods to shift taxes from high tax jurisdictions to low tax jurisdictions. For instance, if Exxon pumps crude out of the ground in Saudi Arabia, ships it to a refinery in the Caribbean and then sells the refined gasoline in the United States, how do you allocate the profits across the various countries?

Now, one more thing I want to do. I want to compare Exxon's EBITDA and Net Income to other large companies in the United States, just to give an idea that its profits are not outrageous. All dollar figures are in billions:

CompanySales ($B)EBITDA ($B)EBITDA %Net IncomeNet Income %
Exxon Mobil $361.71 $73.01 20.18% $40.61 11.23%
Apple Computer $26.50 $5.56 20.98% $4.07 15.36%
AT&T $120.70 $42.38 35.11% $12.56 10.41%
Boeing $66.39 $7.09 10.68% $4.06 6.12%
Coca Cola $30.13 $8.99 29.84% $6.22 20.64%
Costco $67.91 $2.39 3.52% $1.19 1.75%
Ford $172.46 $13.84 8.03% $(2.76) -1.60%
G.E. $172.95 $37.69 21.79% $21.90 12.66%
Google $18.12 $6.51 35.93% $4.51 24.89%
H.P. $107.67 $12.25 11.38% $7.85 7.29%
IBM $101.26 $20.83 20.57% $10.89 10.75%
Procter & Gamble $79.74 $19.32 24.23% $10.96 13.74%
Starbucks $9.82 $1.47 14.97% $0.68 6.87%

So when you look at a smattering of other companies, you see that Exxon Mobil's profits as a percentage of revenue are not that outrageous. They'll beat most pure retail operations: pure retail companies are very competitive, and they are just selling what others make, so they rely on volume. Automobile producers have low profits these days as they cope with legacy costs.

So, overall, while Exxon Mobil has high dollar figures for its profits, it does not have really excessive profits. How could it? It competes with other firms seeking to make a profit: if Exxon charged a lot more for gasoline than Shell, very few people would patronize Exxon instead of Shell. The oil industry is highly competitive.

So what does Barack Obama think could be gained by taking more of Exxon Mobil's profits? Well, presumably, votes. However, taxing oil companies more would almost certainly lead to higher prices, not lower prices, as they'd pass their costs on to consumers. They'd also be more likely to shift profits out of the United States, which already has a higher tax rate than most other industrialized nations. It certainly wouldn't lead to cheaper gas at the pump.