On Thursday, U.S.-based oil giant Exxon Mobile Corp. (XOM, Financial) announced it has agreed to buy carbon capture leader Denbury Inc. (DEN, Financial) for $4.9 billion, which would make it the company’s largest acquisition in six years.
The market did not have much enthusiasm for the announcement, sending shares of both Exxon and Denbury down a couple of percentage points following the news. One contributing factor to this could be the fact that it is an all-stock deal, so it is not impacted by arbitrage plays the same way cash deals are. However, another reason for the lukewarm reception could be that investors have yet to notice just how much value Denbury can bring to Exxon in the long run.
The details of the deal
The $4.9 billion all-stock deal values Denbury at approximately $89.45 a share, which was slightly above the $87 per share level on the day before the announcement, but the value gap has widened since then with Denbury shares having fallen to around $84 on Friday.
Dan Ammann, president of Exxon’s Low Carbon Solutions business, said in a Bloomberg Television interview that the acquisition will “allow us to move much more quickly than if we were to go out and try to build and replicate that infrastructure ourselves… [It will] accelerate the growth of this business and do that on a very profitable basis.”
This infrastructure is necessary in the long run in order to capture carbon emissions from heavily-polluting facilities. Exxon can also now take advantage of landmark climate provisions in the Inflation Reduction Act, which boost the profitability of carbon capture operations.
An unmatched head start on carbon capture
The Denbury acquisition will give the oil giant access to the largest existing network of carbon dioxide pipelines in the U.S. Denbury has more than 1,300 miles of pipelines that transport over 14 million metric tons of carbon dioxide per year throughout the Gulf Coast and Rocky Mountain regions.
This should put Exxon in a great spot to meet carbon reduction goals and comply with future regulations for many years to come. It seems like a wise move to get a head start in this regard so that Exxon is not rushing to play catch-up when stricter carbon emissions regulations come into play, as last-minute compliance leaves little room for negotiating favorable deals or securing access to the best resources.
Another advantage of gaining access to CO2 pipelines via the Denbury acquisition is that Denbury also produces crude oil and turns CO2 into energy. Its oil operations should make the business combination with Exxon much easier from an operational perspective, while turning a profit off of captured carbon means that Exxon’s carbon remediation efforts will not be a drain on financial resources.
Denbury is highly profitable and growing fast
Usually, innovation and progress are things that investors like to see in companies, but due to unique circumstances, the opposite has often been the case when it comes to oil and gas producers. Many of those who invest in oil and gas stocks may have the misconception that investing in anything “green,” whether it be solar energy or carbon capture, is the same as throwing money away.
That is not to say all investors in oil and gas stocks have this misconception, but it is a trend born from the historic profitability of oil and gas stocks versus the recent struggles of many clean energy companies to turn a profit.
Thus, it may be surprising to learn that Denbury is not just a liability that Exxon is taking on to satisfy potential future regulations; in fact, Denbury is already extremely profitable, even more so than Exxon as of this writing, and it is growing at a breakneck pace. The company boasts a three-year revenue per share growth rate of 133.3% and a three-year earnings per share growth rate of 169.7%.
Denbury’s operating margin of 40.59% and its return on assets of 25.52% demonstrate impressive ability to turn a profit from business investments. The return on invested capital is usually higher than the weighted average cost of capital, which means the company is creating value for shareholders.
Looking at the company’s income statement breakdown for fiscal 2022, we see it does generate the majority of its revenue from oil sales. However, the CO2 segment, which gains revenue from sales and transportation fees, is also contributing to the top line and has a lot of room to grow considering the carbon capture market in the U.S. is a mostly untapped market. Note that CO2 segment revenue includes transportation fees from customers naturally having to pay for the use of Denbury’s CO2 pipelines. Owning these pipelines means that Exxon will be able to save on transportation costs.
Valuation and takeaway
In the present, the $4.9 billion Denbury acquisition does not make much of an immediate impact considering Exxon’s market cap is $412 billion. The GF Value chart rates Exxon as fairly valued, but in the highly cyclical oil and gas sector, the situation can change rapidly.
Nevertheless, when it comes to a long-term outlook, Exxon has several key advantages, including its juggernaut size, its high financial strength rank of 8 out of 10 and its dedication to returning capital to shareholders with a solid dividend yield of 3.55% and share buybacks. The acquisition of Denbury adds another reason to be positive about Exxon’s long-term potential and dedication to shareholder value creation as it gives the company a profitable leg up over competitors in the carbon capture market.
