- Chevron's production is steadily increasing and cap-ex budgets are coming down. Free cash flow levels are set to increase which will help the dividend.
- Ignore Chevron's price to earnings ratio. A more accurate valuation metric is the price to book ratio.
- Crude oil may have bottomed. If it has, Chevron will outperform other integrated majors due to its bigger upstream presence.
ConocoPhillips (NYSE:COP) announced a dividend cut recently. That along with poor earnings has crippled the share price (stock down 30% year to date) and investors in the energy space are very cautious about where they put their money. In the aftermath of Conoco's breakdown, many analysts have come out and said that Chevron's dividend may be the next to be cut in this sector, especially considering its latest set of earnings which posted a net loss of $588 million. Many dividend investors may gravitate towards Exxon Mobil (NYSE:XOM) in this sector due to its credit rating, strong earnings and large balance sheet.
However, Exxon is a far more integrated (balanced) company than Chevron (NYSE:CVX). Chevron is more upstream orientated which means its earnings should benefit more from rising oil prices. However, this doesn't get past the fact that Chevron only did around $4.5 billion in net income in 2015, while having to service big shareholder commitments ($8 billion a year in dividends) and cap-ex ($27 billion expected in 2016). What has this done to its balance sheet? Well despite selling off almost $12 billion worth of assets through Q4-2014, long-term debt has skyrocketed to almost $40 billion, which was an increase of more than $14 billion over 2014. Nevertheless, the management's stand on dividends has always been steadfast. The company has repeatedly stated that dividends are a high priority and will be safeguarded indefinitely. We have learned that we cannot take these statements at face value but Chevron is an interesting play right now for the following reasons.
Firstly, although there hasn't been a hike in the quarterly dividend since 2014, Chevron is still a dividend aristocrat, as 2015's dividend outlay was slightly higher than 2014. This means that Chevron only has to hike one of its quarterly payments by as little as $0.01 this year to keep its aristocrat status active. However apart from the generous 5% yield, investors should be looking at Chevron stock as a growth play as it could easily return 100% in the next few years. Chevron traded at above $130 a share less than 2 years ago before the price of crude oil started to slide. However, what is being overlooked here is that Chevron's production in 2015 grew to 2.62 MMBOED which was 2% higher than 2014. Furthermore, more robust growth is expected from projects such as Gorgon, Wheatstone & Angola LNG in the near term which illustrates to me that Chevron's target of $2.9-3.0 MMBOED will be achieved. What does this mean for investors? Well, growing production will mean more free cash flow, which will stabilize the dividend for Chevron. Investors should remember that cap-ex budgets from LNG projects fall off substantially after first cargoes are shipped. This will also keep the company liquid. A rally in oil prices would be another huge bonus as upstream profits would be fatter, which would then mean Chevron could get back to raising its dividends meaningfully again.
Another reason why Chevron is attractive at the moment is because of the number of shares you can accumulate. Being a dividend aristocrat, investors know that the best way to maximize their investment is to accumulate more shares. Ignore the high price to earnings multiple of 35. It is supposed to be high in a cyclical stock such as Chevron. A better fundamental valuation metric to use would be the price to book ratio which is currently 1.1. Chevron's
A better fundamental valuation metric to use would be the price to book ratio which is currently 1.1. Chevron's 5-year average is 1.6 and 10-year average is 1.73 which illustrates undervaluation as the stock has never traded closer to its book value. Furthermore, analyst estimates are far too bearish in my view with respect to earnings and revenues over the next few years. Analysts are expecting $1.62 in earnings per shares on revenues of $109 billion which illustrate to me that they are expecting a zero move in the price of crude. I don't concur, especially when you see freeze deals which are slowly coming into play which should over time help demand catch up with supply.
On the crude oil technical chart, investors have to come around to the line of thinking that any sharp rally could mean a permanent bottom for crude oil. In my opinion, there is a high possibility that Gold, for example, formed a permanent bear market bottom recently, so crude may have already formed a bottom or is in the process of doing so.
To have minimal downside risk, place a stop loss on your Chevron shares which equates to the sub $27 dollar a barrel crude price we experienced recently. I believe its a good play. You may be risking around 5% to have the opportunity to make much more. Chevron will outperform with rising oil prices (67% upstream oriented) and now may be the time to go long.
To sum up, Chevron has received a lot of negative coverage over the past few weeks as a result of its disappointing fourth-quarter results, its worst in decades. However bearish analysts are forgetting growing production, impending larger free cash flows and crude oil fundamentals. Crude may have bottomed and if so, it's off to the races for Chevron stock.