- Chevron is a riskier oil producer due to costlier mega projects that have higher break-even points.
- Assuming oil prices recover, Chevron is a marginally better play than ExxonMobil.
- However, if oil prices decline, investors stand to lose much more on Chevron.
Chevron (NYSE:CVX) is expected to report revenue of $21.43 billion and EPS of -.15 in Q1’16 on April 29th 2016. Much of the weakness in operating results can be owed to lower oil prices. However, the company hasn’t executed on significant cost reductions despite the significant drop in revenue. As such, even if Chevron’s sales were to recover, the company hasn’t restructured its business to be as cost effective coming out of an oil price recovery.
However, depending on the price of oil, Chevron plans to increase its daily production upto 4%, which could be a potential revenue tailwind. However, if oil prices remain deflated, Chevron’s added capacity becomes a hindrance to the company’s profitability as the break-even point for some of its higher cost projects is roughly $40 to $50 per/barrel.
Despite these near-term challenges to oil prices, the company plans to reduce costs at a more significant pace over FY’16.
As you can tell, Exxon Mobil (NYSE:XOM) sustained a higher rate of profitability when compared to Chevron over the course of FY’15 as it reduced operating costs by $6.264 billion. I’m also anticipating ExxonMobil to remain more profitable than Chevron even if oil prices were to recover.
Chevron increased its operating expenses by $1.621 billion between FY’15 and FY’14, and only recently reduced operating expenses significantly enough to drive net profit margins to comparable levels to XOM. In other words, ExxonMobil tends to be more conservative with its oil field projects whereas Chevron invested into riskier oil fields at peak oil prices.
ExxonMobil outperformed Chevron in the past 12-months as the company demonstrated better efficiency with its cost structure. Shareholders reward companies for better risk management and better capital return policies. On the other hand, Chevron is ramping production quicker and is likely to sustain higher rates of sales growth assuming oil prices recover. But, if oil prices decline, the stock will significantly underperform ExxonMobil stock.
Here’s what was mentioned at the Chevron analyst meeting on March 8th 2016:
The next component of our strategy is to reduce our cost structure, which includes both lowering cost of goods in services and improving our efficiency. We reduced our unit cash production cost by 23% in 2015 and we continue to lower our cost. We are systematically working through each of our business unit to ensure we have an efficient organizational structure and an appropriately sized work force. Our actions are aligned with planned activity levels and by the end of this year, we expect 20% to 25% headcount reduction in total Upstream work force relative to 2014. Almost half of the planned reduction have already occurred.
I’m pretty bullish on oil prices going into the second half of 2016. This is driven by reduced production among OPEC, and even in the United States. The pace of production has really slowed given the reduction in oil rig counts. I will explain more of the factors driving oil prices in my Exxon article. But, essentially Chevron offers better exposure to higher oil prices, but it’s also riskier assuming a bearish scenario (contango), which will occur if the OPEC member nations don’t agree to production cuts.
Recent analyst commentary is bullish, as Edward Westlake at Credit Suisse mentioned:
We have discussed in many reports over the last 5 years how CVX would eventually reach a crossover point where long-lived megaprojects would be completed, cash flow would rise, and management could steer the capex wheel towards shorter cycle & lower capital intensive activity. Cost deflation and foreign currency also help. CVX lowered its capex guidance at the analyst day, outlined how opex would fall, and how production should still rise (it would be disappointing if it did not given the amount of Major Capital Projects coming on stream and the rising contribution from the Permian). This lowers the dividend breakeven into the low 50's by 2017 (and it could fall further).
Generally speaking, yes I agree with Credit Suisse’s stance, but it’s still heavily dependent on oil prices increasing. If the opposite scenario plays out (contango), it’s more likely that ExxonMobil with its higher concentration of projects in the Permian Basin and Bakken Oil formation will generate better unit economics over a shorter timeframe. Furthermore, Chevron only recently transitioned to shorter cycle investments, whereas ExxonMobil made it a major priority over the past couple years. So, when taking into consideration the risk-to-reward I still prefer ExxonMobil. Lower volatility yet reasonable returns? Yes, please.
Furthermore, both companies have downstream refineries and retail locations. Since both companies are so similar in the downstream, the argument then gets summarized by the risk-to-reward in costlier oil production. Less aggressive investors should stick with ExxonMobil, however, the more aggressive investor wanting to capitalize on recovering oil prices will hitch a slightly better ride on Chevron.
I’m initiating my coverage on Chevron with a hold recommendation, and will provide a price target following Q1’16 earnings.