- Chevron needs to report meaningful production increases in its upstream and downstream divisions along with more cuts in expenses.
- Investors will be become more convinced about the long term viability of Chevron if downstream earnings growth can continue where it left off in Q3.
- Production initiation dates at some key projects will be looked for, as well as timing of asset sales and coverage on when the dividend will be raised again.
Firstly, given Chevron's cap-ex, the integrated oil major is expecting at least a 13% increase in production throughout 2016 and 2017 which could mean earnings in 2017 could easily top $5.50 a share, if oil prices plays ball to some extent. So basically the market has 2017 growth already priced into the Chevron stock, but still, it's attractive to me for a number of reasons. Firstly you have a very strong dividend of 5.1%, which will be raised this year despite the company's present cash flow problems.
Chevron expects to be cash flow neutral by the end of 2017 (where free cash flow will cover the dividend), and fourth quarter earnings will determine if the company is still on track to achieve this goal. Dividend investors more so will be looking to see if the guidance on asset sales going forward remains strong, and whether expenses are coming down on the upstream side, so that elevated production can produce more meaningful results. On the downstream side, which posted excellent results last quarter, investors will want to see continued momentum through higher margins. Downstream is key as it is acting like a true hedge at present in that it is buying the company time to get its big projects like Gorgon & Wheatstone in Australia, to market.
Analysts don't expect that Chevron's earnings will top $1 billion in the fourth quarter but the company could surprise again on the upside like it did in its third quarter earnings. Lower revenue doesn't necessarily mean lower bottom lines, and if the company can continue to cut operating administrative expenses meaningfully (down 7% last quarter), these savings can offset the upstream earnings hit from low oil prices ( see oil price chart below ).
From the chart above, it would appear that the average sales price of a barrel of crude was lower in the fourth quarter than the third quarter. So, astute investors will be watching for production levels and operating expenses on the upstream side. In the last quarter, net production was up 8% in the US and down 4% internationally. $59 billion net was earned from upstream operations in Q3 (Positive international earnings were slightly higher than US losses), and even if sizable losses are posted in Q4, it will be the production and expenses trend that will most interest investors.
Last November, Chevron announced that it will be stepping up its asset sales program, which will positively impact Chevron's income statement going forward. Chevron had $25.3 billion in cap-ex through the first nine months in 2015. For the full year, it will end up being close to $35 billion, but Chevron is guiding significantly lower cap-ex in 2016 and right through 2017 ($20 to $24 billion projected in 2017). When these pending asset sales drop, they will have a big impact on quarterly earnings reports, but since no major asset was sold in Q4, earnings may be tepid.
On the downstream side, Chevron currently is mulling the sale of its South African assets, but if a sale goes through, it will be future earnings announcements that will get the benefit. Last quarter, Chevron managed $2.2 billion in total downstream earnings and I'm expecting a bigger number in Q4 due to the higher margins, but again investors will be watching whether volumes increased meaningfully (133,000 barrels per day increase last quarter). Downstream was instrumental in enabling Chevron bounce off its lows last year. It needs to keep this momentum going, as underlying oil prices could be low for a long time now.
Chevron is more upstream orientated though, which explains why it has under-performed its big integrated sister Exxon Mobil since the oil rout began back in the Summer of 2014 (see chart).
However, going long a stock like Chevron with oil under $30 a barrel is far less risky than going long the stock with oil at over $80 a barrel. Investors who are worried about the sustainability of the dividends, should take to look at Chevron's balance sheet. Its assets currently total $268 billion, whereas its liabilities total $112 billion, which means there is ample equity in this company to keep on selling assets for as long as it takes. The company has over $13 billion in cash on its balance sheet, along with its long term debt ($29 billion) being only 20% of the its equity. If the stock does sell off because it misses analysts projections, but fundamentals are still strong (impending asset sales, higher production, expenses dropping), I do not feel the stock will remain low for long.
To sum up, investors will be looking out for the expected asset sales of $10 billion+ in 2016 and 2017. Furthermore, the questions to be answered from this earnings release are, when will shipments begin at Gorgon? And will downstream in particular continue its momentum from Q3 earnings? Nevertheless, Chevron's balance sheet, earnings and cash flow statements are king. Chevron will probably end up with net income of just over $6 billion for 2015 which is not enough to service the present dividend of over $8 billion a year, so if oil prices remain low, robust asset sales will be needed to support a dividend hike in 2016.