- In my opinion Chevron is through the worst of it. Gorgon will make a big difference to its cash flows with Wheatstone to follow.
- Whereas bearish commentary talks about dividend cuts in the event of even lower oil prices, I maintain this company would buy cheap assets if oil prices revisited the $30's.
- Inflation will come, even though many people seem to be blinkered by the dollar's strength.
I have always recommended in my writing that income investors have the opportunity to boost their dividend income by re-investing more distributions into stocks which have been badly beaten up. Chevron (NYSE:CVX) for example (although the true opportunity to buy was when it was trading under $70 a share back in August) still holds plenty of potential to the upside especially when you see what is coming down the track with the company.
Look at Becton Dickinson (NYSE:BDX) for example, which is also a dividend aristocrat as it has raised its dividend for the last 43 years. However with the stock being up 15%+ over the last 12 months, the dividend yield has dropped to 1.76% ( a long way behind Chevron's 4.71% yield). Furthermore the spike in Becton Dickinson's share price has resulted in the p/e ratio surpassing 44, which again is much greater than Chevron stock's current p/e ratio of 19.
Therefore if you are a dividend growth investor and are holding both of these underlyings in your portfolio, my advice would be to start redirecting the distributions from Becton Dickinson back into beaten up stocks like Chevron which over time will increase the portfolio's income. Chevron and the whole energy sector is too risky you may say but I don't share the same level of pessimism about this sector or Chevron for that matter. Let's outline why..
A Dividend Aristocrat
Firstly and as mentioned above Chevron is a dividend aristocrat as it has raised its dividend for the last 27 years. I see no risk to the dividend being cut despite crude oil trading at just under $42 a barrel and here is why. Dividend investors became worried in recent quarters when they saw Chevron having to borrow funds in order to maintain capex spend whilst also paying the dividend but I believe this situation is temporary. The main reason why Chevron's capex spend has been elevated throughout this cycle is the Gorgon LNG project in Australia which has gone way over budget.
Furthermore the project was originally scheduled to start in mid 2015 but shipments now are not expected until early to mid 2016. Nevertheless when Gorgon is up and running (and Wheatstone soon thereafter), free cash flow will increase substantially which will put less pressures on management to keep increasing dividend payments.
Also capex spending is coming down with about $26 billion earmarked for 2016 followed by $22 billion in 2017 and 2018. Moreover when Gorgon is fully up and running, huge amount of employees will be let go, not because of severe cutbacks but because the oil major will simply not need them as once they are up and running. These projects will require very little additional investment.
Gorgon is expected to return "prolific cash flows" for the next 40 years despite the current low price of oil. If you don't believe this, just look at when Chevron signed the exploration and production contract which was in 2009 when oil prices were close to $50 a barrel. LNG projects have pricing linked to oil meaning that if we get an upturn in the oil price, profits and cash flow generation will increase meaningfully just by applying the law of large numbers (The project is expected to ship up to 20 million tonnes of LNG a year)
Chevron Will Pick Up Cheap Assets
Secondly, investors must consider where future oil is going to come from. I acknowledge that fracking technology has changed the playing field but global oil demand keeps on going up every year. This is why the likes of Chevron and Exxon Mobil (NYSE:XOM) always think of the long term and their integrated models enable them do so.
Just look at Marathon Oil (NYSE:MRO) which incidentally spun off its downstream division a few years ago. Marathon's share price has lost 52% off its share price compared to a 26% decline for Chevron (see chart) since the price of oil started to decline in June 2014. This has led to Marathon having to cut its dividend recently whereas Chevron's downstream's division have really delivered in recent quarters. Chevron in its last set of quarterly earnings had almost a 60% increase in profits year on year with the number coming in at $2.21 billion.
Furthermore if oil continues to fall in the near term, you are going to have more upstream companies cutting back on their dividends and production. This would lead to mass asset sales on the upstream from which I have no doubt Chevron would pick up the cheap ones. Multiple bearish analysts keep on harping about "a new oil patch era", "continuing elevated supply from Opec countries", "fracking" and renewable sources as the reason why oil prices will remain low. My reasoning is that LNG and oil will continue to power the world and with a new growing middle class emerging in the east, I don't see oil and gas prices remaining low for long.
Inflation Will Raise Oil Prices
Finally and it is something that is rarely discussed is the inflation argument. Because dollar strength has been one of the main reasons why oil has more than halved in price, most analysts believe that things will continue to stay this way. Supply/demand fundamentals are one thing but inflation is another and a weaker dollar is another metric that could easily spike the price of oil.
All throughout history, quantitative easing or money printing has caused inflation. Europe is on the precipice of re-commencing its own easing measures which can't be good long term for the well being of its currency. As investors, we get paid to predict the future. Do you think more elevated money printing will lead to more deflation or inflation? The more deflation we get, the more central banks will print money which will one day lead to an inflection point in the commodity markets. Chevron's current annual dividend pay-out of around $8 billion a year may be difficult to fund at the moment but wouldn't be in an inflationary environment with oil trading above $60+ per barrel.
To sum up, I believe Chevron stock is still a buy at these levels. It is growing production, divesting assets, cutting capex and reducing costs all in order to keep the $8 billion annual dividend a priority. Moreover its Gorgon project is expected to be fully up and running next year which will really help on the cash flow front. Ignore the bearish commentary on this one. This company has the balance sheet to keep moving forward.