Chevron Q4 Earnings Imply Deeper Capex Cuts Will Come Soon

  • Chevron loses $588 million in Q4. Poor upstream performance combined with lower refining margins were responsible for the loss
  • One shining light for Chevron is the Permian Basin. Costs are coming down so it makes sense to concentrate drilling there.
  • Gorgon is expected to be producing LNG  within a matter of weeks
  • Chevron stock stayed elevated after earnings were announced. Dividend yield of 5% is still safe for now

In my Chevron Q4 earnings preview, I pointed out that Chevron (NYSE:CVX) would need to report meaningful momentum in its downstream divisions as we knew upstream was going to be crippled due to the oil price fall over the last 3 months. Well, unfortunately for investors, downstream didn't provide the boost for a positive set of fourth quarter results and Chevron slumped to a loss of $588 million for the quarter. Downstream (US and International) came in at $1.011 billion which was over $400 million lesser than Q4 2014 and a whopping $1.2 billion behind the company's downstream figure in Q3 2015. Nevertheless, when you go through the downstream numbers, it was the US that reported the biggest diverge from the same quarter in 2014. The reason for the 45% decline was mainly due to the absence of an asset sale (which would have boosted earnings) and declining refining margins (crack spreads). Crack spreads declined by at least 20% across the board last quarter but it is more worrying that spreads have continued to fall heavily so far in 2016. This is going to adversely impact Chevron's downstream divisions meaningfully at the start of 2016 meaning asset sales will have to brought forward sooner than originally expected.

Now that we have full year results, Let's go through Chevron's income, cash flow statements and the current state of company's balance sheet. Despite the current brutal environment for the oil majors, Chevron still reported $4.59 billion in net income or a diluted EPS of $2.45 for 2015. However, elevated capex spend of $33.98 billion plus shareholder dividend payments of approximately $8 billion meant the company ended up much deeper in debt ( net debt is up $50%+ to $27.3 billion) despite asset sales of $5.7 billion reported during the year. Therefore if downstream margins remain muted combined with sustained lower oil prices, Chevron will have to significantly lower its 2016 capex budget ($26.6 billion already guided) and sell off more assets quickly in order to balance the books. Free cash flow which shows the severity of the situation fell to -$14.52 billion in 2015.

So, if Chevron's downstream divisions are not predicted to provide earnings growth in the near term, can both US and international upstream divisions start performing better in 2016? Well, the price of oil seems to have found a badly needed bottom on the 20th of January as the rally out of that bottom has been sharp indeed.


Source: Stockcharts

However, as the chart shows, the average price of crude oil in January is still substantially lower than the fourth quarter of 2015. Chevron lost $1.954 billion in its US upstream operations in Q4 despite production being up around 7% compared to Q4 2014. The gains in production predominantly came from ramp-ups in the Gulf of Mexico and the Permian Basin and Chevron will now need all its experience to ensure these projects are executed at maximum efficiency possible. Why? Well, these assets are not cheap (earnings are negative) and furthermore the average sales price per barrel of crude was around $35 last quarter ($4 lower than international rates) meaning margins are really getting squeezed in US upstream production. Chevron simply has to get better. It is noted as an expert in deep water exploration and production and it now has to prove it with its drilling numbers.

The Permian is a totally different play involving stacked shale plays and Chevron definitely seems to have momentum in its productivity measures here. In fact, the company at short notice decided not to take on a new development in the Gulf because it felt the Permian basin was the right location to spend any extra funds. Why? Well, Chevron has been in the Permian for years. They have seen where other companies have drilled and ongoing cost cutting efforts have resulted in the company now having 3,000 locations with an expected economic threshold of $50. Therefore it makes sense to keep investing in the Permian.  Chevron has to keep losses to a minimum in the US and the Permian seems to be the best place currently to perform the drilling.

International upstream had earnings of almost $600 million last quarter with production being up 2% and average selling prices coming in around $39 a barrel. Gorgon (Chevron's huge LNG project in Australia) is expected to start producing by March at the latest and I don't see this production adversely affecting profitability. Although Liquefied Natural Gas  is linked to oil prices, Chevron signed up to Gorgon way back in 2009 when oil prices were also in a big downswing. Investors should also be comforted by the fact that the cash flow should increase substantially because of having the extra benefit of capex falling off once shipments begin in earnest.

On the valuation side, the stock seems to be trading on the high side especially when you compare it to the price of oil over the last 6 months. Chevron traded at sub $70 levels last August when crude oil dipped down to just under $40 a share. Oil has continued to fall but Chevron has traded in the opposite direction since then (see chart)


Forward price to earnings ratio in this sector is very difficult to predict due to the volatility of the commodity but this sector definitely gives the investor a more favorable risk/reward at present as compared to other sectors. Chevron has the balance sheet to keep cutting if that's what is required and if more carnage comes to this sector before a final bottom is printed, I see many other small and mid caps going under before the likes of Chevron. This eventually has to affect the supply side which should mean rising prices from then on.

To sum up, Chevron delivered a poor set of fourth quarter earnings as a loss was printed which surprised many analysts. However, the stock didn't sell off as it was helped by the rally oil prices have been undergoing over the last few trading days. Worrying signs are reducing crack spreads and big losses in US upstream. However production is still increasing (0 to 4% increase projected for 2016) meaning operating cash flows should stay elevated. At this stage, I still don't see any risk of a dividend cut and the 5% dividend yield should keep dividend investors in Chevron stock.

Jack Foley Jack Foley   on Amigobulls :
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