- There is always a lag between share price appreciation and earnings. Operating cash flows will substantially improve going forward.
- Chevron has further asset sales and reduced capex on the horizon if oil prices were to retreat. A dividend cut would only be a last resort.
- Oil is making higher highs and could easily take out $50 in this intermediate cycle. This would lead to a spike in Chevron's upstream earnings.
The whole subject of Chevron's (NYSE:CVX) dividend security raised its ugly head again after the oil major reported a poor set of first quarter earnings. Although Chevron beat on the top line ($23.55 billion reported against $21.43 billion predicted), the bottom line loss of -$725 million came in well below what was expected. Surprisingly, the stock didn't sell off that much but that didn't deter the bears from making their voice heard once again.
Chevron (especially since ConocoPhillips (NYSE:COP) cut its dividend) has been an easy target for bears due to its continued borrowings to fund operations and dividends. In the first quarter, operating cash flows plunged to $1.1 billion which meant there was a cash shortfall of over $6 billion when one takes into account the dividend and capex take for the quarter. Obviously, this is not sustainable but what investors are missing is that Chevron believes it can be cash flow neutral by the end of 2017 assuming crude oil is trading at $52 a barrel.
In fact, the oil major only managed to attain an average price of $26 per barrel in the first quarter which illustrates the potential Chevron has for increased upstream earnings going forward especially if oil can keep on its upward path. I have always stated that Chevron's dividend sustainability will outlast this current downturn mainly because it has managed to invest right through the cycle.
In terms of falling earnings, shareholders need to start looking at the bigger picture. In 2009, for example, when crude oil prices underwent a V shaped rally, free cash flow went from -$470 million in 2009 to $11,747 billion in 2010. I acknowledge that oil prices more or less doubled from its bottom in 2009 but oil prices in 2016 are already up 60% this year since its February bottom.
Furthermore, earnings per share went from $5.24 in 2009 to $9.48 in 2010 and this is precisely why the market is pricing the stock higher as it knows higher earnings are ahead of us. Operating cash flows will improve not just from rising oil prices but also from ongoing cost-cutting initiatives and productivity improvements. This is the first key to dividend sustainability.
The second key to dividend sustainability is the company's balance sheet. After the first quarter, Chevron had reported assets of $266 billion on its balance sheet. Its liability count came in at $113 billion and its debt totaled $38.59 billion. Now Chevron may have cash flow problems presently but it certainly doesn't have equity problems. Its debt to equity ratio of 0.22 illustrates that this company can easily take on more debt, cut capex or sell more assets in order to keep funding the dividend and operations.
In fact, the oil major has another $5 to $10 billion of asset sales on its radar in case the price of crude continues to head south. However here is the real question. Isn't it the largest majors such as Chevron and Exxon Mobil (NYSE:XOM) who should be buying assets and not selling them? If the likes of Chevron and Exxon have to repeatedly divest of their assets, what companies are going to be buying these assets? If this scenario were to play out, supply would have to be affected which would definitely move the price of oil upwards over the long term.
The daily technical chart in crude oil illustrates that the 5 day RSI indicator is currently at 42.81 and I wouldn't be surprised if crude oil went down as far as its 200 day moving average of 40.41. However, I definitely don't see crude oil breaking through its April lows as I believe we currently are in the middle of a strong intermediate cycle (started on the 10th of February) which should last another 8 to 10 weeks at least. Crude oil could easily get to $50 to $55 within this time frame especially if dollar strength remains mute as it has been of late. This would mean Chevron stock could easily surpass $110 a share as the market would know substantial upstream earnings would be waiting ahead. It would be interesting to see if the bears would still be running down Chevron if this scenario played out. Only time will tell...
To sum up, Chevron's dividend is going nowhere. Yes, growth will be practically nonexistent although the company needs to raise dividends this year (from its current quarterly payout of $1.07) to keep its aristocrat status intact. However, its balance sheet, production pipeline and rising oil prices will ensure earnings and cash flows will come back into sync. If you are a dividend investor, no need to sell here, just yet.