Things are looking pretty grim for Chevron Corporation (CVX) headed into Friday morning’s pre-open earnings announcement. That’s because the earnings season thus far hasn’t been a thrilling one for the energy sector.
BP plc (ADR) (BP) managed to top its earnings estimates, but per-share profits were still down 80% on a year-over-year basis. Meanwhile, Halliburton Company (HAL) pre-reported revenue that was 40% lower than the year-ago, first-quarter top line.
But, while the recent past may have been ugly for the oil and gas industry, few would argue that the energy sector isn’t in a transition right now, coming out of a profit-killing glut and going into an environment that at least offers a ray of hope.
The question is, will that ray of hope shine on Chevron stock Friday morning?
Here’s What’s to Come for Chevron
As of the latest look, Chevron is expected to post a per-share loss of 20 cents on revenue of $21.43 billion for the first quarter of 2016. Both are a far cry from the profit of $1.07 per share of CVX and top line of $34.56 billion reported in the first quarter of 2015, when crude oil was still trading above $60 per barrel, and when the company was still benefiting from oil price hedges.
It’s not as if traders have a great deal of reason to feel confident Chevron will do all that well either. It was just three months ago when the company reported a profit of only 26 cents per share, down 86% from the year-earlier bottom line of $1.85 per share, and missing estimates of 47 cents per share by a mile.
Could anything have changed that much in just a few weeks?
Granted, the company has continued to shave expenses whenever and wherever it can, culling $2 billion worth of operating expenses last year. There’s only so much spending that can be cut, however, before Chevron begins to undercut its ability to remain operational. We’re near, or even at, that point. From here, survival becomes a matter of three things.
Three Things to Think About
While current and prospective CVX shareholders have a lot to think about right now, three specific items are going to provide the bulk of the headwind or tailwind for the stock for the foreseeable future.
1. Cash flow
Not that net income isn’t important, but right now, net income isn’t a meaningful reflection of how well an energy company is or isn’t functioning. Much more relevant in the current environment is how much cash an oil and gas outfit is able to extract from its operation and ultimately put in the bank, or in your pocket.
For perspective, the free cash flow from Chevron a quarter ago was a negative $2.72 billion. That’s big, but it spent $7.28 billion on capital expenditures. To the extent it matters, the oil giant lost (operationally) $588 million in Q4 of 2015. It’s also got $11.33 billion in the bank, so it can deal with a couple more quarters of red ink. The clock is ticking though — hints of a reversal of these deteriorating numbers are very much needed.
2. Oil prices
While it’s an obvious factor, it still needs to be made crystal clear that a higher oil price could cure a lot of Chevron’s woes, while lower oil prices could make bad problems worse.
The proverbial magic profit number for Chevron stock is a moving target, but based on the most recent analysis, crude prices need to remain above $52 per barrel for Chevron to continue paying its dividend — without borrowing — and also make its most necessary capital investments.
3. Liquefied Natural Gas
Last but not least, assuming crude oil doesn’t come roaring back, liquefied natural gas may end up becoming Chevron’s savior.
It’s been a bit of a saga. All told, CVX has spent $54 billion — far more than initially budgeted — to establish the Gorgon gas facility in Australia, which has been rife with setbacks since its construction began. It finally went operational in March, but soon ran into a snag that forced a multi-week shutdown again.
If Chevron can keep the massive site up and running, it could offset the performance of the company’s struggling crude oil business. That’s a big “if” though.
The price of LNG and crude oil remain relatively well linked. They would need to decouple if crude continues to flounder.
Bottom Line for Chevron Stock
There’s no doubt Chevron still has a mountain to climb, and the path to reliable viability is a narrow one with plenty of pitfalls … at least one of which may be unavoidable.
Yet, it’s worth noting there are several “Buy” and a handful of “Strong buy” ratings on CVX heading into earnings; this suggests the pros think the worst for Chevron is in the past.
As long as Friday’s numbers and outlook don’t make it clear that more forward progress is an outright impossibility, the upcoming Chevron earnings report has a pretty good chance at being a positive for the stock’s price.
All the same, the risk/reward scenario is still only one that makes sense for true long-term investors.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
