Chevron Corporation (CVX) has taken a proactive approach to surviving in a new low oil price environment. While many of its peers are crumbling by the day, Chevron stock has held up quite well. The big question is whether management’s approach will pay long-term dividends.
Without factoring in the Wednesday’s in-progress 4% gain on CVX, Chevron stock has fallen just 14% over the past year.
While significant, it is less than one would expect given the price of oil and its large upstream business. (Companies with large upstream operations have suffered the most over the past couple years.)
CVX stock has remained a bright spot in an otherwise bloody sector due to its willingness to completely redress its operating approach, making smart decisions in the process; transitioning from a company that makes heavy investments in growth to one that emphasizes free cash flow creation.
Over the past six months, investors have watched this transformation. On Tuesday, CVX took an even bigger step toward completing this transition, announcing that it will spend about $19.5 billion in capital expenditures (midpoint) during 2017 and 2018 (PDF). That’s about $3 billion lower than its previous outlook for 2017 and 2018, and significantly lower than the $29.5 billion last year and $26.6 billion it plans to spend this year.
If successful, CVX would have reduced its annual capex by $10 billion in just 24 months. This $10 billion reduction is no coincidence, as it represents the free cash flow loss that Chevron reported for the last four quarters. So theoretically, with lower costs and investments, Chevron will be able to achieve positive free cash flow in 2017 and 2018, regardless if oil prices remain at current levels.
The Cost for Chevron Stock
With that said, positive free cash flow with oil prices at $40/bbl sounds good and all, but one must ask what CVX must give up to achieve such cost savings, and specifically, what it means for Chevron stock?
Therein lies the answer for what makes CVX stock such an appealing investment. The company is finally doing what it should have done all along: cutting back its long-term investments on big projects and prioritizing fields and the Texas shale with short-term investments.
In other words, Chevron is prioritizing oil-rich areas like the Permian Basin, and cutting back in longer-term, from-the-ground-up projects. It is going to concentrate rigs in fewer areas to increase production (three-fold in four years), and will continue to repeat this cycle.
It is a smarter, more efficient plan that not only protects its dividend, but achieves profitability in the most challenging of environments. And for that reason, Chevron stock is a buy.
A Blessing in Disguise for CVX
While crude prices may never top $100/bbl again, it’s unlikely sub-$40 prices are sustainable. However, if CVX can thrive in this environment, just think of what it can do with this newfound approach and higher oil prices, say $65/bbl coupled with its 2017 and 2018 capex budget.
This is a company with a very strong balance sheet and impressive credit rating. A company that created an operating margin over 15.5% during 2014.
If CVX can achieve a 15%-plus operating margin in an era of heavy spending and low emphasis on profits, then just think of what it can do with spending control and a focus on free cash flow creation if oil does, in fact, recover.
In retrospect, it is likely that a collapse in crude oil prices was a blessing in disguise for Chevron stock owners, as the company would have unlikely made any of these changes otherwise.
In other words, now is a good time to own CVX stock.
As of this writing, Brian Nichols did not hold a position in Chevron stock, but may initiate a long position in CVX within the next 72 hours.