It’s not easy being an oil company like Chevron Corporation (CVX) these days, but under wise management, CVX stock still has a lot going for it in the long-term.
Since the future is uncertain, it is challenging to operate any company, but especially a large one whose performance is hugely dependent on the price of a commodity. In the energy space, if the price of oil (or gas) is high enough, an oil and gas company makes money. If it drops too low, the company must scramble to cut spending, jobs and profits can evaporate just like that.
Investors are well aware that oil prices have been volatile lately, and the domestic industry has struggled mightily because of tumbling oil and gas prices. A fairly high number of smaller exploration and production companies have already gone bust.
Due to high supply, gas prices in the U.S. have been in a multi-year rut, with companies waiting for export activity to kick into high gear and hopefully push prices up closer to global averages.
The safest place to invest in this tough environment has been with the integrated energy firms. These firms explore for oil and gas and take it out of the ground (upstream), but also refine it and turn it into more valuable chemicals (downstream). And they do all of this on a global scale.
Bigger is better in energy investing these days.
As such, CVX is a best-in-breed energy firm, and although its fundamentals look weak right now, there are several important factors supporting a bullish stance on CVX stock.
The Bullish Case for CVX Stock
Prior to the current difficult operating environment, its shareholder returns were some of the strongest in the industry. Management is working overtime to return to these levels, and investors can be paid to wait for that to happen.
On its annual investor day back in March, Chevron updated shareholders on the state of its business. It emphasized growing more carefully in a “lower price environment” by completing its existing new projects and being much more selective in its capital and operating spending.
Its top priority is to support a generous current dividend coupon and grow it over time. CVX stock’s current dividend yield is 4.3%, or about double that of the overall market. Right now, it pays out $4.28 per share in dividends annually. Its commitment to maintaining this payout should let income-minded investors rest somewhat easily.
Keeping this payout level was a slam-dunk just a couple of years ago. In 2014, Chevron reported over $10 in earnings per share, leaving ample cushion to pay the dividend. However, 2016 will be tough: analysts expect only $1.22 in earnings per share, and they expect the number to jump back to $4.60 per share in 2017.
In other words, this year will be similar to 2015, where cash flow from operations won’t support the dividend and Chevron will have to rely on selling assets and raising debt to pay its dividend. After this year, it can reasonably return to growing the dividend, which has averaged 9% growth annually since 2005, and is one of the highest in the industry.
Along with an alluring dividend at its side, Chevron’s business practices are improving. Management has drastic plans to cut its capital spending and exploration costs.
In 2014, this combined spending totaled $40 billion. By 2017, it should be about half of that at between $17 billion and $22 billion. CVX also estimates it can sell as much as $10 billion in international energy assets each year. This should help the firm shore up its capital needs until oil and gas pricing become more stable.
Chevron also has goals to boost its upstream production volume. U.S. shale, which relies on hydraulic fracturing (fracking) to get energy out of the ground, remains a growth focus. Obviously, its “expansion [is] strongly linked to oil prices”. The company estimates modest profitability when oil prices are around $50 per barrel, and profits really start to jump if oil gets back to the $60 to $70 level.
In addition to Chevron’s favorable dividend ambitions and sound management approach, its debt levels are below peers. Its debt ratio (debt as a percent of its total capital) currently hovers below 30%, which is close to Exxon Mobil Corporation (XOM), but well below Total SA (ADR) (TOT), BP plc (ADR) (BP) and Royal Dutch Shell plc (ADR) (RDS.A, RDS.B). This leaves capacity to raise debt should energy commodity prices remain depressed.
Chevron’s historical returns on capital (profits divided by capital on the balance sheet) have also led the industry. Its five-year average has been in the low teens, which again, leads its peer group and the market.
It plans to get back to this leadership position by focusing on the upstream business and projects that are more profitable overall. This includes shale production and focusing less on major, long-term capital projects.
Since Chevron is a global company, it also plans to focus on higher-profit parts of the world. It believes it has a competitive advantage in the U.S., as evidenced by its higher shareholder returns. Asia has great potential for longer-term projects given that countries including China, Singapore and Korea are still growing rather briskly. It sees Europe and the Middle East as tougher areas to operate.
Low oil and gas prices also help profitability in the chemicals business. Combined with abundant supply in the U.S., Chevron can boost production and compete more easily with the international players including Total, BP and Royal Dutch.
To support this stance, it is selling chemical assets in Asia and South Africa. Management also thinks it has the scale to make chemicals with high-profit margins.
A final consideration down the road is the potential for exporting natural gas abroad. Chevron committed an entire session during its investor day to exporting liquefied natural gas. Gas pricing outside of the U.S. can be three to four times as high as domestic prices. This leaves a great potential to boost gas profits over time.
Bottom Line on Chevron Stock
Energy industry conditions are challenging, but Chevron has a background as one of the best operators in the business. This helps it weather the current dip in profits, and low debt levels enable its capacity to raise more of it should industry conditions take longer than expected to recover. Until this happens, investors can collect the generous dividend yield CVX stock offers.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.
