There’s no denying that the oil rout was pretty rough for the energy sector. The price crash from north of $100 per barrel all the way down to less than $30 was mind-blowingly dramatic. It caused widespread bankruptcies, share price declines and even some investors/analysts to question the safety of some of the energy sector’s biggest stalwarts.
That included major integrated giant Chevron Corporation (NYSE:CVX).
CVX’s high debt and negative cash flows during the period of low oil prices meant that the energy stock was playing fast and loose with its juicy dividend. That high and growing dividend has become a retiree staple and was seen as a source of stability in the sector. But given the circumstances, the potentially of a cut was very real at CVX.
The question today is … is it still a possibility. Could CVX still chop its dividend? Or has Chevron made it through the worst of the oil rout?
A Potential Problem At CVX
For CVX, lower oil prices have been a rough pill to swallow. That’s because, unlike rival Exxon Mobil Corporation (NYSE:XOM), CVX is highly tied to oil production versus natural gas. Likewise, it doesn’t feature as big of a refining operation. So the need for higher oil prices is there, in order for it to remain profitable and actually produce meaningful cash flows.
In fact, during the worst of the oil price crash, Chevron managed to do something it hasn’t done in at least two decades as an integrated super major — record back-to-back quarterly losses.
Under that framework, investors have been nervous about CVX’s ability to keep paying its lucrative dividend. Remember, cash flows from operations are different than free cash flows. FCF is the “extra” cash businesses throw off after all the spending is taken out. Free cash flows are the things that pay dividends and fund lucrative buyback operations. CVX hasn’t had them for some time. In fact, it really hasn’t had any since 2013.
CVX has continued to pay its dividend though. That dividend has been funded via new debt issues, asset sales and spending its cash balances down to paltry amount. But these moves aren’t exactly inspiring.
And yet, CVX stock is up by roughly 30% from its lows to its highs in 2016.
All About the Inflection Point for CVX Stock
So what gives with the rise at CVX? You’d think investors would be abandoning ship, given the cash flow issues at Chevron.
Well, for CVX, it all comes down to the inflection point.
The inflection point for energy stocks is basically the cash price per barrel at which they move from being unprofitable to profitable. Oil prices have moved higher on the year, and thanks to the recent OPEC pledge we’re now bumping up against the $50 per barrel mark. That’s great news for CVX and its ability to actually fund its dividend. It’s basically at its inflection point.
According to a September presentation, Chevron has stated that with oil averaging $52 per barrel, it will be able to fully fund its CAPEX spending plan and pay dividends in 2017.
Now, part of that comes from its continued reduction in CAPEX spending. Labor reductions, drilling stoppages and project cancellations have helped reduce the amount of cash that Chevron needs to function. In addition, several major projects — such as its massive Gorgon and Wheatstone liquefied natural gas projects — will go from being capital spenders to capital producers, as they are now completed.
And analysts at BMO Capital actually think that CVX could see a break-even of around $50 per barrel as new projects in old operating areas start to yield results. It’s a lot cheaper to drill a new well adjacent to an existing one rather than plow headfirst into a new field.
BMO believes that shift in Chevron’s strategy will yield better results — including higher production, lower spending and better cash flows.
The real key is that it’ll bring the inflection point down to about $50 per barrel — basically, right where we are today.
The Dividend Is Safe … With a Big Asterisk
So with oil prices starting to rise, Chevron may finally be out of the dividend dog house. New former CAPEX-sucking projects will kick on and the higher roil price will allow it start realizing meaningful free cash flows once again. In fact, analysts at JP Morgan actually think CVX will raise its dividend this month — albeit by only a penny.
So it seems that CVX has pushed back the naysayers and muddled its way through its dividend mess.
However, this fact comes with a big asterisk. The real thing for investors to watch is that oil price. Oil isn’t exactly trading for $10 or $15 over Chevron’s inflection point. It’s basically at the number. There are plenty of “hiccups” that could happen and send oil back in the basement.
Even the main cause for the rising price — the OPEC cut — wasn’t made at an “official” OPEC meeting, but an informal gathering. There’s nothing technically binding about that pledge. And let’s not forget about the pending rate increase from the Federal Reserve or other global recessionary fears.
In the end, investors may not want to get too excited about CVX’s dividend coverage just yet, especially considering how far the stock has risen this year. Depending on how the year goes, we could be revisiting the Chevron-can’t-pay-its-dividend narrative sooner rather than later.
The bottom line is, the rising oil price is great news for CVX and its dividend coverage. Investors can breathe a sigh of relief. Many of its problems with cash flows could be going away. However, before getting too excited over Chevron’s potential, we need to see the oil prices move significantly higher, to give ourselves a decent cushion.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
