Earlier in March, Chevron (NYSE:CVX) held its 2020 Security Analyst meeting. CEO Mike Wirth said it had the potential to return $75 billion to $80 billion to owners of Chevron stock over the next five years. If the airline industry is a guide to govern by, to do so would be a huge mistake.
Here’s why.
Significant Potential for Chevron Stock
In fairness, I should add that Wirth didn’t guarantee the company would make these share repurchases and dividend payouts between now and the end of 2024, just that it could based on the growth of its operational cash flow per share.
“We have the potential to return $75 billion to $80 billion to shareholders over the next five years. We expect to deliver this capacity at flat nominal prices while still investing in our business and maintaining a strong balance sheet,” Wirth stated.
“To be clear, no decisions have been made about future dividends or buybacks. This guidance reflects our ambition to increase returns on capital and to share the benefits with our investors. This doesn’t depend on higher oil prices. It relies on self-help through greater cost efficiency, continued capital discipline, and effective portfolio management.”
On the surface, Wirth provides a confident picture of the future for Chevron and its shareholders. That’s a big part of the job of a CEO — to rally the troops.
But will it work? And is it a wise allocation of capital given how badly share repurchases have choked the life out of the airline industry?
The Airline Industry Provides a Cautionary Tale
Yes, the coronavirus is what brought the airline industry to its knees. But spending 96% of its free cash flow over the past decade certainly didn’t help.
An argument can be made that low-interest rates over the past decade make the airline’s level of debt and interest expense irrelevant to the industry’s current challenge of severely reduced cash flow. The $50-billion-plus bailout sought by Airlines for America, which includes $25 billion in low-interest loans, $25 billion in grants, and the return of $4 billion in taxes paid, is meant to keep the airlines solvent until the travel bans disappear and air travel resumes.
I get that.
But when the top five airlines returned $45 billion to shareholders in the form of share repurchases and dividends over the past five years, it ought to make Chevron’s CEO think twice about following the airline industry down the same path.
Are Share Repurchases the Best Use of Capital?
In 2020, according to Chevron’s 10-K, it expects to spend $5 billion on share repurchases. That’s likely to change. In 2019, it spent $4.05 billion on share repurchases at an average share price of $118.20. In 2018, it doled out $1.75 billion at an average share price of $117.45. It did not repurchase any shares from 2015 through 2017.
In July 2010, Chevron’s board authorized an ongoing stock repurchase program with no monetary limits. Through the end of 2018, it repurchased $21.75 billion of Chevron stock at an average share price of $111.08.
As I write this, Chevron closed at $59.39, which means over the past decade, the company’s return on its investment has been -46.5%. Add in the $9 billion and $8.5 billion spent on dividends in 2019 and 2018 alone, and we’re talking about a massive amount of money going out the door at a time of generally weak oil and gas prices.
Bloomberg News contributor Liam Denning recently discussed how Chevron’s cash return strategy is a big reason why Chevron’s stock has gone from trading at a discount to Exxon Mobil (NYSE:XOM) to selling at a premium.
He also pointed out that the presentations Exxon and Chevron made at the 2020 Security Analyst meeting had charts that showed oil demand would continue to rise for at least the next decade. However, it is Denning’s comments about the impending threats to both companies’ legacy businesses that make me wonder why anyone would consider an oil and gas stock for the long haul.
“Chevron and Exxon may well be right that, for one reason or another, oil demand keeps rising through the 2030s. But given the threat of climate change, the growing political and investor focus on it, and the falling cost of rival, zero-carbon energy sources, who now really believes the next decade or two in energy can be defined by a straight(ish) line?” Denning wrote Mar. 5.
The Bottom Line
I took a lot of flack from readers after my Mar. 11 article about Exxon. I’ll probably take some for this one as well.
Given what’s happened in the airline industry, I hope that companies from every sector will reconsider their share repurchase programs. They do more harm than good.
I believe that Chevron should take the $20 billion or so it could use to buy back its shares over the next five years to projects that will allow it to transition more smoothly from fossil fuels to renewable energy.
Chevron stock becomes far more attractive by not following down the same road as the airline industry.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
