Chevron (NYSE:CVX) has spiked since mid-March stock going from $54 to $86 – for a gain of 59%. But of course, the shares are still way off their recent highs. Note that Chevron stock was trading at $121 at the start of the year.
Yet I think this rally may be, well, running out of gas. As we near earnings season, we’ll start to get a better understanding of the extent of the damage.
Simply put, the macro environment for the oil industry is truly a worst-case scenario, with massive adverse impacts on the demand and supply side.
A Closer Look at Chevron Stock
First, let’s take a look at the demand side. With the novel coronavirus, the global economy appears to be in the midst of a total free-fall. Even moderate recessions can have a major shock on the price of oil. But of course, the current environment is much different.
Air travel is at minimal levels and the highways are seeing little activity. Consider that various analysts predict that oil demand will decline by 20 million barrels a day or about 20%. Although, this could prove too optimistic.
Next, as for the supply side, there is massive excess in the world markets. It’s actually getting to the point where there may not be enough capacity to store it! Even before the outbreak of the coronavirus, there was already an oversupply. This was worsened recently because of the spat between Russia and Saudi Arabia, which set off a brutal price war.
Granted, OPEC has been able to reach an agreement. But it is fragile. Let’s face it, OPEC has a long history of not being particularly cohesive, especially during challenging times.
In this extreme environment, CEO Mike Wirth has had no choice but to take tough cost-cutting actions. To this end, he has announced a slashing of capital expenditures by 20% to $16 billion as well as a suspension of its $5 billion share buyback program. He also initiated an effort to reduce operating expenses by $1 billion.
Interestingly enough, Wirth says his main priority is to protect the dividend. Keep in mind that Chevron has increased its payout for the past 34 years and there has not been a cut since the depths of the Great Depression in 1934. But Wirth’s commitment to the dividend will be far from easy. The fact is that there will be incredible compression on cash flows.
According to InvestorPlace.com’s Vince Martin: “It’s worth going back to the fourth-quarter report on Jan. 31, itself not all that long ago. In its earnings presentation, Chevron noted that a $1 move in the per-barrel price of Brent crude would hit cash flow by roughly $450 million. Brent crude has fallen about $24 per barrel since then. That’s a hit to cash flow of over $10 billion.”
The issue is that there is little clarity on how long the economic slump will continue. Even if the global economy opens up, it seems like people will not rush to fly planes or take cruises.
Bottom Line on Chevron Stock
Now Chevron will definitely survive. Hey, the company has gone through World Wars, inflations and oil crises. Chevron has a top-notch management team, a diversified global platform and significant financial resources.
There will likely be consolidation opportunities. For example, smaller operators like ConocoPhillips (NYSE:COP), Occidental Petroleum (NYSE:OXY), and Phillips 66 (NYSE:PSX) could be buyout bait for Chevron. But when looking at the near-term – say the next couple quarters – it is probably best to be cautious. There are just too many unknowns that could weigh on Chevron stock.
Tom Taulli (@ttaulli) is the author of various books on investing and technology, including Artificial Intelligence Basics, High-Profit IPO Strategies and All About Short Selling. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s. As of this writing, he did not hold a position in any of the aforementioned securities.