Published by Nick McCullum on October 20th, 2017
Chevron is one of the largest and most well-known oil corporations in the world.
It is also one of the most stable. In fact, Chevron is a member of the exclusive Dividend Aristocrats list – a group of elite dividend stocks with 25+ years of consecutive dividend increases.
Due to its reliance on oil prices, the energy sector represents just 2 of 51 Dividend Aristocrats. Chevron’s dividend consistency and stability help it to stand out in the otherwise-volatile energy industry.
This article will analyze the long-term investment prospects of Chevron in detail.
Chevron is one of six oil and gas supermajors, along with:
- BP (BP)
- Eni SpA (E)
- Total SA (TOT)
- Chevron (CVX)
- ExxonMobil (XOM)
- Royal Dutch Shell (RDS-B)
Chevron is one of only two oil and gas supermajors to be headquartered in the United States, along with fellow Dividend Aristocrat Exxon Mobil.
Indeed, the sheer size of Chevron is almost difficult to comprehend. In the first half of fiscal 2017 alone, the company reported cash flow from operations of $8.9 billion and paid $4.1 billion in total dividends.
Source: Chevron September 2017 Investor Presentation, slide 5
Chevron has also maintained a reasonable amount of leverage, with a debt ratio of just 22.7% at the end of the most recent quarter despite one of the most difficult operating environments on record for oil companies. Rebounding oil prices are one of the main drivers of Chevron’s near-term growth, a factor which is discussed in detail in the next section.
Chevron is one of the largest publicly-traded energy corporations in the world and stands to benefit tremendously from the continued rebound in oil prices.
Specifically, Chevron is expecting 4%-9% growth in net production in 2017 before the impact of asset sales, with continued growth expected beyond the current fiscal year. The company’s projected net production over the next several years can be seen below.
Source: Chevron September 2017 Investor Presentation, slide 10
Make no mistake – the rebound in oil prices is already underway and can be seen in Chevron’s financial performance during the most recent quarter (the second quarter of fiscal 2017). In the quarter, the company’s oil production increase by 10% over the same period a year ago, as shown below.
Source: Chevron 2Q2017 Investor Presentation, slide 6
Importantly, Chevron is now a net generator of cash after all expenses and the payment of common share dividends. The first half of fiscal 2017 represents the first six-month-period in more than two years that the company’s cash flow after dividends was positive, coming in at $1 billion.
Source: Chevron September 2017 Investor Presentation, slide 5
Indeed, we believe that Chevron is well-positioned to continue paying steadily rising dividends for years to come. The company lists the maintenance and growth of its common share dividend payments as one of its major financial priorities and expects to maintain a debt ratio of 20%-25% moving forward.
Source: Chevron September 2017 Investor Presentation, slide 7
In the near-term, Chevron’s growth will undoubtedly come primarily from rising oil prices. In the long run, the company will be one of the prime beneficiaries of the growing demand for energy (which stems from both population growth and improvements in the average standard of living worldwide).
Investors should also note the company’s strong track record of building shareholder value:
Source: Value Line
During the decade prior to 2014 (the year that oil prices dropped off a cliff), Chevron compounded its adjusted earnings-per-share at a rate of 4.9% per year. Over the long run, we believe that growth of at least 4%-6% per year is likely for this high-quality dividend stocks.
Competitive Advantage & Recession Performance
Chevron’s competitive advantage comes primarily from its size and financial strength in the highly-cyclical energy sector.
The company’s operational expertise allowed it to successfully navigate through one of the worst oil bear markets on record. There were two factors that allowed for this.
The first factor is the company’s remarkable cost-cutting. Chevron reduced its capital expenditures and exploratory budget from ~$10 billion to ~$5 billion between fiscal 2014 and fiscal 2015, while operating expenditures and sales, general, and administrative costs declined from ~$7.5 billion to $~5.5 billion during the same period.
Source: Chevron 2Q2017 Investor Presentation, slide 16
The second lever that Chevron was able to pull to maintain its viability during this tough oil environment is the company’s asset sales program. The company is targeting between $5 billion and $10 billion of cumulative asset sales between fiscal 2016 and fiscal 2017, which has helped it to maintain its dividend and continue its general operations.
Source: Chevron 2Q2017 Investor Presentation, slide 17
Chevron’s size is a key reason why cost-cutting and asset sales were able to help the company so much during this oil recession – as a larger company, it can utilize economies of scale to save money while also having a much larger asset base from which to identify potential divestitures.
Chevron stacks up well among its peer in the energy sector. However, the company is certainly not the most recession-resistant Dividend Aristocrat, as evidenced by its performance during the 2007-2009 financial crisis:
- 2006 adjusted earnings-per-share: $7.80
- 2007 adjusted earnings-per-share: $8.77
- 2008 adjusted earnings-per-share: $11.67
- 2009 adjusted earnings-per-share: $5.24
- 2010 adjusted earnings-per-share: $9.48
- 2011 adjusted earnings-per-share: $13.44
Chevron’s adjusted earnings-per-share declined by more than 50% during the 2007-2009 financial crisis, but the company did manage to remain profitable during a bear market that drove many of its competitors out of business. Moreover, Chevron continued to raise its dividend payment each and every year of the Great Recession.
Chevron’s profits will always swing along with oil prices, but we view the business as one of the more conservative securities in the broader energy sector.
Valuation & Expected Total Returns
Chevron’s expected total returns are more difficult to assess than many of the companies we cover at Sure Dividend. This is primarily due to the company’s current earnings situation, which is highly likely to be lower than its ‘real’ earnings power under a more normalized oil price environment.
Value Line – a source that we use, trust, and recommend – estimates that Chevron’s earnings will return to the level of ~$9.50 over the next several years. Moreover, Chevron has traded at an average price-to-earnings ratio of 9.4x during the decade prior to 2014 (the year when the current oil bear market began). The company’s long-term valuation history can be seen below.
Source: Value Line
Adjusted earnings-per-share of $9.50 combined with a price-to-earnings ratio of 9.4 gives a price target of $89 – which is actually lower than Chevron’s current stock price of ~$119.
With that said, this approach makes a number of assumptions that may not be realized. Chevron’s earnings could rebound to above the $9.50 mark, or the company could return to a price-to-earnings ratio higher than 9.4x (or both!). If these assumptions were changed, the result of this valuation analysis would change as well.
It should also be noted that this is only one way of assessing the company’s current valuation. There is no ‘perfect’ valuation metric. We also believe that investors are likely valuing Chevron based on its dividend potential more than its underlying earnings power; with this in mind, another valuation approach would be to compare Chevron’s current dividend yield to its long-term historical average, which is done below:
Chevron’s current dividend yield is slightly above its 10-year historical average. The company’s current yield indicates a modest amount of undervaluation.
Taking this all into account, the conservatively-calculated quantitative figures do not suggest that Chevron is an appealing security to buy today. However, this stock’s investors will likely realize considerable upside if oil prices return to the ~$120/barrel level that they experienced in 2014.
Chevron is one of the rare oil and gas companies that was able to navigate through both the Great Recession of 2007-2009 and the current oil bear market. Clearly, there is something special about this Dividend Aristocrat.
Surprisingly, though, a quantitative analysis does not suggest that Chevron is undervalued at current prices. While existing investors may want to hold on to capture the enticing 3.6% dividend yield, Chevron’s total return potential appears to be lower than certain other Dividend Aristocrats.