Stock price action
Chevron (CVX) lost about $17 from the all-time peak $118.53 in early October to about $101.60 on November 15th. In just one month the stock nearly erased all the gains achieved in 4 months, thus confirming the well-known rule that declines are steeper than rallies in the stock market. The decline from the historical peak was triggered by a warning that Q3 results would be significantly lower than Q2 results.
Subsequently, the stock price fell steeply and seemed to discount the imminent Q3 results in the 3 weeks that led to the earnings announcement. However, the decline continued even after the earnings announcement. Only during the last week did the stock price rebound by about $4 to $105.47.
Q3 results were 9% lower than expectations, caused mainly by 6% (Y/Y) lower prices of crude oil and natural gas and 3% (Y/Y) lower production volumes. A decrease in the production volume is worrying for investors of all oil companies but part of the decrease in Q3 was attributed to storms in Gulf of Mexico.
At $105.47 Chevron trades at a forward P/E of 8.3, which is very cheap (it corresponds to a 12% annual yield) as long as current earnings are achievable in the future. In reference to this, it is remarkable that Chevron has exhibited exceptional performance in improving its earnings over the years. The company managed to multiply its earnings by 7 times from 2001 to 2011 and by 10 times from the mild recession of 2002 to the great recession of 2009. This reveals a clear trend that in every boom and bust cycle of the economy Chevron greatly improves earnings over the previous cycle.
For instance, compared to the record earnings of 2008 (the last year of the last boom cycle), Chevron managed to increase its earnings by 13% in 2011, whereas its competitor Exxon Mobil (XOM) had 4% lower earnings in 2011 vs. 2008. Chevron produces crude oil and natural gas at a ratio of 68/32 while Exxon Mobil produces crude oil and natural gas at a ratio 50/50. Therefore, the low price of natural gas, as compared to the price of crude oil, partly explains the superior performance of Chevron vs. Exxon Mobil in the last few years and leads me to expect continuation of this trend in the near future.
In the full year 2012, EPS are likely to come out about 4% lower than last year's EPS ($12.64 vs. $13.19, from Yahoo Finance). This is mainly due to a temporary dip in the price of crude oil and also a decrease in the production volume. However, while there is limited downside risk in the current oil price ($85), there is great upside risk due to geopolitical issues in Middle East, particularly Iran. Moreover, as mentioned in the earnings conference call, there are numerous projects that will start contributing to earnings in 2013 and 2014.
Another important advantage of Chevron is that it carries a minimum amount of debt. The net debt in the end of 2011 stood at $47 B, which is less than 2 years' earnings. This is an exceptionally low amount of debt (compared to earnings) that very few companies have. It is really impressive how Chevron manages to multiply its earnings at such a high rate without the need to borrow. This definitely reveals sound management.
The extremely low debt is one of the most important factors to be considered by potential investors of any company because it enhances earnings growth through the absence of interest payments and through the availability of cash for profitable investments. Furthermore, the company cannot be endangered by sudden macro deterioration, thus ensuring Chevron investors a relaxing night sleep.
Another proof of financial strength is the fact that Chevron has consistently increased its dividend for about 30 years in a row and still has a low payout ratio, as the current dividend is only 28% of current earnings. Therefore, there is plenty of room for future dividend increases. In addition, current cash of about $21.6 B ($12 per share) is at a record high level and guarantees future dividend increases.
All the above strengths of Chevron are reflected in its equity value, which approximately doubles every 5 years. In the last 10 years, Chevron almost quadrupled its equity value whereas Exxon Mobil just doubled its equity value. In the short run the stock price may deviate from equity but in the long run the stock price always follows it closely. Therefore, based on its consistent performance of the last 20 years, I expect Chevron's stock price to approximately double every 5 years, which corresponds to annualized yield 15%.
It is really impressive that Chevron has been paying dividends in the area of 3% and at the same time has been doubling its equity value every 5 years. Cash cows pay similar or slightly higher dividend yields but hardly manage to increase their equity. Therefore, Chevron is a company that pays dividends almost like a cash cow but at the same time it manages to grow at remarkable rates.
Target for stock price
Chevron's stock price has outperformed Dow Jones by a wide margin in the last 10 years. Chevron managed to triple in value whereas Dow Jones just increased 50%. I believe Chevron cannot fall below $95 in a market correction and cannot fall below $80 in a major bear market like the one 4 years ago unless Chevron incurs a Macondo-type accident. The P/E ratio would be compelling for smart money to heavily invest in Chevron at such low valuations. A reasonable target for the next 12 months is $130, which corresponds to a modest P/E of 10. The mean analyst target is $123.80, which is 17% higher than current price ($105.47).
As I expect a correction of Dow Jones to about 12,000 - 12,400 in the short term, I would wait for the correction to occur and then I would initiate a position in Chevron.