Given the decline in profitability and production volumes for Chevron's (CVX) oil business, its efforts in the shale gas exploration is a positive step. The recent shale gas exploration projects in China are expected to bring revenue growth for the company. The strong position of the company in terms of its refineries in the Asian Pacific region is considered an important catalyst for its short-term growth. Chevron's plan to capitalize on its excessive cash through investing in lucrative projects reaffirms our bullish stance on the stock.
The extraction of natural gas through the innovative process of hydraulic fracturing has lead to excess supply in the last six months. Hydraulic fracturing is the unique process of extracting natural gas by exerting pressure on fluids in the rock layer. The government's efforts towards natural gas to oil switch would be highly beneficial for shale gas producers.
Moreover, the company is expected to strengthen its position in the oil market. In our opinion, the high exposure of the company in deepwater exploration would prove to be instrumental in driving its future growth. The Environmental Protection Agency (EPA) imposed a ban on awarding new contracts in the United States to BP due to the tragic Gulf of Mexico oil spill incident. We believe Chevron is in a good place to win the contracts being denied to BP in the auction expected to take place in March next year. This would help the company obtain some of BP's market share and start supplying oil to the United States government and armed forces.
We maintained our bullish stance on CVX due to some key developments that took place in the third quarter of the year, pertaining to the company's upstream business segment. These developments are as follows:
CVX finished the acquisition of Acme and Clio fields in the Camarvon Basin of Australia, which would create further expansion opportunities.
The company sold its non-strategic equity interest in the Wheatstone project to Tokyo Electric.
Cheveron announced 2 natural gas discoveries, namely Satyr-4 and Satyr-2, at the Camarvon Basin. These discoveries would enhance its production volumes considerably.
The company secured 55% operatorship and interest in 2 deepwater exploration blocks in Sierra Leone.
In the United States, the company proclaimed an agreement regarding the acquisition of some new land in the Delaware Basin. The company is the largest leaseholder in the Delaware Basin and this acquisition initiative would further strengthen its position in the area.
Upstream Business Segment:
The company registered oil equivalent production of 2.52 mmboe/d in Q3 2012 compared to 2.6 mmboe/d in the same quarter of last year. It saw an increase in production in its projects involving ramp-ups in the United States, Nigeria and Thailand. However, the impact of this increase was offset by the decline experienced by its normal field projects, the operational shut down at the Gulf of Mexico due to the storm, as well as due to maintenance-related downtime. The company's management expects production to increase in the coming period, with the expected increase in energy demand. According to Citi Research, Chevron's oil production will increase to up to 2.6 million barrels of oil equivalent per day by the end of fiscal year 2012.
Downstream Business Segment:
The company's earnings from its Downstream Business Segment declined to $456 million in Q3 2012, from $704 million in Q3 2012. The decline was witnessed primarily because of the considerable decrease in margins on the sale of refined products and increase in operating margins. Output for crude oil refineries also decreased due to a fire at the Richmond refinery in California. In our opinion, the expected increase in oil consumption will enhance the company's profitability for this segment as well.
The company's margins have been increasing continuously since 2009 due to the rapid increase in sales. In our opinion, its margins will improve in the coming years through cost efficiencies in its drilling activities. However, the company's capital expenditure increased by $1.9 billion over the period of the previous year. Out of the company's total expenditure, 90% went towards its Upstream Business segment. The company's profitability is expected to increase in the coming period with the structural transformation towards natural gas.
Chevron's return on invested capital decreased considerably due to the decline in oil production volumes. The restructuring efforts towards shale gas exploration and production are expected to improve the returns of the company.
The stock is trading at an EV/EBITDA of 4x, at a premium when compared to Total SA's (TOT) 3.18x. However, it is trading at a discount to BP PLC's (BP) 4.41x, Exxon Mobil (XOM) and Royal Dutch Shell's (RDS.A) EV/EBITDA of 6.18x each.