Chevron (CVX) announced its 4th quarter earnings this Friday, February 1st. The street had been expecting the company to deliver an EBITDA of $13.92 billion on revenue of $68.64 billion with an EPS of $3.04. Chevron represents the U.S.'s second largest integrated oil and gas company by market capitalization and is usually a good bellwether on how the economy and sector did for the quarter. Earlier this month the company announced that it expects its fourth quarter earnings to be notably higher than the third quarter of 2012, which the market perceived as good news and has sense sent the stock higher. For the fourth quarter Chevron reported an increase in net income of $7.2 billion which translated into an EPS of $3.70. This is a significant improvement over last quarter's numbers where the company posted net income of $5 billion and an EPS of $2.57 for the quarter. The below chart compares Chevron some of its major global competitors.
Exxon Mobile (XOM)
Conoco Phillips (COP)
Royal Dutch Shell (RDS.A)
Total S.A. (TOT)
BP plc (BP)
PetroChina Limited (PTR)
Chevron stated the reason for its optimistic fourth quarter was primarily due to the improvements the firm has made in its exploration and production businesses, which increased by 20% to $6.9 billion. Chevron also stated that its refining and chemical operations businesses continued to improve compared to the third quarter. Chevron generated a profit this past quarter in refining of $925 million, compared to the $61 million loss last quarter. Over the last year Chevron has also been actively involved in expanding its businesses across Asia and the greater Pacific. As part of that expansion strategy Chevron announced earlier this month that it entered into a production sharing contracts with China's National Offshore Oil Company (CNOOC).
Chevron in its earnings release showed an increase in U.S. oil production which translated into higher margins for the company. In guidance that was given earlier this month the company said that in the first two months of the quarter it had reached 676,000 barrels per day of oil in total U.S. production. This is up 2.3% from a year ago and 6% higher than what was reported at the third quarter.
Risks to Consider Ongoing
The biggest risk that Chevron faces for the remainder of the year is in its refining margins. The firm was able increase refining margins compared to the third quarter. Refining margins can differ greatly from one company to another, especially when it comes to what type of crude oil the company is focused on refined (Sweet or Sour). With the U.S. being a bigger player in the oil and gas markets, understanding it is not only important to understand the type of crude that is being refined, but to also important where it is coming from and how much it costs.
An excellent example of this was seen earlier this week when Valero Energy (VLO) reported its fourth quarter numbers. The company announced net income for the quarter of $1.01 billion compared to $45 million from the year prior. The main reason attributed to this extraordinary jump in net income was Valero replacing its foreign crude oil with cheaper local (U.S.) oil, which resulted in much high margins for the company.
As much as this new found oil here in the U.S. may seem to be a blessing for the U.S. economy it may also come as a margin burden to the major integrated oil and gas names out there. This can be simply explained by simple supply and demand numbers. In December and January the U.S. oil stockpiles (http://www.tradingnrg.com/crude-oil-price-weekly-report-for-january-14-18-2013/) rose by 7.7 million barrels reaching a total of 51.7 million barrels in storage. Additionally, from a supply side according to the most recent EIA report (http://www.eia.gov/oog/info/twip/twip_crude.html) U.S. oil production increased during December and January by 2.4%. Refinery inputs were also higher by 3.7% than they were the year prior.
Looking at the demand side the U.S. economy is slowly starting to show signs of growth, but these signals have been very mixed and are certainly not robust. With all of the new supply that is flooding the oil market current demand levels are not absorbing it fast enough to keep prices at equilibrium, ultimately causing oil prices to fall to its new equilibrium price. I will say that the most recent spike in oil prices toward the ever critical $100 level is not a long term trend. Instead I believe it is primarily attributed to the current geopolitical issues affecting Algeria.
Chevron also faces the risk of higher costs throughout the rest of the year. The firm noted earlier this month that total net charges were pacing toward $300 - $400 million. These higher costs are mainly due to higher potential income taxes, settlements on pension plans, and environmental costs. Now, I will be the first to say that $300 - $400 million might not sound like a lot for a company that posted $68 billion in revenue. It is still important to note that $300 - $400 million still translates to roughly $0.15 - $0.20 in EPS loss. If costs were to continue to creep up this year the overall effect on EPS might cause the stock to experience a great deal of volatility. Excellent examples of this include Apple (AAPL) and Google (GOOG) and how each company's stock responded to the EPS and guidance numbers that were shared.
The Long View
Regardless of the above mentioned risks for the company I still remain very optimistic on Chevron's overall growth and continued dominance in the integrated oil and gas space. Even as the oil supply in the United States continues to grow, which will ultimately drive down the price of crude, I feel that Chevron is hedging its bets by positioning itself well in the growing LNG market. Chevron continues to be a leader among its peers in the LNG space. The company continues to develop LNG at the fastest rate compared to its peers and continues to increase its developments around the world. The company did announce that this aggressive expansion is expensive, costing an estimated $36.7 billion for 2013. The money has been allocated primarily for large, multi-year developments that should continue to pay out for years to come. The planned capital expenditures that are being made now are expected to see a positive return by 2017. Some of Chevron's more notable investments for 2013 will be the Gorgon natural gas project in Australia and in deep-water opportunities off of the Gulf of Mexico.
I think it is also important to note that Chevron has been known to be an excellent dividend stock, with a consistent track record of increases over the last 25 years straight. This level of diversification has allowed Chevron to continue to grow, even within changing markets and stay competitive. Chevron currently pays an annual dividend of $3.60 per share, which translates to a 3.10% yield. Chevron has done an excellent job of ensuring that its dividend is managed responsibly and is sustainable. The company currently has an EPS payout ratio of 33%. Below is a chart that shows the total dividend rate, EPS, and payout ratio from the last five quarters. The below chart clearly shows that even in down quarters the dividend rate is still well within manageable distribution levels leaving plenty for the company to use on further growth opportunities.
What's the Trade?
Even amongst all of the economic headwinds that continue to put pressure on Chevron's stock and oil prices, I still remain optimistic on the growth potential for Chevron. As the global economy, especially Europe, China, and the U.S. begin to recover I see overall global demand for oil and gas products continuing to grow. Given this expected demand growth in the months and years to come and the amount of up front capital expenditures that Chevron is currently making will ultimately pay dividends to its shareholders for years to come.
I like Chevron as a long term trade and feel that any acquisition made of the stock between the $105 - $110 levels would present an excellent opportunity for any long term investor. I would recommend that any future pull backs in price, whether it is due to the greater company or the overall market should be viewed as a buying opportunity. As margins continue to improve and the annual dividend rate continues to increase any acquisition of Chevron in the $105 - $110 range should pay off very nicely for any investor.