By Ahmed Ishtiaq
Chevron (NYSE:CVX) is the second largest integrated oil company in the U.S., behind Exxon Mobil (XOM). It has reserves of 11.2 billion barrels of oil and a daily production of 2.7 million barrels. Furthermore, the company owns interests in mining, chemicals and power production businesses. The company owns 8,170 gas stations in the U.S. that operate under the Chevron and Texaco brands. Outside the U.S., Chevron owns 9,660 gas stations. The company also owns 50% of chemicals concern Chevron Phillips Chemical. In a major move in 2011, Chevron acquired Atlas Energy in a $4.3 billion deal.
As of the time of writing this article, CVX stock was trading at around $116, with a 52-week range of $95.73 - $118.53. It has a market cap of about $227 billion. The trailing twelve-month P/E ratio of 9.5 is above the forward P/E ratio of 9.1. P/B, P/S, and P/CF ratios stand at 1.7, 0.9, and 6.5, respectively. The operating margin is 18.4% while the net profit margin is 10%. The company has a low debt load, with a debt/equity ratio of 0.1.
Chevron has a 4-star rating from Morningstar. Out of ten analysts covering the stock, four have a buy recommendation, three have hold recommendations and one analyst has market outperform rating. On the other hand, only one analyst is neutral about the stock. Average five-year annualized growth forecast estimate is 1.97%.
We can estimate Chevron's fair value using discounted earnings plus equity model as follows.
Discounted Earnings plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5+ Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year. The average EPS for ConocoPhillips is $4.50.
While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 1.97%. Book value per share is $68.41.
Fair Value Estimator | ||
V0 | E0 | $10.50 |
V1 | E0 (1+g)/(1+r) | $9.65 |
V2 | E0((1+g)/(1+r))2 | $8.86 |
V3 | E0((1+g)/(1+r))3 | $8.14 |
V4 | E0((1+g)/(1+r))4 | $7.48 |
V5 | E0((1+g)/(1+r))5 | $6.87 |
D | E0(1+g)5/[r(1+r)5] | $62.45 |
BV | Equals | $68.41 |
Fair Value Range | Lower Boundary | $113.95 |
Upper Boundary | $182.36 | |
Potential | 57.33% | |
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Chevron is between $113.95 and $182.36 per share. At a price of about $115.90, Chevron is trading close to the lower boundary of its fair value range. The stock still has up to 57% upside potential to reach its fair value maximum.
Competition:
Chevron competitors are Exxon Mobil Corporation , Royal Dutch Shell PLC (RDS.A) and BP (BP).
CVX | XOM | RDS.A | BP | |
Forward P/E | 9.50 | 9.50 | 8.4 | 8.00 |
P/B | 1.70 | 2.20 | 1.20 | 1.20 |
P/S | 0.90 | 0.90 | 0.50 | 0.40 |
EPS Growth | 4.80% | -0.90% | 5.30% | 6.40% |
Operating Margin | 18.40% | 16.00% | 10.50% | 7.20% |
Net Margin | 10.00% | 9.10% | 5.50% | 4.60% |
ROE TTM | 19.00% | 27.50% | 15.20% | 15.60% |
Debt to Equity | 0.10 | 0.10 | 0.20 | 0.40 |
Source: Morningstar.com
Chevron trades at a slight premium compared to BP and RDS.A. However, the company beats all of its competitors with strong margins. In addition, Chevron offers attractive ROE and lower debt to equity than most of its competitors.
Summary
At the moment, most of the energy giants are facing trouble in replacing their reserves and expanding production. Most countries with oil reserves are now focusing on promoting government backed energy companies in order to take control of their oil reserves. However, there are massive opportunities in deep-water exploration. At the moment, most of the energy companies are focusing on deep-water drilling and trying to exploit these untapped reserves. Demand for energy is on the rise, and it will become strong over the next two years. According to my valuation model, there is considerable upside potential in Chevron, and it can prove to be an astute investment.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Efsinvestments is a team of analysts. This article was written by Ahmed Ishtiaq, one of our equity analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.
