I've been on a kick buying the Big Oil companies over the past twelve months. I've gotten nice starter yields from Conoco (COP) and BP (BP), and I am getting somewhat stable 8-9% growth from Exxon (XOM). One company I have yet to buy is Chevron (CVX), and in some ways, that has been a mistake. The company has grown earnings by 15.0% and dividends by 8.5% annually over the past ten years, and seems to have nearly the same earnings quality as Exxon but can use its smaller size to grow earnings at a faster rate.
In a world where a lot of defensive blue chips are overvalued by 10-25%, you have a company like Chevron sitting right in plain sight, fairly valued.
From an operational standpoint, things are looking up. From 2007 to 2012, Chevron was only replacing its reserves at a rate of 95%. This is less than ideal because anything below 100% is eventually unsustainable, and Chevron was trailing its peers (the industry average over that five-year window was 109%). But now, Chevron is replacing its reserves at a rate slightly above 112%. This is a welcome trend shift for long-term shareholders.
This does not mean that the company is perfect:
Chevron achieved returns on capital employed of 18.7%, while Exxon crossed the 25% threshold (in fact, this was one of the reasons why I selected Exxon over Chevron, although my general attitude towards the Chevron vs. Exxon debate is the same as the Coca-Cola (KO) vs. Pepsi (PEP) debate: when the right price strikes, I'll take both, please).
Additionally, Chevron has high finding costs at over $5 per barrel, while Exxon is able to do it at under $4 per barrel (I consider this negative a positive of sorts because Chevron has still been able to grow earnings per share from $9.48 in 2010 to $13.23 despite this disadvantage, and Chevron seems likely to decrease finding costs in the future, which should/could be a nice boost for shareholders).
And, of course, there is the albatross around the company's neck: the Ecuador lawsuit that is trying to shake $19 billion out of the Chevron treasury. This fact has not deterred me from considering Chevron as a potential investment not only because it is unlikely that Chevron will be paying out anything near $19 billion, but also because Chevron could withstand a worst case scenario.
Heck, at the end of 2012, Chevron has $21 billion in cash assets on its balance sheet. It has current reserves worth $173 billion. It owns 4,000 gas stations, and supplies 11,000 stations. It has the capacity to produce 2.67 million barrels of oil equivalents per day. If the company had to face a worst case scenario with the $19 billion lawsuit, it could handle it (if you believe this is a high likelihood event, then it may make sense to insist upon a 15-20% margin of safety in the stock price). Logistically, the plaintiffs in the lawsuit are trying to seize billions of dollars worth of Chevron's assets in Canada, Brazil, and Argentina.
But once you get past that, Chevron looks very interesting. The company is expected to have production growth of 5% each of the next two years, driven by the operation of two major liquefied natural gas projects (Gorgon and Wheatstone) in Australia that will serve Japanese and other Asian customers. To read more about those projects, you can click here.
From an income investor's perspective, Chevron may be one of those opportunities to "buy a wonderful company at a reasonable price" (unlike buying something like Hershey (HSY) or Brown-Forman (BF.B), where you would be buying an excellent company at a highly overvalued price based on fifteen years' worth of valuation metrics). There are not a whole lot of opportunities out there where you can buy a company with a 3-4% starting yield that is expected to grow dividends at a rate of 8-11% annually over the medium term.
When you achieve that kind of dividend growth for five years, you can minimize some of the effects that the fluctuations in stock price will have on your ability to realize satisfactory returns on your investment.
Right now, Chevron pays out a $4.00 annual dividend. If you can get five years of 9% dividend growth, your income returns might look something like this:
$4.00 this year.
$4.36 in year one.
$4.75 in year two.
$5.18 in year three.
$5.64 in year four.
$6.14 in year five.
Over the next five years, a Chevron investor has a reasonable chance of collecting $30.07 in dividends for every share he pays $122 for today. When 2018 rolls around, you have a decent chance of capturing about a quarter of your initial purchase price in the form of accumulated dividends along the way. If you choose to reinvest, you could accelerate that figure even more (the lower the price, the more shares you will accumulate, all else equal).
The wrong type of investor to purchase shares of Chevron right now would be someone that anticipates a significant drop in commodity prices, significant ramifications from the Ecuador lawsuit, or someone that insists upon a margin of safety in terms of purchase price. But if you believe energy prices are stable and Chevron will be able to cue the REO Speedwagon and ride the storm out with the Texaco legacy lawsuit, then Chevron is probably a good example of what it means to buy a wonderful company at a fair price, and is one of the few fairly valued blue-chips that stands a chance of delivering 8-11% annual dividend growth while giving investors a nice starter yield of over 3% today.