Energy is becoming an increasingly important part of the lives of the global population. While the development of alternative energy sources will be critical to the success of civilization in the future, oil and natural gas remain an important part of our lives today (and likely for the foreseeable future). Despite the volatility in this sector, stocks with exposure to energy sources such as oil and natural gas can play an important role in a diversified portfolio. My target income contribution from the energy space is between 5% and 10%. This space holds great opportunity for dividend investors, but also is fraught with potential risk.
While the trajectory of energy prices is important to the operations of any oil company, investors must assess the long-term health of the company by asking the questions below:
- How much can I make today?
- What is management's ability to raise the dividend?
- What is management's willingness to raise the dividend?
- Is what I am paying reasonable?
Chevron (CVX) represents a stock in the industry that has great answers to the questions above. The analysis below provides viewpoint into how well CVX performs across the dimensions listed above.
How Much Money Can I Make Today?
The amount of money that one can expect to generate today is determined by the yield on the investment available to investors today. The table below shows the yields currently available on these stocks:
As the chart above shows, CVX does by no means have the highest dividend in the industry, but does meet the needs of most income investors with a dividend yield north of 3%.
What Is Management's Ability to Raise the Dividend?
Yield does not mean a whole lot if the dividend is in jeopardy and gets cut tomorrow. Additionally, for investors with a longer-term horizon, it is important to consider the ability for a dividend to grow. Investors can test the sustainability of a company's dividend by assessing a few core metrics.
Barrels of oil and cubic feet of natural gas are the bread and butter of operations for CVX. A period of time may hit when the productivity of exploration campaigns will start to fall. The companies that have a wealth of reserves would be able to sustain this patch for an extended period of time. The chart below shows the number of years that the reserves for CVX could sustain its 2012 unit volume sales:
Years of Reserve Backlog (2010-12)
The rate has increased over time, indicating that if CVX stopped production of natural gas and oil tomorrow, it could sustain its natural gas and oil output for eight years and five years, respectively. This in conjunction with increasing revenue is a strong indicator CVX is using its resources efficiently and can sustain a dividend in the long term.
Limited top-line growth reduces the likelihood of long-term sustainable dividend growth. For many of these companies, revenue growth is largely dictated by the prices of energy inputs and refined products such as crude oil, natural gas, and jet fuel. The chart below shows that all companies have experienced revenue growth over the last few years. CVX has lagged behind its peers in respect to this metric, but has still had solid revenue growth over the last three-year period.
Indexed Revenue Growth (2009-12)
FCFE to Dividends
The next measure to assess is the amount of cash available to cover the dividend today. A high FCFE-to-dividend ratio indicates there is plenty of room for the dividend to grow. A level below one for an extended period of time signals future stagnant dividend growth, or potentially even a dividend cut in the future.
FCFE to Dividends (2009-12)
The chart above shows that CVX has double the amount of cash available to it that it needs to pay shareholders. While not as strong as some of its peers, CVX has ample cash available to it to pay out to shareholders.
CFO to FCFE
A company can boost its FCFE by simply issuing debt. As such, it is important to get a proxy for the quality of FCFE. The amount of FCFE from cash flow from operations is one way to do this. How these companies performed between 2009 and 2012 against this metric is shown below:
CFO to FCFE (2009-12)
While CVX has less FCFE available to it than its peers, the quality of the FCFE available to it is higher than its peers. The chart above shows that CVX generates a substantial amount of its FCFE from its operations. This is again indicative of a company that is able to increase dividends to shareholders in the long term.
What Is Management's Willingness to Increase the Dividend?
Historical dividend growth and the number of consecutive years a management team has raised dividend provides an indication of their willingness to raise the dividend in the future. Companies with long track records of strong dividend growth are likely to continue them in the future.
Consecutive Dividend Increases
Increasing dividend payouts to shareholders for 25 consecutive years is no easy feat to pull off and is likely not a track record that a management team would be proud to break. Given this fact, investors can be assured that as long as they are able to, management will be willing to continue increasing dividend payouts to shareholders.
Historical Dividend Growth
In addition to looking at how many times a company has increased its dividend, it is important to get a sense for by how much they have increased it. The chart below shows the dividend growth of these companies between 2009 and 2012:
Indexed Dividend Growth (2009-12)
CVX again emerges as a clear leader in this regard. Since 2004, CVX has increased the dividend at an average annual rate of 11% per annum. This in conjunction with a 3% yield would result in a 14% annual increase in income for shareholders opting to reinvest their dividends. Not too shabby at all.
Is What I'm Paying Reasonable?
The final piece of the puzzle to look at is to measure how CVX is valued relative to its peers. The P/E ratio provides a proxy to do this.
The table above shows CVX trades at a premium to RDS.A and BP (BP), but almost at parity to Exxon Mobil (XOM). This would be expected given the current distressed situation that BP, as well as the limited dividend growth of RDS.A in the past.
CVX is a great opportunity for dividend investors looking for exposure to the energy sector. With a strong presence both domestically and internationally, investors can benefit from increasing energy demand from emerging markets around the world. An investment in CVX provides investors with access to a great management team that is able and has shown a strong willingness to increase payouts to shareholders. Additionally, valuations for oil companies appear to be low relative to historical norms. Risks such as oil spills faced by both XOM and BP in the past remain a constant threat to the operations (and ultimately dividends) of oil companies. However, given the strength of CVX's operations and reserves, investors would be wise to consider the addition of CVX as an income generating source to their portfolio.