Why Chevron Is Undervalued Right Now

Jul. 2.13 | About: Chevron Corporation (CVX)

This article is part of an ongoing series that highlights specific companies that are on sale. It helps me to document my thought processes when I add to my holdings. Please provide your feedback in the comments section below.

(NYSE:CVX) is currently offering investors an opportunity to buy portions of the company at under $120/share. Just a few weeks ago, this ownership interest would have cost you about $127. Chevron recently increased its dividend, but the stock price hasn't increased accordingly.

CVX has a business model that is sustainable. Its gross margins have been steadily increasing, from about 30% a decade ago to over 40% today, which would imply that it has been able to successfully pass along price increases to customers. Indeed, according to the 2012 Annual Report, it bested competitors in earnings per barrel for the third year in a row.

Chevron had 11.35 billion barrels of proven reserves at the end of 2012, and it has been increasing this amount. At the current market price of $95/barrel, CVX is sitting on over $1 trillion worth of oil. Even if the price of oil declines to $50/barrel, the value of the oil is still over $500 billion. Of course, there are costs associated with extracting this oil and Chevron will not be able to realize the entire value as profit. What this illustrates, rather, is that the company is not dependent on the discovery of new oil for it to continue its current earnings trend. It could still earn $13/share, buy back shares outstanding, and continue paying its dividend with the oil that it's sitting on. Additional discoveries will only increase future earnings.

CVX currently sports a P/E of under 9. I would expect to see multiple expansion in the coming months due to the recent dividend increase. Prior to the increase, CVX also traded at 9x earnings. There may be a small window here to acquire additional shares at the higher yield before the price increases.

The payout ratio remains very strong at about 27%. By having a relatively low payout ratio, the company has room to increase the dividend, should earnings stagnate or decline. Additionally, Chevron has enough cash on the balance sheet to fully fund the dividend for the next few years, even if it stopped making any money.

The dividend is elevated, as well. Because the stock is priced at a discount, your entry yield is a bit higher than it has been in the recent past. In fact, Chevron increased its annual dividend by 11% for this last payout. Prior to the increase, CVX offered a 3.10% yield. Currently, the yield is 3.35%. This yield acts as a floor for the stock price. If the price were to decline further, the yield would increase, enticing investors to bid the price back up.

As always, this article represents my opinions at the time of writing. You should do your own due diligence before making any decisions. However, I believe that CVX represents a quality company that is trading hands at a discount.

Disclosure: I am long CVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.