An Opportunity in Chevron

If you bought $100 of Chevron (CVX) at average annual prices prevalent during 1999 and reinvested dividends received over the years, by now the capital value would be $310 and you would have a dividend income flow of $11.787. Between 1999 and 2009, earnings have grown at an annualized rate of 9.8%; dividends have grown at 7.93%. The median payout ratio has run at just below 30% and while the expected payout ratio in 2009 is expected to be 66.50%, in my view the dividend is safe, provided that oil prices sustain at levels above $60; the balance sheet is strong which allows CVX to maintain sustainable policy unaffected by temporary disruptions. At recent prices, the dividend yield is a healthy 3.8%.

The company also returned considerable value via share buybacks during 2007 and 2008. With the benefit of hindsight this might not appear to have been a great idea because the share prices peaked during these years; however, it must be noted that the share buybacks were conducted when PE ratios ran at between 7 and 9 which are indicative of good value.

The net debt to net debt plus equity is a meager 5% which provides a strong balance sheet; this provides adequate resources to invest in growth.

In my view, the energy sector has unrivalled strong fundamentals; you can read the reasons why on a prior post here. Over the coming years, I expect elevated inflation; furthermore, even if inflation as measured by core CPI is stable to restrained, the inflation levels measured including food and energy is likely to be high; even very high. The massive investment in drilling vessels during the past five years provides a better balance between drilling rig demand and supply; accordingly CVX and other oil majors can expect lower levels of operating and capital expense inflation compared with the past five years. Even with nominal/low growth in production, CVX is likely to deliver earnings growth at 7% annualized because of higher than inflation growth in oil prices coupled with comparatively lower operating and capex inflation levels. Keep in mind that I am not implying CVX production will not grow; I am merely pointing out that their earnings can grow considerably even without production growth.

CVX’s resource replacement during 2002 and 2008 has been the best amongst all major E&P companies; in addition CVX has 40 projects where CVX’s net share is in excess of $1 billion and a further 90 projects where CVX’s net share is in excess of $200 million. Their growth portfolio is formidable: Agbami in Nigeria, Tengiz in Kazakhstan, Blind Faith & Tahiti in US Gulf of Mexico, Frade in Brazil and Tombua-Landana in Angola, all provide visible growth opportunities. Longer term, investments in Australia and a leading position in the US Gulf can be expected to provide sustainable growth. Their growth portfolio is high potential and well diversified across most major deep and ultra-deepwater markets (Gulf of Guinea, Brazil, US Gulf, West Africa (Angola) are amongst the most high potential deepwater opportunities available today) in the world.

Priced at $70 CVX is a good buy for almost every buy side investor; buy and hold investors, cycle investors, 12 to 24 month investors and shorter horizon investors can all expect good upside. The energy sector can be expected to start outperforming once the early cyclical (financials, materials, discretionary and industrials) have outperformed for six months or so. Energy tends to underperform during the last legs (say three months) of an economic contraction (early bull April 09 to June 09); the sector typically comes into strength three to six months after the end of economic contractions (expect end of recession July 09); so energy should start outperforming during q4 2009 to q1 2010. Now feels like a good time to buy.

My 2014 target price for CVX is $150 with upside potential to $180; on an annualized basis that translates to a return expectation of 16.5% to 20.8% excluding the returns which will be earned through dividends.

Please refer to CVX on the Quant Report for insight into numbers referred to above.

Disclosure: No holdings.

Comments

[Senan:]

CVX is one I'm watching also. It's been pretty flat for months but it's portfolio is great.

Oct 01 07:44 AM

[gjg49:]

just how safe is the dividend??

by my calculation (and i err as frequently as anyone else, so i am open to correction) over the past 12 months, cvx generated $20 billion in operating cash flow and spent $21.1 billion on capital spending. if that is correct, then cvx did not generate a sufficient level of cash flow to pay the dividend over the past 12 months. if correct, cvx effectively "borrowed" (either consuming cash off the balance sheet or increasing external borrowing) by approximately $6.3 billion to pay the $5.2 billion in dividends over the past 12 months.

as of june 30, 2009, cvx also runs a net debt position of $4.7 billion (that is, total debt exceeds cash on the balance sheet--this contrasts with a $600 million net cash position at dec 31, 2008 and a $2 billion net cash position at june 30, 2008), albeit not very large relative to the size of the $161 billion asset base and $87 billion equity base. if the operating cash flow and capital spending remain on the same path, chevron will need to increase net debt to continue to pay the dividend at the same rate.

management may well be able to tweak the operating cash flow and/or capital spending to improve the free cash flow generation, but unless they do, i would be less comfortable about the sustainability of the dividend at the current rate. i would not expect a dividend cut imminently, but at the same time, things will need to improve to sustain the dividend at the current rate.

Oct 01 09:41 PM