Chevron Is A Disappointment

Feb. 4.14 | About: Chevron Corporation (CVX)

On Friday, Chevron (NYSE:CVX) reported quarterly earnings that severely disappointed and forced me to temper my optimism for the oil giant (press release available here). While the company is outperforming Exxon Mobil (NYSE:XOM), which continues to see declining production, production growth is disappointing despite a massive capital plan that will see the company spend $39.8 billion in 2014. While this pace will be below 2013's $41.9 billion, it will leave the company with no to slightly negative free cash flow. Given this backdrop, it is unsurprising shares are sitting at a 52 week low despite a gigantic rally in the broader market.

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In the fourth quarter, the company earned $2.57 per share on $56 billion in revenue. For comparison, analysts were looking for $2.58 and over $60 billion in revenue. Earnings fell 32% year over year thanks to considerably tighter refining margins while revenue was 7% lower. Suffice it to say, these were not the numbers that Wall Street was looking for. Frankly, the weakness was across the board. Total upstream earnings were down 30% year over year with U.S. profits down 41% and international down 27%. Downstream activities were hurt by tighter crude spreads, and earnings were down by 58% with international down a whopping 79%. 2012 saw extremely large spreads, which were unsustainable over a long period of time, so this decline was driven more by an abnormally strong 2012 than weak 2013. I would look for 2014 downstream profits to be similar to 2013 results.

However, Chevron is driven by its upstream (exploration and production) activities, which account for 90% of the company's earnings. Unfortunately, upstream earnings left much to be desired. Increasing supply has put a cap on crude prices, so growth will be driven primarily by production increases rather than prices. It should be noted though that the unseasonably cold winter has spent natural gas skyrocketing above $5. This increase may prove to be temporary once it warms back up given the massive amount of domestic supply. If prices do stay elevated for a longer period of time though, Chevron would be a major beneficiary.

In the fourth quarter, U.S. production fell 4% to 650,000 barrels of oil-equivalents ("BOE") per day in the quarter. Oil production was down 5% while gas production was down 1% despite increasing investments in the Permian and Marcellus Shale. Weather was a headwind for domestic producers, but this decline was disappointing given the company's refocus of onshore energy production. Overseas, production fell by 3% to 1.93 million BOE per day as new projects failed to make up for the natural decline in existing fields. Liquids were down 4% while gas was down 3%. With a push into Nigeria and a massive Australian LNG project, results should be somewhat better in 2014.

For the full year, CVX produced 2.6 million BOE daily, which was down 0.5% year over year. With its massive cap-ex budget, CVX had been targeting 1-3% production growth, which should accelerate to 4-5% in 2015 and beyond. Unfortunately, management guided to 2.6 million BOE daily production in 2014 on the conference call (transcript available here). In other words, Chevron will not grow production this year despite its massive capital budget that eats all of its operating cash flow and increased the company's net debt position by $13 billion in 2013. Flat production is deeply disappointing and leads one to question whether CVX will achieve 4% growth in 2015 while simultaneously cutting the size of its cap-ex budget.

Now while Chevron clearly underperformed, it isn't all bad news. The company has been buying back some stock, including $1.25 billion this quarter. With the lack of free cash flow, I wouldn't expect a brisker pace this year. The company has increased its dividend for 26 years, and I expect another hike of $0.05-$0.10 this year. With a $1 quarterly payout currently, shares sport a solid 3.6% yield. Further with a similar production level and relatively stable prices, earnings should be roughly flat in 2014 at $11.10-$11.50. As a consequence, shares are trading at only 10x earnings. Chevron stock is far from expensive, but given weak production despite the massive cap-ex budget, shares will struggle to get back to $120. While Chevron is still a solid long term name thanks to valuation and the dividend, it will likely be dead money for some time. Investors will do better in ConocoPhillips (NYSE:COP), which has had more success growing production.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.