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Executive summary:

  • Chevron is facing operational troubles such as project delays and higher research and development costs.
  • The company's current valuation is pretty comparable to its historical valuation both in terms of earnings multiples and dividend yield.
  • This stock is more suited for dividend investors who are looking for a relatively stable investment with decent income.

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Even though the market has been on a rally mode for the last couple years, the oil industry has not faced the same enthusiasm from the investors. This is especially true for the large oil companies that used to receive a lot of love from the market. One of such companies is Chevron (CVX). The chart below shows the performance of the market in the last two years in comparison to Chevron and the two items started separating from each other after last summer.

^SPX Chart

If we look at a longer term trend, like the last 20 years, Chevron has been outperforming the market; however, the gap has been closing in the last couple years. Actually the figure below does not include the dividends and if we include the dividends, the gap between Chevron and the overall market in the last 20 years would have been much wider.

CVX Chart

So what's going on with Chevron? Well, there are two types of issues around the company at the moment, the external issues and internal issues. The external issues stem from the fact that the oil prices haven't appreciated much in the last couple years, even though the Fed's quantitative easing program helped many assets (such as stocks and houses) appreciate in price during this period. As the conventional oil reserves are shrinking and it is becoming increasingly difficult to find more reserves of conventional oil, it becomes increasingly expensive to find and produce oil for companies since non-conventional oil tends to take more effort and investment than conventional oil does. Furthermore, natural gas prices have been at historically low levels in the recent years and this hurt margins of many energy companies in the process.

There are also internal issues with the company, such as missing production goals, not moving fast enough to cut some of its costs and relying too much on oil prices. The company has several big projects that are behind the schedule and many investors are running out of patience due to these delays.

The chart below shows the historical gross margins for Chevron. Notice that the company's gross margins are far below the levels seen in 1990s; however, they are doing better than how they did from about 2003 to 2010. Typically, the gross margins of energy companies will rely heavily on energy prices and there will be a strong correlation between oil gross margins and oil prices, as well as natural gas margins and natural gas prices. Of course, the method of oil extraction will also make a big difference. In 1990s, a great majority of the oil production came from conventional oil, but the percentage of conventional oil production (in relation to overall oil production) has been falling for the last decade.

CVX Gross Profit Margin (Quarterly) Chart

Keep in mind that there has been a little disconnect between Chevron's gross margins and oil prices in the last couple years though. The last time this happened was back in 2008 during the great recession.

Brent Crude Oil Spot Price Chart

Gross margin is just one of the metrics to look at. The company's operating margin and net profit margin has been on the decline in the last couple months. Many people feel that Chevron's 2012 margins were outliers and the company's performance hit the ceiling during that year. Recently, the company has been losing money on project delays and slowing production.

CVX Operating Margin (<a href='http://seekingalpha.com/symbol/ttm' title='Tata Motors Limited'>TTM</a>) Chart

In fact, if we look at Chevron's operating expenses, we see a rising trend. The company continues to spend an increasing amount of money on research and development in order to increase its production.

CVX Total Operating Expenses (Quarterly) Chart

On a positive side, Chevron still generates a healthy amount of cash flow from its operations. In fact, the current figure is pretty close to the all-time high figure.

CVX Cash from Operations (Quarterly) Chart

The problem is that when it invests this cash flow towards new projects, it doesn't get the returns it would like to get. The chart below demonstrates this as the company's return on equity, return on assets and return on invested capital metrics have been pointing downwards for a while.

CVX Return On Equity (Annual) Chart

So, Chevron's performance has been falling for the last couple years. The real question is, does the market already bake that in the company's price? After all, good investment opportunities arise when market panics too much and oversells a company until it reaches a valuation too cheap to resist for the opportunistic investors. In the chart below, you can view Chevron's trailing P/E, the company's forward P/E, the company's normalized P/E and its P/E excluding cash. If you look at the last decade, there were some ups and downs in Chevron's valuation; however, the long-term trend looks pretty flat. The company's 10 year average ratios are pretty close to the company's current ratios, which tells us that it is fairly valued compared to its historical standards.

CVX PE Ratio (<a href='http://seekingalpha.com/symbol/ttm' title='Tata Motors Limited'>TTM</a>) Chart

Some investors value companies based on dividend yields. Sometimes, tempting yields can bring new investors to a company and this can support the share price since dividend-investors tend to hold their shares for a long time and reinvest their dividends to increase their exposure to a company. In the last 20 years, Chevron's dividend yield ranged from 2.40% to 4.45% and the company's current yield of 3.54% is close to average even though it's much higher than the 3.00% yield of last couple years.

CVX Dividend Yield (<a href='http://seekingalpha.com/symbol/ttm' title='Tata Motors Limited'>TTM</a>) Chart

Finally, we will look at Chevron's share count. The company has been aggressively buying its shares back in the last 10 years or so and the company's share count fell below 2 billion in late 2011. Currently the share count is closer to 1.9 billion and if the trend continues, this will continue to support the share price from falling too sharply in the short term.

CVX Shares Outstanding Chart

Chevron's margins are suffering from delayed projects, low natural gas prices and operating difficulties while the market gives the company a valuation comparable to its historic valuation. In the next few years, I expect the global oil demand to increase by 2-3% annually and if Chevron can get its delayed projects finished, it can take advantage of a new growth opportunity. For the time being, this will be a relatively stable stock and probably not have much of a volatility unless we face something drastic in the coming quarters, such as a sharp increase or decrease in oil prices. For dividend investors, this stock will continue to be an attractive play.

Source: Chevron Is Fairly Valued Compared To Historical Standards