Berkshire Hathaway's portfolio consists of 43 companies and is worth $105 billion. In 2013, the company purchased nearly 1% of Exxon Mobil (NYSE:XOM) . This represents about 3.97% of Berkshire's overall holdings and about 50% of its investments in the energy sector.
This article will explore Exxon's merits and explain why Chevron (NYSE:CVX) makes a good a long-term investment.
The case for Exxon
Exxon is a master of reserve replacement with over 20 consecutive years of finding more oil than it produces. Thanks to 2013's 103% reserve replacement rate the company now has 25.2 billion barrels of proven reserves, which is almost exactly as much as the country of China. This is sufficient to cover its annual production (4 million barrels per day, or bpd) for nearly 14 years.
On the production expansion front, the company is pursuing over 120 projects to produce a total of 24 billion barrels of oil. Twenty-four of these projects are scheduled to come online by 2017, including 10 in 2014 (2014's projects will increase daily production capacity by 300,000 bpd).
The company spent $42.5 billion on capital expenditures, or capex, in 2013, is guiding for $39.8 billion in 2014 and under $37 billion in 2015-2017.
Despite the decreasing investments, management is guiding for flat production growth in 2014 and 4% increased oil production in 2015-2017 (gas increases of 1%). The increased production and lower costs will result in margin growth on (already) above industry average profitability.
Adding the fundamental strengths just mentioned to Exxon's investing history makes a good case for owning the stock. In the last 21 years Exxon has returned 12.5% CAGR (with dividend reinvestment) compared to the market's 9.5%. The company is a dividend aristocrat with 31 consecutive years of payout increases (dividend growth of 6.11% CAGR for the last 20 years).
As a final cherry on top, the company is trading at an 18% discount to its historical valuation (21-year average P/E of 15 versus 12.3 today). On a yield basis, Exxon is now the cheapest it has been in three years.
Why Chevron is better
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As seen above, Chevron, despite being just as safe and diversified an oil giant, outperforms Exxon in the areas investors care about most: earnings growth, profitability, yield and dividend growth.
Chevron is also a dividend aristocrat with 25 years of consecutive dividend increases.
However, the largest reason for investors to choose Chevron over Exxon is the company's near-term growth prospects.
Over the next four years, Chevron plans to increase its capacity by 20%, from 2.6 mboe/d to 3.1 mboe/d. It plans to maintain its 2014 capex rate of $35.8 billion through this time and to spend the funds on deepwater offshore drilling, shale oil and the Tengizchevroil consortium. This last project is a partnership of companies developing the Tengiz super-giant oil field in Kazakhstan. Chevron owns 50% of the consortium.
The increased production, when combined with flat capex, will likely result in dividend growth accelerating to about 9% annually over the next five years.
Chevron's recent price weakness is a result of an earnings warning issued by the company. Poor weather in the U.S., Canada and Kazakhstan during the fourth quarter, along with increased refinery maintenance and foreign currency effects, will cause the company to miss earnings by about $0.2 per share.
The Giant from California
To most consumers, San Ramon, Calif.,-based Chevron Corp is little more than a gasoline retailer - a place to fuel up, squeegee your windshield and inflate your tires. In point of fact, Chevron is a $237 billion leviathan that trades at a modest 11 times earnings and has increased its dividend payments every year since the mid-1980s. Are those superlative measures nothing more than byproducts of being a major global player in a vital industry, or is there more to Chevron's profound success?
One of the 6 largest petrochemical companies on Earth, Chevron is the very embodiment of the epithet "Big Oil." Like its competing petroleum producers, Chevron classifies its primary operations into the categories of "upstream" (discovery, extraction) and "downstream" (refinement, processing), each of which makes its own distinct contributions to the company's bottom line. Downstream also includes Chevron's chemical operations, specifically commodity petrochemicals, and fuel and lubricant additives derived via the company's refining processes.
It's no surprise that Chevron primarily explores for and produces oil, with natural gas a distant secondary business. Chevron conducts its upstream oil operations around the world, often in areas not traditionally considered petroleum development hotbeds. Upstream profits actually declined in the most recent fiscal year, although $17 billion in net income is hardly anything for investors to complain about. According to Chevron's own 2013 annual report, the decrease was largely the result of factors beyond the company's control (e.g. crude oil prices, currency movements). To remain dynamic and growing, Chevron has taken to expanding its operations in heretofore underdeveloped areas. These new ventures include the single-largest resource undertaking in the history of the Australian continent. Located off the northern shore of Western Australia, the Gorgon project is all but complete and will eventually develop enough liquid natural gas for both domestic use and export. Chevron also has comparably large investments in Angola that total $10 billion, money that Chevron could conceivably take from its voluminous cash on hand and still have $6 billion remaining.
Despite the relative downturn in 2013, upstream operations represented 97% of Chevron's profits during the most recent fiscal year. Of that, 19% came from operations in the United States, reinforcing a downward trend that has been in place for several years. Or, if you prefer to look at the other side of an extremely lucrative coin, international operations are becoming gradually more important with each passing year.
Upstream, Chevron produces two primary commodities: crude oil and natural gas. The per-unit spot prices of each have remained consistent over the last couple of years, decreasing 1.6% and 1.4%, respectively, between 2012 and 2013. While production has ramped up in certain parts of the world under Chevron's purview (the Gulf of Mexico, Alaska), comparable reductions in other places (Brazil, Kazakhstan) have offset the advances, leaving the company's large revenue and profit numbers relatively unchanged.
As much as natural gas is touted as ecologically beneficial (clean burning, minimal byproducts, low toxicity), it still remains an exceedingly distant second to crude oil in terms of worldwide importance. In 2013 Chevron extracted 449,000 barrels of net crude oil (plus an ancillary product, natural gas liquids, as distinguished from natural gas) in the United States daily. At $93.46 per barrel (and granted, that price fluctuates over the course of a year), that means annual revenues of about $15.3 billion. Contrast that with domestic daily natural gas production of 1.246 billion cubic feet, and with natural gas selling for 0.337¢ per cubic foot, that means that Chevron generates 10 times as much revenue from crude oil as it does from natural gas.
Looking at Chevron's global operations, the relative importance of the two commodities is similar to what it is domestically. International crude oil prices averaged 7% higher than they did in the United States, while natural gas prices averaged 75% higher (the latter discrepancy thanks mostly to a domestic glut). Crude oil revenues were about eight times larger than natural gas revenues in Chevron's non-U.S. markets.
My Bottom Line
As a legacy corporation, and an entrenched component of the Dow 30 with operations in 180 countries and annual sales of about $220 billion, Chevron seems to be scraping against the upper limit of how large a company can get, or at least how large a company can get given the limitations of current oil- and natural gas-producing technology. Chevron's substantial investments in alternative energy (solar, wind, geothermal) notwithstanding, the company remains an oil producer more than anything else. With crude oil and its derivatives still offering greater energy density than any fuel this side of uranium, it appears that Chevron will continue to be a dominant player in the world economy for the foreseeable future.
Exxon Mobil is a terrific company, and investors are likely to do well owning its shares over the long term (especially given how undervalued it is). However, due to its higher yield, faster dividend growth and better short- to medium-term growth prospects (as well as higher profitability and equal undervaluation), I believe Chevron is a better long-term investment.
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.