- Chevron's interim report showed weak production growth again, and earnings will be driven by asset sales rather than continuing operations.
- While the US showed mild improvement, international results were weak, which means Chevron produced less oil and gas than last year despite a $40 billion cap-ex budget.
- With limited growth and no free cash flow, a 12.4x earnings multiple is very fair and investors should wait for a further pullback before buying.
Like many of its major oil peers from Exxon Mobil (NYSE:XOM) to BP (NYSE:BP), Chevron (NYSE:CVX) has been struggling to grow production. Natural declines at its massive existing wells around the world are proving hard to replace, and the company has been spending nearly $40 billion a year to replace this decline and return to production growth. This cap-ex binge has left the company free cash flow negative, forcing it to borrow to fund a portion of the cap-ex and dividend. With a debt to equity ratio of 0.13 (financial data available here), Chevron certainly has the financial capacity to borrow to fund expansion projects from Angola to Australia. Nonetheless, shareholders care mightily about the results from this cap-ex spending as no one wants to see a corporation waste its money. Unfortunately, the results have been subpar thus far as the company struggles to grow production. Chevron's interim report on the second quarter (available here) was another let-down on the growth front.
This interim report covers the first two months of the second quarter, so results during the third month could make the quarter a bit better or worse. Still, it provides worthwhile insight into the company's operating performance. At first glance, this report seems strong as "earnings for the second quarter 2014 are expected to be higher than first quarter 2014." Stronger sequential earnings is a positive, but this strength is mainly due to an accounting gain rather than better production. This improvement is a "result of gains on asset sales and an absence of impairments in the prior quarter." Like other oil companies, Chevron is constantly selling and buying land to fund some cap-ex and maintain focus in certain regions. Chevron sold some land above its carrying cost, which helps earnings, but it is a one-time item rather than an improvement at continuing operations. While headline EPS may be stronger, it seems like EPS from continuing operations may be a bit weaker. The main culprit of this is disappointing production.
In its US upstream operations, which is where Chevron explores for and produces oil, there was a sequential improvement. Liquid production improved to 460 MBD from 455 MBD in the previous quarter while gas production came in at 1,229 MMCFD versus 1,212. As a consequence, oil equivalent production increased to 665 MBOED from 640. Now as has been well documented, the weather in the first quarter was miserable, which cut first quarter production. Chevron also had some additional downtime for maintenance in the Gulf, which depressed first quarter results, making this sequential gain seem overly strong. Still, on a year over year basis, production increased 1%, which is a solid number.
Conversely, international figures were pretty weak. Liquid production fell 2% sequentially to 1,248 MBD while natural gas production dropped 3%. On an oil equivalent basis, production dropped about 2.5%. Year over year, production was also lower by 1%. Chevron has been spending billions on mega-projects overseas, but many of these projects have seen cost overruns and delays, which is dragging on international production. This decline overseas more than outweighed improvements in the U.S., and Chevron's production is tracking down about 0.6% in the second quarter. For a company spending nearly $40 billion on cap-ex, that is unambiguously disappointing.
Given these numbers, I expect Chevron's earnings from continuing operations to be $2.25-$2.35 in the second quarter, inline or slightly below last quarter's number. That would put Chevron on the path to earn $10.30-$10.50 in the calendar year, which will be lower year over year. Chevron is trading about 12.4x 2014 earnings. While this is lower than many other companies, this is on the higher end of integrated oil valuations. After all, Chevron isn't generating free cash flow, and it also isn't delivering on production growth targets. For a company with limited real growth and massive cap-ex needs, this is a very fair multiple. I think investors would be best to wait for a pullback below $120 to buy, and I would recommend oil companies delivering on production growth targets like ConocoPhillips (NYSE:COP) and Anadarko (NYSE:APC) over Chevron.