Chevron - Unexpected Decline In Production Results In A Modest Disappointment Among Investors

Aug. 4.14 | About: Chevron Corporation (CVX)

Summary

Chevron posted an unexpected decline in production, as the investment community was looking for a small increase.

This is as the company is preparing for a significant planned ramp up in production in the coming three years.

This anticipated growth, the fair valuation and strong financial position allow for better days ahead.

Investors in Chevron (NYSE:CVX) were slightly disappointed by the firm's second quarter results, as production fell a bit while analysts were projecting a modest increase in production.

Yet despite the short term disappointment, shares continue to offer great long term value amidst a projected increase in production, earnings, free cash flows amidst a very fair valuation.

Key Second Quarter Results

Chevron posted second quarter revenues of $57.94 billion, a 1% increase compared to last year.

The company managed to show some operating leverage, posting a 5.6% increase in earnings towards $5.66 billion. Given the modest pace of share repurchases, the company managed to report a 7.6% increase in diluted earnings per share which advanced to $2.98 per share.

Analysts were anticipating earnings per share to fall modestly to $2.68 per share. While the reported earnings of nearly three bucks per share seems like a comfortably earnings beat, results were aided by gains on asset sales with their effects not being completely specified in the press release. At its interim release a few weeks ago, Chevron anticipated asset gains to come in between $500-$600 million, or about $0.26-$0.31 per share, partially offset by severe currency headwinds.

Looking Into The Real Performance

Chevron reported oil-equivalent production of 2.55 million barrels per day for the quarter, down from 2.58 million barrels reported last year. Analysts were anticipating a modest increase in production to 2.595 million barrels of oil-equivalent per day.

Chevron's US operations saw earnings fall by $29 million to $1.05 billion despite an 8,000 barrels increase in production to 667 thousands barrels per day. Higher exploration and operating expenses were too blame for declining earnings.

More importantly, the company's international upstream business performed very well based on the headline results, reporting earnings of $4.21 billion, a near 9% increase from last year.

This was despite production being down by 45 thousand barrels to 1.88 million barrels per day. Downtime and changed production entitlement agreements reduced production by some 55,000 barrels. Despite this and a $147 million currency headwind earnings were up as notably realized crude prices were up more than $7 per barrel compared to last year. Reported gains on the sale of assets in Chad and Cameroon aided the bottom line as well.

The refining segment showed an impressive improvement despite falling throughput by 53,000 barrels to 761,000 barrels per day. Earnings came in at $517 million, compared to just $138 million last year thanks to asset sales, better refining margins and a very strong contribution from the 50% ownership in Chevron Phillips Chemical Company.

While the domestic downstream activities had a great quarter, it was the opposite case for the international business as earnings plunged from $628 million to just $204 million. Crude input fell by 28,000 barrels to 844,000 barrels as earnings were battered by lower margins and adverse currency movements.

Valuation

By the end of the quarter Chevron held about $14.2 billion in cash, equivalents and marketable securities. Its total debt has increased toward $23.5 billion, resulting in a net debt position of little over $9 billion. While such leverage is perfectly manageable given the profitability of the firm it has increased from a net debt position of about $4 billion a year ago.

Trading at $128 per share, and given that there are 1.90 billion shares outstanding, equity in the business is valued at $243 billion. On a trailing basis, Chevron has posted sales of $226 billion on which it has net earned about $20 billion.

This values equity in the business at roughly 1.1 times annual revenues and roughly 12 times annual earnings.

Lack Of Consistent Growth, But Perhaps Brighter Days Ahead

Just like any major integrated oil company Chevron is challenged to grow production and this quarter's fall in production is no exception. As such revenues and earnings in recent years have largely floated with general levels of oil and gas prices. Despite this, the company has managed to increase its through the cycle margins over this time, after shedding a lot of non-core assets.

Earnings have ranged between $13 and $27 billion over the past decade, currently coming in at the middle of the range. Earnings attributable to shareholders have been on the increase given the cumulative 10% increase of the shareholder base in the meantime.

The current net debt position of $9 billion results from a steady increase in capital expenditures which exceed the sum of depreciation charges and earnings. As an illustration of this, Chevron spend $10.2 billion in capital expenditures this quarter versus just $3.8 billion in depreciation charges, resulting in a lot of pressure on free cash flows given that earnings don't even make up the difference. As such, divestments are crucial to avoid a runaway in the built up in debt in the short term with the company paying out $2 billion in quarterly dividends and repurchasing another $1.25 billion in shares for the quarter.

Yet these high capital expenditures are targeted to be able to report a cumulative 20% increase in production by 2017. This is very aggressive and could provide a big boost to revenues and earnings if production targets are achieved. Especially with capital expenditures anticipated to decline going forwards, this should provide a big boost to both operational and free cash flows.

Final Takeaway

So far this year and over the past year, shares of Chevron are trading roughly flat. This is as investors are continuously seeing modest disappointments in current production, while the company continues to guide for much better days ahead. This time more maintenance activity, notably at Tengizchevroil in Kazakhstan, was blamed for the production shortfall.

Yet CEO John Watson remains confident in the guidance of 20% production growth by 2017 given the deepwater Gulf of Mexico projects, the near term start up of the Jack/St. Malo project this year and the Big Foot project next year. Of course the other much anticipated projects are the huge Gorgon and Wheatstone LNG projects in Australia, with Gorgon anticipated to start production in the middle of 2015. Not everything is going well, the development of the Kitimat LNG project in Canada is under some pressure with partnering Apache (NYSE:APA) pulling out of the project, requiring Chevron to find a new partner.

Last month, Chevron already updated the market with its interim statement, given me an opportunity to check upon its prospects. I concluded that given the outlook for production growth, earnings of $25 billion could very well be attainable a few years down the road. In the meantime, the company operates with a solid balance sheet, pays about a near 3.4% dividend yield and returns even more cash through share repurchases.

Give the recent pullback, I continue to like the shares for the long run based on the valuation, sound financial position, payouts and anticipated growth. I continue to add to my position on dips.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.