Chevron (NYSE:CVX) has had a relatively soft 2014 compared to 2013. CVX gained 18% last year, in comparison YTD the stock is only up 3%. This is largely due to company's increasing capex and project execution issues that have combined to compress CVX profitability. However, similar to industry, CVX's execution is getting better, courtesy to better supply chain availability and management, and CVX's next wave of development projects also offer a better economic framework.
The second largest U.S. oil company, Chevron, reported better than expected results still the stock fell post earnings, as production fell and the company lowered its FY14 production guidance. The company reported 2Q14 EPS of $2.98, above consensus estimates of $2.66. However, the reported earnings included $750 million worth of asset sales gains compared to CVX's own previous guidance of $500-$600 million. Excluding these special items earnings would have been $2.58. The reported results were also helped by higher oil prices, at a time when production fell.
Near-Term Challenges as Last Phase of Spending Kicks In
Similar to ExxonMobil (NYSE:XOM), CVX is struggling to maintain production volumes. Weaker contribution from downstream had an adverse effect on production in what was a tough macro environment. Planned turnaround at El Segundo lowered U.S. throughput and refining earnings in the quarter. The company reported impressive results from the Permian Basin in Texas, New Mexico and Pennsylvania; however, these were offset by below average performance and normal field declines elsewhere.
The company lowered its FY14 production guidance from 2,610 mboed to 98-99% of 2,610 mboed, which is equivalent to 2,555 - 2,585 mboed. While the company has lowered its FY14 guidance, management during the earnings call spent some time re-affirming the guidance around key projects that drive medium-term growth ambitions. The company remains in the period of high spending to deliver future growth. Investment is up double digits Y/Y through 1H14, taking spending to some 115% of operating cash flow. Moreover, the capex will remain high till 2015 as the last phase of spending kicks in some of CVX's major growth projects.
Long-Term Growth Story Intact
Despite of the challenges that Chevron has faced in the recent past and the soft 2014 performance, the company's long-term growth profile remains intact. Chevron's long-term production growth forecast is meaningfully higher than its European and the closer U.S. peer, XOM. While CVX's European peers are lowering capex despite of falling/flat production levels, the company's closet U.S. peer, ExxonMobil, is spending the same amount ($37-$38 billion) to keep the production levels flat.
Chevron's production growth is expected to accelerate in 2016-2019 to 5-6% a year from start-up of oil-linked projects for 3 year growth rate of ~20%. Toward this goal, CVX currently has the highest percentage of non-productive capital employed which should normalize over the next several years, improving returns (ROCE). As these major projects come online, CVX expects non-productive capital to drop from over 42%+ to 35% in 2014-2016. Once Wheatstone [LNG] and Tengiz expansion come online, non-productive capital should drop further.
CVX currently trades at a significant discount (12%+) to peer XOM, and even bigger discount to broader energy sector and to S&P. CVX has a forward price/earnings of 10.9 vs. XOM's 12.4. Similarly, CVX has EV/EBITDA ratio of 6.0 compared to 7.1 of XOM. As more of capital employed begins generating returns, CVX should see improved ROCE and relative valuation re-rating. XOM's current higher ROCE is supported by the largest and strong profitable chemical and refining business in the midst of a strong cycle. As CVX non-productive capital declines and the two ROCE's converge, I believe CVX will close the valuation gap to XOM.
I continue to prefer CVX over XOM, due to strong profitability, attractive valuation, strong growth profile, and higher dividend yield (3.4% vs. 2.8%). Moreover, I expect CVX to continue to outperform relatively because of the same factors mentioned above.
The timing and development of Chevron's key projects, as well as the company's capex budget remains key to company's near term performance. However, CVX's portfolio looks well set to deliver strong growth versus Big Oil peers over the next few years as the growth projects come online, particularly the giant LNG projects in Australia. Chevron's growth/profitability framework to 2018 looks undervalued vs. peers.
The company is trading at a significant discount to XOM. As more and more growth projects come online and more of capital employed begins earning returns, I expect improved ROCE and relative valuation re-rating. As CVX non-productive capital declines and the company's ROCE converge with XOM, I believe CVX will close the valuation gap to XOM. In the meanwhile, the company continues to pay healthy dividend yield.
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