Without A Generous Dividend, What's Left For Chevron Shareholders?

| About: Chevron Corporation (CVX)

Summary

Chevron reported its first quarterly loss in at least 7 years.

As the free cash flows of the company have been insufficient to fund the dividend and the capital expenses, Chevron has maintained its dividend by adding excessive amounts of debt.

However, the company cannot maintain this strategy for long. Even if it decides to do so, this is not a sound strategy, particularly near the bottom of the cycle.

Chevron (NYSE:CVX) has been severely beaten by the collapse of the oil price. To be sure, the company reported a loss of $0.31 per share in Q4 while the analysts expected earnings per share $0.46. This was the first quarterly loss in at least 7 years. As the stock has lost 40% off its peak in the summer of 2014, the only consolation for the shareholders has been the generous dividend of the company, which currently stands at $4.28 or a 5.27% yield. Therefore, as numerous shareholders hold the stock for its dividend, the big question is whether the company will be forced to cut it in the near future.

First of all, the management has repeated at every chance, including the last conference call, that its top priority is to maintain and grow the dividend. To this end, it has taken some measures. More specifically, it reduced the upstream operating cost by about 10% in 2015 while it also intends to reduce the capital expenses by about 7.4 B in 2016 and another $4 B in 2017. However, while no-one has any doubts about the efforts of the management, the current conditions of the oil market are so adverse for the company that these efforts may turn out to be too little - too late for the dividend.

For instance, despite the reduced future capital expenses, their amount is still too high compared to the earnings and the free cash flow of the company. More specifically, while Chevron is expected to earn just $3.35 B this year, the expected capital expenses are $26.6 B for this year and about $22 B per year for 2017-2018. As the annual dividend of $8 B is much higher than the expected earnings, it is evident that the company will struggle to maintain its dividend this year. This is already evident from the free cash flows of the last 5 quarters (see chart below, assets sales are not included), which have been clearly insufficient to support the dividend.

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Of course the company sold assets worth $6 B last year and plans to divest another $5-10 B of assets during 2016-2017 but still it cannot cover the wide gap between its dividend and its free cash flows. That's why the company increased its net debt (as per Buffett, net debt = total liabilities - cash - receivables) from $65 B in Q3-2014 to $86 B in Q3-2015. Obviously, the company cannot keep adding debt at this pace for long. This is also confirmed by the rating cut of the company by S&P today.

The gap between the dividend and the free cash flows is also prominent in the presentation slide taken from the conference call. Given the deficit depicted below for 2015 and the fact that this year's earnings are expected to be only half of last year's earnings, it is evident that the company will have to pronouncedly increase its debt load to sustain its current dividend. Oppenheimer's Fadel Gheit agrees on this, stating that the dividend of Chevron is unsustainable with crude oil prices at current levels.

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Of course one should not forget that Chevron is a dividend aristocrat that has grown its dividend for 27 consecutive years. Therefore, the management will exhaust all the possible means to avoid the painful decision of cutting the dividend and putting a stop at the exceptional streak. Nevertheless, while the company was supposed to raise the dividend last May, it chose to freeze it and hence it will pay the same dividend for an 8th consecutive quarter this month. This only proves that the decision of maintaining or cutting the dividend is marginal. In addition, the company eliminated share repurchases last year after spending $13 B on them during 2012-2014. This is just another sign that the company is struggling to maintain the current dividend. It is also unfortunate for the shareholders that the share repurchases were executed during the "fat" years 2012-2014, with the price of oil around $100 and the stock around its all-time highs. If the company saved the above amount, it could fund the current dividend for almost 2 years under the prevailing rough conditions.

To sum up, the collapse of the oil price has greatly affected Chevron, causing a large deficit between its dividend and its free cash flows. The company has been adding debt in order to maintain its high dividend and its elevated capital expenses but it cannot keep leveraging its balance sheet forever. Therefore, if oil does not experience a strong rebound, up to at least $60-$70 till the end of the year, the management is likely to take the painful decision of cutting the dividend till the end of the year. On the other hand, even if the oil price remains suppressed, the management may choose to postpone the dividend cut for another one or two quarters, in hope of a rebound. In any case, adding excessive amounts of debt to maintain a dividend disconnected from cash flows is never a sound strategy. This is particularly true near the bottom of the cycle, when the prudent strategy is to preserve cash in order to take advantage of great bargains.

Disclosure: I/we 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.