Chevron Corporation: My Investment Thesis Was Busted

| About: Chevron Corporation (CVX)

Summary

Chevron is the second largest oil/gas company in the US, by market capitalization.

Chevron is headquartered in San Ramon, California.

Chevron currently trades at a price to earnings ratio of 37.8 with a dividend yield of 4.54%.

During the 2008/2009 financial crisis I was looking for a large integrated oil/gas firm in which to invest. Eventually my research brought me to Chevron Corporation (NYSE:CVX). Just recently I sold all of my shares in the company, after finally coming to the conclusion that my investment thesis for buying Chevron was busted. I probably would have eventually sold the shares anyway, because the company does not have the characteristics I now look for in a long term holding... but I have been roundly disappointed by the news coming out of the company over the last year.

First, my original investment thesis. I wanted to build a significant position in a large integrated oil/gas company. At the time my portfolio had little exposure to the oil/gas industry and oil prices had collapsed to unsustainably low levels at the time. Sensing opportunity, I decided the time was right to make an investment in the industry. I wanted to select one of the large integrated players because I figured that even if oil prices stayed depressed for a long period of time, the company's downstream operations would provide consistent cash flow while oil prices recovered. That idea worked for a while, and management did increase the dividends for shareholders along the way.

Then oil prices started dropping in 2014, but Chevron's management assumed prices would quickly rebound. Obviously oil prices have not rebounded yet. So the company slashed capital expenditures and started selling assets, in order to protect the dividend and keep the company afloat. Don't get me wrong, I've enjoyed my dividend checks. They consistently rolled in every quarter since I bought my first group of shares, but I am now left with long-term questions about the company.

In 2010 and 2011 alone, Chevron moved to sell downstream assets in more than 20 countries including Britain, Spain, various Caribbean counties and various southern African countries. Ok, I can understand selling off assets in some far flung (and nonstrategic) locations. So I didn't think that much about the sales campaign. The company was still performing pretty well and oil prices were elevated after all. There were various other small asset sales over the next few years, but fast forward to the spring of 2015. In March 2015, Chevron's management announced that they would curtail all new CapEx for two years and boost the planned asset sale program by 50%. That didn't sound promising for long-term shareholders, but I decided to withhold judgment and see what management was looking to sell... and what they were going to do with the cash.

Then in February of 2016, management announced they were not only going to sell the company's geothermal operations in Asia (based in Indonesia and the Philippines) but had also put ALL of the company's shallow water assets (in the Gulf of Mexico) up for sale. At the same time, management announced that they were targeting an additional (though undisclosed) $5-$10 billion in asset sales through 2017. Where does it end?

I have three central concerns about all of these asset sales. First, downstream assets have been the majority of the assets sold. Those downstream assets, like refineries and retail operations, are a big part of why I chose to invest in Chevron in the first place. Those downstream operations provide the company with a reasonably steady cash flow when the price of oil has impaired the profitability of the upstream operations. Times like now, in 2016. I recognize that when oil prices are high, the upstream exploration and production operations are wildly profitable... but those operations are a huge drag when oil prices are down. I liked Chevron's balance (between upstream and downstream operations) when I first invested in the company, but that balance has been drastically skewed to the upstream E&P side over the last few years. Leaving the company's revenue and profitability highly vulnerable to the prices of oil and gas. I can only assume that management wants to ultimately turn Chevron into a pure exploration and production company.

My second concern is that when management announced they had put all of the company's shallow Gulf operations up for sale, they said the eventual goal was to have fewer (but more complicated) production assets. They went on to say that they wanted to focus on the deep water offshore space. I am sure that the industry veterans that run Chevron know a great deal more about oil production than I do, but when I hear "complicated... deep water... and offshore" I naturally think of a higher cost of production. In a world that is currently flooded with oil, what gives them the confidence that those high cost of production offshore assets will be economical to bring to market in the near term? Sure, I think eventually oil prices will rise... they are likely to rise eventually if for no other reason than inflation... but in the near term? I don't want the stable integrated oil company I invested in, to be transformed into a leveraged exploration & production company... which loses money until the price of WTI rises to $80 per barrel. It just seems like keeping the inshore assets, which are already largely developed and certainly have a lower cost of production, would be the way to go if management really wanted to generate predictable cash flow and profits on the upstream side of the business.

Which brings me to my third concern, the assets themselves. There is almost certainly a better time to sell assets, than when the industry is struggling with low oil prices. I acknowledge that up to this point there have been relatively few bankruptcies and mergers, so maybe Chevron's management is trying to be proactive and dump the assets while there is still a market for those assets. This seems unlikely, however. What seems more likely is that management has decided that the company's costs are too high and cash flow is too weak, so they need to raise cash however they can. That means selling assets, rather than spook investors with a secondary stock offering or additional bond sales. For a long-term investor, this is a very unpleasant proposition. Not only is the company struggling with poor profitability and low oil prices, but management has decided to sell productive assets in order to slow the losses. My concern is not only that the company is losing money, but Chevron will no longer own those quality assets whenever oil prices do recover; thereby hampering profitability when oil/gas prices rise at some point in the future.

There you have the three reasons why I lost faith in the direction of Chevron's management and why I recently sold all my shares. The investment was a profitable one overall, and I did enjoy many years of dividends, but I am glad to be free of this investment. While I am not sure that oil will have much demand growth 20 years out, I will probably invest in a different integrated oil company at some point. Some readers will point out that I am selling 30% below the company's high price, and others will remember that I am also selling my shares 30% above the recent low share price, but I have never found the movement of share prices to be very instructive. Instead, I sold because my investment thesis on Chevron Corporation proved incorrect and I don't like the company's direction. It is better for me to take my profits and move on to another investment, which better fits my long-term goals.

Disclosure: Do not own a security mentioned in this article. This article is for informational purposes only and should not be considered a recommendation for anyone to buy, sell, or hold any equities. I am not a financial professional. The information above is provided by Bloomberg.com, TheGuardian.com, Bizjournals.com and Investor.chevron.com.

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.