Troubles for big oil majors continue. Chevron (NYSE:CVX) released its quarterly results last week and they contained few reasons to be upbeat. During the initial slump in oil prices, downstream activities acted as a cushion as those activities posted record profits. This is no longer the case.
Worse, while oil prices have rebounded towards $50 in recent times, marking a near doubling of the headline price from the absolute bottom, prices have recently fallen back towards $40 again.
As all the oil majors stick to their fat dividend payments, while they actually post losses in this environment, the situation does not look that good. This is certainly the case as innovative shale producers continue to lower their break-even costs, becoming more competitive versus oil majors. Given these headwinds and relatively strong share price performance, I see no real appeal.
Chevron posted a sizable $1.47 billion loss for the second quarter although that number has been influenced by impairment charges as well as other items. Upstream losses widened a bit to $2.46 billion as production fell from 2.60 million barrels of oil-equivalent per day last year to 2.53 million in the past quarter. Incidental items and divestitures hurt current production, although the company still plans to exit the year with a production run rate of 2.65-2.70 million barrels of oil equivalent.
That is equivalent to a loss of roughly $6 per barrel at a time when realizations for the quarter averaged $36 per barrel of oil equivalent. Note that gas and NGL production results in a discount of this realization number versus headline oil prices, which came in around $45 on average for the quarter. Given that oil futures are currently falling towards the $40 mark again, it will be very hard to narrow these losses in the current third quarter.
The downstream earnings were cut in half to $1.28 billion. While this optically looks like a very bad result, note that last year's earnings were artificially inflated by gains related to asset sales.
The All Important Cash Flows
In essence, Chevron did report an operating loss of $2 billion this quarter. While non-cash impairment charges hurt earnings by $2.8 billion, gains related to asset sales and currency fluctuations did provide a $700 million boost to earnings. That pretty much suggests that adjusted operating profits came in around 0.
The good thing is that Chevron has rapidly cut capital spending in recent years. While the company spent over $40 billion per year in recent years in order to finish large projects, capital spending fell to just $5.5 billion in the past quarter. With depreciation charges running at $6.7 billion, Chevron is actually net divesting to the tune of $1.2 billion a quarter, not even taking into account asset sales.
With flat adjusted operating profits and small divestments made by the business, the only real cash outflow is the dividend, which runs at a cost of $2 billion a quarter. That suggests that actual cash outflows come in at $3 billion a year at the current moment, although that entails that the business will be shrinking in the long run.
While costs savings continue to provide downward pressure on break-even prices, realizations are not expected to improve, especially given the recent leg lower in oil prices. Net of cash, Chevron now runs the business with a debt load of $36 billion. While leverage ratios are not that high, net debt has increased by $10 billion in the period of just a year.
With quarterly EBITDA still amounting to some $5 billion, leverage is contained at nearly 2 times annualized EBITDA, making Chevron look good among the oil majors. The trouble is that there is simply not much good news around. To cover the dividend alone, Chevron would need to post operating profits of $3 billion, for after-tax earnings of roughly $2 billion.
As we know that Chevron pretty much broke even on an adjusted basis with WTI at $45 per barrel, realizations would need to increase by roughly $12 per barrel, suggesting that Chevron needs oil at $55-$60 in order to cover the dividend.
Rig Count Increases
The issue is that Chevron has engaged in huge projects in recent years and while these are nearing completion, the actual costs are not very likely to be ultimately recovered in this environment.
In recent weeks, we have seen upbeat comments of shale producers regarding production, as well as a rebound in the rig count when oil approached $50 per barrel. It is clear that many shale producers have not been wiped out during the restructuring process. These players are willing and appear to be able to increase production in case oil prices recover. This swing production can play a major factor in limiting any potential recovery in oil prices.
That suggests that oil majors will need to continue to make cuts as their legacy and offshore projects makes them relatively less attractive from a cost perspective. At the same time, dividend commitments result in a crucial competitive disadvantage as well.
In this light, it is somewhat remarkable to see shares of many of these players hold up so well, and that includes the share price of Chevron. It simply seems that yield hungry investors continue to be attracted to the 4% dividend yield, even if it might be unsustainable in the longer run.
While dividends are nice, I see no structural growth story at Chevron as the company is failing to produce any earnings, let alone is able to cover the dividend as the debt load continues to increase.
Given the commitment to the dividend, the recent renewed plunge in crude prices and the relative strong performance of the stock, there is simply not much good news around. While the company still has many levers to pull, including cost savings, potential asset sales, and nearby completion of major projects, Chevron remains a relatively solid house in a bad neighborhood.
Given the crazy interest rate world in which we live, many resort to blue-chip names with strong dividend track records. While the situation in the oil industry is dire, investors continue to move their money into this field, even if they know that the situation is not very sustainable. For these reasons, I continue to avoid the shares of Chevron, but most other majors as well. Legacy projects, large past obligations, less competitive marginal costs and dividend commitments create structural disadvantages versus some shale players.
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.