Chevron: Should I Stay Or Should I Go Now?

| About: Chevron Corporation (CVX)

Summary

Oil Majors have had a difficult time due to low oil prices.

Chevron seems to be having more problems than some, but might recover.

Is Chevron's dividend safe or not and what should I do about it?

The price of oil has been pretty low for some time now. And that causes a problem for lots of companies in the oil sector. This especially has caused some profit and cash flow problems for the major integrated oil companies that DG investors like because they provide a good and growing dividend payment. Much concern has been raised by how much longer these companies can continue to pay their current dividend, much less raise it. One company that is seen as being in a difficult spot is Chevron (NYSE:CVX). A couple of SA authors have written articles on CVX with conflicting views as to what an investor should do.

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Brandon Dempster has concluded that the dividend isn't safe in his article. One of his concerns is that a large amount of debt coming due soon can't be entirely covered by CXV's cash flow and that this will result in a dividend cut. Read the whole article, but his concerns about this debt coming due at the end of 2017 are valid and investors should be concerned. His conclusions should give any investor depending on CXV maintaining its current divided pause:

The inflows that Chevron currently has versus its outflows don't add up to sustainability. The company is producing negative free cash flow in the current environment and has a large amount of debt that needs to be repaid in the next fourteen months. Unless the crude oil market improves materially, ramps up its divestment program, or slashes capex further, this company may be looking to cut its dividend to preserve liquidity. Just not something I expected to find looking at an AA- rated company.

Chris Bazzle in his recent article reached a different conclusion about a week ago. Although he does think that investors shouldn't rely on it for short-term trading profits.

For now, based on the trend charts (long-term, mid-term and short-term) and certain technical indicators (50 DMA, 200 DMA, Relative Strength, SMA(20), SMA(50), SMA(100), SMA(200), and seasonality data), Chevron still seems to be a solid medium- to long-term dividend play, with possible prospects for growth. Chevron's track record as a blue chip dividend aristocrat and some of its fundamentals (quarterly EPS growth, inventory to sales, account receivables to sales, average shares outstanding, and dividend data) also support this view.

I am of two minds on what CVX's prospects are going forward. It certainly is facing an increasing problem the longer oil prices remain low. There are some encouraging signs that a production cap deal might be reached and abided by. But I thought that before, and oil is still priced pretty low. I, like many others I am sure, have been burned by figuring that oil prices just couldn't stay this low much longer.

At this point, I think a prudent DG investor should prepare a plan for what they will do when CVX cuts its dividend. I don't think there is any rush to sell, as there is likely to be more than six months before the dividend cut is announced.

How to prepare for a dividend cut using options

Similar to what I showed in this article, where I used covered calls to get a discount when buying a stock, I will use covered calls to get a bonus now to sell the stock at a good price in the future. I originally bought my CVX shares at an average cost of about $114. It's currently trading just a bit above $100. So ideally I'd like to get a total of $114 for my shares.

I am going to work with the idea that we have until about next June or so to get out before a potential dividend cut. So my goal will be to collect as much of the dividend income as possible between now and then while collecting some nice premiums and selling the shares with as small a loss as possible.

What I want to do, if I can get a contract with a good strike price and premium is write a contract that expires next month. If I can get a good one, that gives me a possible six premiums to collect before my predicted dividend cut announcement in June. It also gives me flexibility in adjusting strike price too as every month I can bump up my strike price if CVX trends higher.

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Okay, the Delta here is 0.38. If we were looking to keep the stock, this would be a bit on the high side, but I think a ~62 percent chance to keep the stock will work well here given that we eventually want to sell. If we can write similar calls to this, we will have about a 23% chance or so of still having the stock after we have written three contracts with a similar Delta. Given that just the one contract will get use half back to our cost basis, this is a good enough contract for me to write it. Since I already wrote covered calls on this position that expire at the close in this coming Friday (I wrote a call for $105 expiring in October), unless the market changes a lot, I will write this contract on Monday.

Other options to consider

Depending on what your commission charges are, the $110 strike could work for you as well.

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The advantage to writing this call is that it has a very low Delta, so you aren't as likely to get called. If you can write six calls like it between now and June, you have about a 56% of still having the shares. While you get a lot less premium, if the shares are called away you will get $110 per share for this contract which is $5 more than you would get for the contract with the higher premium.

A third option you could take is to write the $100 call, which is currently ITM.

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As you can see, that offers a very nice premium where the bid is $4.10. Now there is a 76% chance that come November 18th, you will have your shares called away. But between the premium and the strike price you will get $104.10 for your shares. Depending on what your cost basis is, what your broker commissions are and how quickly you want to exit CVX, this might be a good result for you.

Takeaways

DGI, and plenty of other strategies as well, require that the investor monitor the performance of the companies they own. But there is no reason that just because a sale of the position is not required now, that the investor can't take actions short of selling immediately to protect themselves. A prudent investor, seeing issues ahead for one of their companies, can write covered calls to reduce their cost basis and/or lock in a sale at a price of their choosing.

Disclosure: I am/we are long CVX.

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.

Additional disclosure: I also have an outstanding call on CVX and plan to write more calls on my position once the current call expires.