Chevron Corporation: Capex A Concern

Mar.26.12 | About: Chevron Corporation (CVX)

Chevron Corporation (NYSE:CVX) is one of the big global oil and gas players with operations in more than 180 countries around the world. It has interests in oil, gas as well as geothermal and covers exploration, production, refining, chemicals manufacturing and power generation. The company is also a big investor in alternative energy sources and has set high standards for reducing its own emissions.

Recent Performance:

EPS has grown from $0.54 in 2002 to $13.44 in 2011 representing a compound average growth rate of an amazing 43%. It should be pointed out that since 2008 that rate has been a paltry 5% due to the company recovering from the effects of the GFC.

Dividends per share have grown from $1.40 in 2002 to $3.09 in 2011, representing a compound average growth rate of 9%. The DPS growth rate has varied from 5% to 15% over the past 8 years.

Free Cash Flow has totaled $83B over the last 10 years versus total net earnings over that time of $152B. This discrepancy in cash flow versus accounting earnings is a concern. Of further concern is the negative Free Cash Flow realized in 2009 while net earnings for the same year was reported as over $10B. Over the past 5 years the company has reported total net earnings of $99B while the Free Cash Flow achieved over that time was only $44B.

A further look at the financial reports doesn't uncover anything too out of the ordinary regarding property & plant or depreciation values. So the Free Cash Flow issue is simply a function of the company having to increase capital expenditures at a higher rate than they are achieving in growth from cash flow from operations. This is consistent among all the major oil & gas producers - it is becoming more and more expensive to develop new resources, because the oil is deeper and heavier. Cash flow from operations has grown at a rate of 11% over the last 5 years while capital expenditures have grown at 15%.

Investors should be aware that the dividend a company pays comes from its Free Cash Flow generation, and Chevron's Free Cash Flow has been very inconsistent over recent years, and as mentioned above was negative in 2009. Though it is hard for people to believe that a company like Chevron poses much of a risk to investors, Capital Expenditures that are rising faster than cash flows from operations is simply not a sustainable situation. Something has to give. Free Cash Flow (from where dividends come from) has increased at 7% per year for the last 5 years while dividends per share have increased at a rate of 9% per year. There are at least 3 possible outcomes:

Chevron moderates its dividend per share growth.

  1. Capex is brought back in line with operating cash flows - perhaps Chevron is spending now for the future? This looks unlikely as it will probably continue to get harder and more expensive to extract oil. Chevrons capex budgets are expected to only rise into the future.

  2. The third and most likely scenario comes from simple supply and demand - if it is getting harder and more expensive to produce oil then the price of oil will have to rise. A higher price of oil brings higher cash flow from upstream operations - eventually re-balancing the capital expenditure growth rate/cash flow growth rate differential.

Quality Rating:

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The 3 criteria that Chevron scores poorly on are Free Cash Flow, Capital Expenditure Burden, and EPS Growth - all of which are mentioned above. EPS growth was astonishing from 2002 to 2008, but the GFC has meant that EPS growth since 2008 has been very modest.

Intrinsic Value:

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An attractive Margin of Safety exists right now, although Intrinsic Value is forecast to go sideways in the coming years.

CVX IV GraphClick to enlarge
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Surprisingly, the market has undervalued Chevron over much of the past 10 years. This is probably a function of the IV rising at such a rate that the share-price couldn't keep up. Now appears to be a reasonable time to buy on a long term view.

Investment Grade Table:

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With a Margin of Safety of 21 and a Quality Rating of 55, Chevron achieves an Investment Grade Score of 12 which places it at number 103 on the Investment Grade Table.


Due to the Free Cash Flow issue mentioned above, most true "Value Investors" would not be interested in Chevron. But the company has rewarded shareholders handsomely for many years, and for at least the next few years will likely continue to do so. The differential between the capital expenditures growth rate and operating cash flows growth rate will not come to a head for at least a few years yet, so investors have the opportunity to buy some Chevron shares and monitor the situation as a shareholder.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.