Chevron (CVX) is America's second-largest integrated oil company, and the fifth-largest such company in the world by revenue. It has industry leading profit growth, operating margins and dividend growth. What it also has is a modest market valuation relative to its peers.
Financially, Chevron had an excellent 2011, with earnings up about 40% over 2010, or from about $19 billion in 2010 to $26.9 billion, or $13.44 per share in 2011. The company's profit margin was 10.6%, roughly matching its all-time high set the year earlier. It has raised its dividend, sometimes by significant amounts, every year for 24 years. The yield is now 3.1%. Yet, its stock has mostly slid sideways for the past 12 months. This has led in turn to the stock trading at a price-to-earnings ratio well below some of its peers such as Exxon Mobil (XOM) and ConocoPhillips (COP). I will attempt to explain why.
Running an integrated oil company is not for the timid. Accidents, litigation, and political intrigue are part of the game. Chevron has had more than its fair share in recent years. The best known of Chevron's problems stemmed from operations of Texaco, which Chevron purchased in 2001. Texaco dumped millions of tons of industrial waste in Ecuador's Amazon region throughout the 1960s into the 1990s, causing environmental damage and public health woes among the indigenous people. Ecuadoran courts heard the case, and entered an $18 billion judgment against Texaco's successor in interest, Chevron. The case has taken a remarkable record of twists and turns in the courts of Ecuador, the United States and Europe. I do not even want to venture a guess how this case might turn out.
Chevron has an interesting history in Asia, too. In 2008, a fire broke out in a rare natural forest in Bangladesh. Chevron was cited in connection with the incident for failing to inform the government of explosions that were occurring during Chevron's seismic testing. In Africa, Chevron was accused of organizing a military campaign against peaceful protestors, but was ultimately cleared of legal liability for the incident. Again, international oil dealings require a strong stomach indeed.
But the biggest headache today for Chevron is undoubtedly Brazil. Brazil had staked much of its energy future on enormous probable finds off its coast, some of which is in very deep water that was discovered in 2010. Late last year, roughly 100,000 gallons leaked from a well a little over 200 miles off the Brazilian coast near Rio de Janeiro. In response, the government in Brazil seeks $10.9 billion, even though a government investigation report found no evidence of negligence on Chevron's part. A second $10.9 billion dollar suit was also filed concerning a small March, 2012 spill. Brazilian prosecutors are also seeking injunctive relief to kick Chevron out of Brazilian waters. The fact that another spill was discovered in early April calls into question the entire idea of Brazil's commitment to offshore oil. Brazil's chronic manpower shortage, along with its rules stating 65% domestic employment, make Brazil a rough place for a Chevron to be anyways.
Maybe as penance, or maybe as just a prudent business decision, Chevron has become the industry leader in alternative energy. In Indonesia in particular, Chevron is leading a charge to supply 33% of that country's electrical needs from geothermal energy alone by 2025. Chevron has also made investments in solar and wind energy.
Leaving those macro and one time issues aside, there is no reason Chevron should not be trading at a multiple premium to Exxon. Currently, Chevron has a price-to-earnings ratio of 7.7 and an estimated 5-year PEG of 1.34. Exxon is trading at a price-to-earnings ratio of 9.9 and a PEG of 1.43. Chevron's gross and operating margins are 30.8% and 16.2%, while Exxon's same margins are 29.9% and 12.5%. If Chevron were trading at the same price-to-earnings ratio as Exxon, Chevron stock would have to jump 28.5%, a nice discount. The gross dollar amount of the discount in multiple is $4.5 billion. That discount might be thought of as the market's valuation of Chevron's South American exposure. Conoco is selling at a price-to-earnings multiple of 8.4, and may be trading at a premium multiple to Chevron's solely due to Conoco's pending split.
Looking forward, Chevron is as well positioned as any integrated oil and gas producer out there. Even if it is kicked out of South America, the company's stated goal is 20% volume increases by mid-decade. I cannot see natural gas prices staying down as they have, as demand for clean and cheap domestic natural gas is bound to increase. Downstream refining operations should also soon return to profitability after incurring a narrow loss in 2011.
Analysts see a 12-month price target for Chevron 21% above its current price. The same analysts have 12-month targets for Exxon and Conoco of 12% and 8%, respectively. Analysts are broadly bullish on Chevron with a 2.0 rating, compared with Exxon's 2.2 and Conoco's 2.6. No matter how you slice it, Chevron stands out as a more profitable, and more undervalued company than its integrated peers. As such, it is my top choice for a buy and hold stock in its peer group. Few companies overall can beat Chevron's combination of safety, stability, growth and income growth.