Should Chevron Management Sweeten What Is Already A Solid Growth Story?

Apr.30.12 | About: Chevron Corporation (CVX)

Unlike ConocoPhillips (NYSE:COP), which I more or less blasted a week ago, Chevron (NYSE:CVX) is a major oil company with a pretty interesting near-term profile. Although growth in the first quarter was not exactly torrid, the outlook here for production growth in the next three to five years (particularly oil/liquids production) is one of the best among the majors. Better still, this company has a clean balance sheet, solid profitability, and a focus on production sources that other companies tend to avoid.

Q1 Results Mixed, But Basically Okay

On an adjusted basis, Chevron did miss the quarterly target for this first quarter of 2012, but underperformance was largely tied to an inventory loss in the international refining and marketing business, as well as some higher corporate charges.

E&P operations were solid this quarter, with total segment profits up 8% sequentially, helped by surprisingly strong (up 12%) international results. Production was basically flat quarter-on-quarter, as higher gas production offset lower oil/liquids production. US oil production, which is about one-quarter of total liquids production, was up 2% from the fourth quarter.

Realizations were interesting. Oil followed basically the same path here and abroad (single-digit percentage decline sequentially, mid-teens year-on-year growth), with international oil benchmarks staying higher. Gas was a completely different situation; U.S. gas prices tumbled from the year-ago level and declined a bit sequentially, while international gas prices were up strongly on both comparisons.

Downstream performance was not so impressive. On an adjusted basis, profits fell 2% from the year-ago period due in part to that inventory loss. Throughput was okay, but Chevron is definitely trailing the likes of Imperial Oil (NYSEMKT:IMO) and Exxon Mobil (NYSE:XOM) in this business. Looking ahead, it doesn't sound like management is planning to jettison the R&M business, but will instead focus more on Pacific Rim refining and lubricants production.

One Of The Best Near-Term Oil Stories

At nearly 70% of production, Chevron is very well-placed for a market that presently wants more oil. It's also worth noting that about three-quarters of Chevron's oil comes from overseas - which ups the risk to some extent, but also leverages favorable price differentials.

What I like about Chevron is the fact that the company has an excellent 3-5 year growth outlook and solid profitability. On the basis of upstream profitability per barrel, only Petrobras (NYSE:PBR) looks better and Chevron is a solid #2 [Exxon and Royal Dutch Shell (NYSE:RDS.A) score fairly well, while ConocoPhillips brings up the rear].

Outside of Petrobras, Chevron also looks to be best in terms of oncoming production growth. Although these production plans and projects are going to gobble up a lot of operating cash flow (relative to Exxon, especially), Chevron is establishing itself as a major player in deepwater, heavy oil, unconventional production, LNG, and sour oil/gas.

Also remember that this company has a very healthy balance sheet and has been relatively quiet about its spending. While the company has built large acreage positions in the Marcellus, Utica, and Permian formations, the company has been relatively quiet on the M&A front - something that management could look to change.

Will The Chinese Growth Story Deliver?

One area of vulnerability for Chevron (as well as ConocoPhillips) is its large LNG projects in Australian waters. Natural gas demand is projected to quadruple over the next decade and projects like Gorgon and Wheatstone could profitability exploit that growth. The risk, though, is that the higher cost of LNG imports incentivizes China to invest in unconventional gas exploration internally and/or more extensive natural gas pipelines as an alternative supply source.

The Bottom Line

Even though I believe Chevron's EBITDA will decline slightly in 2012, a 4x multiple to that EBITDA suggests a fair value in the $120's. Couple that with a pretty secure 3%-plus dividend, and Chevron's not a bad play for investors with more conservative leanings.

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