Recently Chevron (CVX) announced earnings that missed the consensus of analyst expectations despite higher oil prices. One of the causes cited was failing production, that served to counteract the rise in oil prices and lower overall profits. The miss served as a catalyst to drive the stock price lower, and serves as a classic example of the Wall Street shuffle. This is one of the only legitimate gripes that Main Street may actually have with the investment community; even though the company's earnings missed expectations, profits were still up by about 4% due to pricing power.
In the harshest sense, the company made larger profits and the analysts charged with covering the stock made bad predictions. Does this mean that an investor should sell the stock? Or should an investor conclude that analysts are consistently wrong, and that it is analyst guesses, not the stock, that should be sold? Of course, anyone reading this report will wonder: If analysts are to be ignored, where does that leave the value of anything written on a company? The answer is that there are great analysts, as well as poor analysts.
Relying on consensus numbers can be a dangerous practice that skews reality. While it is often the consensus number that gets reported, and missing this number can be a negative catalyst, one should always make an effort to think independently about what a given piece of information means. The purpose of this report is to give someone considering an investment in Chevron something to think about and a basis for performing his or her own analysis. This should be the purpose of any analyst report, and taken in the right context, any report can provide useful information.
Chevron, which is known primarily as an oil company, derives a significant portion of its profits from natural gas, similar to rival Exxon Mobil (XOM), the largest producer of natural gas in the U.S. Natural gas prices have been extremely weak of late. The average sales price the company received for natural gas was $2.48 per thousand cubic feet; the sales price from a year earlier was $4.04. Using United States Natural Gas (UNG), the leading exchange-traded-fund (ETF) as a proxy, one can see that natural gas prices have been at long-term lows.
Some of this has been blamed on the abundance of shale-based natural gas deposits, but it seems unlikely that these prices can be sustained at this level indefinitely, particularly going into a U.S. presidential election in which energy is almost certainly going to play a critical role. Aside from the general attractiveness of the stock, the likely rebound in natural gas prices should serve as an additional catalyst for the stock's price, and an additional reason why the stock should look particularly appealing at the current level.
An Attractive Income Play
Chevron currently offers a dividend yield of roughly 3.1%, making it attractive as an income option against a backdrop of U.S. Treasuries that are paying roughly 2.0%. Other energy companies are similarly attractive on this front as well. Exxon Mobil has a dividend yield of 2.2%, BP (BP) has a dividend yield of 4.4% and ConocoPhillips (COP) has a dividend yield of 3.7%. On this basis alone, Chevron is not the most attractive option, but there are other arguments for the stock. As an income option, however, the stock is an attractive investment for those looking for income as well as upside potential in an otherwise stingy yield environment.
Valuation and Operating Efficiency
When Chevron is considered as a value play, the company continues to look attractive. The stock is currently trading at a trailing twelve month price-to-earnings ratio (P/E) of 7.9 relative to a P/E of 7.9 for ConocoPhillips, a P/E of 5.4 for BP and a P/E of 10.2 for Exxon Mobil; the industry has an average P/E/ of 10.5. This indicates that the valuation potential is concentrated in the largest companies in the industry. This is not unexpected as investors have looked to smaller capitalization companies for yield and performance. The result is that investors now have the option to buy some of these companies at very attractive valuation levels.
Using the operating margin as a metric for operating efficiency, Chevron stands out. The company has an operating margin of 16.2% relative to an operating margin of 9.7% for ConocoPhillips, 8.3% for BP and 12.5% for Exxon Mobil. In addition to being a pure measurement of how well the company utilizes its resources, this metric gives an investor some insight into the quality of management's decisions. On this metric, one can see that Chevron is very well run and has been effective at using the resources at its disposal for the benefit of its shareholders. The company has a trailing twelve month return on equity (ROE) of 23.7%. While this tends to be a high ROE industry, this is a solid result that should be attractive to investors.
Buy On Dips
The three metrics described above, dividend yield, P/E and operating margin, combine to paint an attractive picture of Chevron at current levels. It presents an attractive income option that is priced for positive performance as well. The recent weakness in the stock is partially deserved, but partially the result of how analyst opinions are spun in the press. Overall, the stock looks attractive on this weakness and investors can use any dips as an opportunity to build a position in the stock.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.