Investors have ample choice in the oil and gas sector these days, with plenty of high-quality names like Apache (APA) and Petrobras (PBR) trading at discounts for one reason or another. Add Chevron (CVX) to that list, for while it's not the cheapest energy stock out (nor the cheapest major), the company's valuation seems to give it only marginal credit for following a game plan that looks more than passingly similar to the one successfully put into place at Exxon Mobil (XOM).
A Beat For Q2, But Maybe Not Where You Want It
Chevron had a good second quarter, but the upside was all weighted towards the company's downstream refining and marketing (R&M) operations - not exactly what most energy investors want to see (though they can be just as quick to punish R&M shortfalls).
Adjusted upstream earnings fell 15% sequentially, missing estimates by about 5%. Profits were hurt by declining oil prices, while production was basically flat on a sequential basis (and down about 3% from last year). Even with this decline, Chevron remains an exceptionally profitable producer - on a per-barrel basis, Chevron trails only Petrobras , while leading the likes of Exxon Mobil and Hess (HES).
While upstream disappointed, R&M earnings were well ahead of expectations, jumping 50% from last year and more than doubling from the first quarter. Timing artifacts and inventory benefits certainly helped, but the company's per-barrel profit was nonetheless quite impressive indeed.
Borrowing A Page From A Best-Seller
I don't want to over-play the "Chevron is Exxon Jr." idea, but I think there's a lot about Chevron that compares favorably. Although Chevron is much more oil-heavy than Exxon (about 70% versus 50%) and has a shorter reserve life, Chevron is making big bets on the future of natural gas, particularly LNG.
Chevron has also followed Exxon (and Marathon (MRO)) into the Kurdistan region of Iraq, buying Reliance's 80% interest in the Sarta and Rovi blocks (Austrian energy company OMV (OMVKY.PK) owns the other 20%). This has not come without a cost, however. The Iraqi government deeply resents oil companies dealing directly with the Kurdistan Regional Government, and has barred Chevron from deals in the rest of Iraq - something of an idle threat as Chevron has no operations in the rest of Iraq and has chosen not to participate in bidding for projects in Central and Southern Iraq.
Last and not least, Chevron is also skewing towards long-lived production assets. While the percentage of Chevron's production made up by long-lived assets won't be as large as Exxon's in 2017, and Chevron has higher interim capex demands, they're going in the same direction towards more sustainable long-lived assets.
Time To Deal?
With Chevron's sizable positions in the Utica, Marcellus, and Permian formations, the company has quite a lot of liquids-rich sale assets. I almost wonder if the company needs more natural gas for the long-term. With costs for the huge Gorgon LNG project rising and everybody fleeing the North America dry gas market as fast as they can, that probably sounds ridiculous. Nevertheless, I think the economics of building LNG terminals and more natural gas-fueled infrastructure in the U.S. are ultimately going to win out, and this may not be a bad time to buy some undervalued assets in North America - even though I doubt the Street would be excited about such a move.
The Bottom Line
Chevron trades at a discount to Exxon Mobil, and I have no problem with that. I also have no problem with investors who see the even lower multiples at Hess, Apache, or Statoil (STO) and choose to go in those directions. But on its own merits, Chevron is a pretty good company and one that I think is a respectable long-term holding.
Right now Chevron is trading close to the low end of its historical forward EV/EBITDA range. Even allowing no particular improvement in that valuation (and going with a 4.0 to 4.5x multiple), fair value falls between $115 and $130. Though I realize return on investments in energy development are likely in perpetual decline, I don't think that the curve is going to be quite as steep as the market seems to assume today, and this looks like a reasonable dividend-growth idea.