The Long Case for Chevron

Summary: Chevron (CVX) is a very good company for long-term growth and dividend investors. It offers moderate growth prospects, participation in the energy industry (thus offering potential inflation protection), and it is currently trading at a very attractive valuation.

Company/Stock Type: Chevron's business = Integrated oil and gas. Size = Large cap. Its stock type is what I call "B-D," meaning a generally large, stable growth company with generous dividends. Morningstar classifies Chevron as "Large Value" and its stock type as "Hard Asset."

Story and Company Quality: Chevron is one of the largest integrated energy companies in the world, second-largest in the USA (to Exxon Mobil (XOM)). Headquartered in California, Chevron conducts business in more than 180 countries. It is engaged in every aspect of the oil and natural gas industry, including exploration, production, refining, marketing, transportation, chemical production, retail sales, and plastics. The present company was formed from the merger of Chevron and Texaco in 2001, with the name changed simply to Chevron in 2005.

Chevron is known as a top-tier finder and producer of oil, with several aggressive deep-water exploration projects underway. In its recent Q2 2008 report, the company announced the start of production at its Agbami deepwater oil project in Nigeria. Chevron owns a 68% stake in that field. The company is also expecting to begin production from two large deepwater projects in the Gulf of Mexico. Beyond these advanced projects, Chevron has several more under development.

Management has stated that Chevron can produce around 3 million barrels of oil equivalent per day in 2010, up from about 2.6 million today, a 15% increase. Chevron has proven reserves of more than 12 billion barrels. About 70% of its production comes from outside the USA (in more than 20 countries).

Chevron also has a growing liquefied natural gas [LNG] business. Once natural gas is liquefied at -260 degrees Fahrenheit, it can be loaded onto tanker ships and shipped just like crude. The USA, Europe, and Asia are projected to generate increased demand for LNG in the coming years.

In addition, Chevron owns refining facilities on the West Coast. No new refining facilities have been built in the USA in more than 30 years, so Chevron's assets there are attractive as the USA seeks energy independence.

Chevron's marketing and sales network supports about 25,800 retail outlets — including those of affiliate companies — in nearly 75 countries.

The company is very solid financially. Chevron's net income in 2007 was $18.7 billion, a 9% jump from 2006, while its revenue increased 5% to $221 billion. Its three-year EPS and revenue growth rates are 12% and 13%, respectively. It has a stellar 25% ROE (return on equity), which it has maintained for more than five years without taking on significant debt. It has around $8 billion in cash reserves.

Chevron's dividend policies are an important reason to like this company. Its current yield is 2.8%. Chevron has increased its dividends for more than 10 years running, delivering dividend growth of 14% per share for the past 3 years (roughly matching its EPS growth). The company increased its dividend 12% in May. The payout ratio is only 21%.

On my Easy-Rate™ scale for company quality, Chevron scores "Very Good." It is one of the highest-scoring dividend companies that I follow.

Valuation: Chevron's valuation measures are all favorable to the S&P 500 averages and to industry figures. At a recent price of $84.31, its P/E ratio is just 9, its Forward P/E is 6, its P/S (price to sales) ratio is under 1, P/B (price to book) is about 2, and its PEG (price-to-earnings-growth) ratio is less than 1.

On my rating scale, Chevron's valuation is "Good+," meaning that it is significantly undervalued at its current price.

Investment Thesis and Conclusion: Chevron scores highly from all angles. The company's quality clocks in as "Very Good," its valuation is favorable, and its dividend is 2.8% and growing in excess of 10% per year.

Disclosure: Long CVX

Comments

[Norman Lepo...:]

CVX has never let me down.

2008 Aug 04 08:10 AM

[Alex T:]

I agree Dr. Is it $.058 per share dividend? Please correct me if I am wrong.

2008 Aug 04 08:35 AM

[T. Myers:]

Before jumping into a dividend play without looking at the underlying fundamentals. Yes it is cheap, but it deserves to be cheap. Look down the road not just at dividends paid. Will they be able to pay the dividends further on down the road - with CVX this is highly probable. However, what does it mean for the stock? The majors are essentially in liquidation. 3/4 of the company is a refiner. A big stinky dirty business that requires some cap ex. The only benefit to the business it the US NIBY policy so that capacity cannot be readily expanded. But there are problems on the horizon for this business as the middle east moves up the value chain from strictly E&P to refining, commodity chemicals and the like. The problem still exists that they must feed this end of their business. The 3.2.1 crack spread has rebounded from its lows of 6.30 last year so this end of this business is reasonably profitable. But it is still subject to enormous swings that are not kind to capitally intensive businesses. In the long run, they will no longer be the low cost provider as the middle east vertically integrates. For the remaining 1/4 of their business they engage in exploration and production of crude oil. Here is a simple piece of information, CVX has not increased its reserves since 2004. Couple this with inflation in the cost of oil services as demand for these services increases and you have real problems. At some point your capex on probability weighted basis becomes too expensive. To some extent this is what you are seeing now. Its precisely why these companies are dividend plays. Now look at list of countries where these companies are going just in order to MAINTAIN their reserves (I warn you some of these are a bit scary): Angola, Australia, Bangladesh, China, Indonesia, Kazakhstan, Republic of Congo, Thailand, Trinidad and Tobago and the US. This is hardly the safety and security associated with dividend plays. And in a way the majors are bets on declining energy prices and cracks widen, capex moderates and high cost fields are shuttered.

2008 Aug 04 10:37 AM

[Jack Yetiv:]

For my money, PWE is a much better value in the oil field, for two general reasons. First, I think crack spreads will be pinched for a long time to come because of decreased gasoline consumption and because of consumer/political pressure. Oil is not so subject to the same influence.

Second, the pure oil and gas Canroy's yield far more than CVX or any of the domestic oil majors. PWE, my favorite, yields over 13%, and yet will probably report a payout ratio of under 50% when it reports earnings this Thurs. That 13% dividend is secure unless gas goes below $7 and oil goes under $90.

If anyone thinks either of those is likely, then oil and gas is not a good place to be. On the other hand, if you believe, as I do, that oil will never go under $100 for any meaningful period of time, nor gas under $9 for any meaningful period of time, PWE is a much better deal than CVX.

Jack

2008 Aug 04 11:08 AM

[phdinsuntan...:]

let oil go down and then we talk

2008 Aug 04 05:45 PM