Chevron (CVX) is an integrated oil and gas company with exploration, production, and refining operations worldwide. The company was first incorporated in 1879 in San Francisco, as the Pacific Coast Oil Company. A summary description can be found here. Since the recession ended in 2009, Chevron has rebounded strongly, with price and earnings near all-time high right now. In this article, we will evaluate whether Chevron stock is still a good buy looking forward.
The stock is rated "2.5 star" by GuruFocus for business predictability. Stocks rated "2.5 star" average 7.3% annual return, with 18% of them still in loss if held for 10 years. The company's long-term debt issues receive an AA rating from S&P, with a stable outlook. An 'AA' ratings means the company has very strong capacity to meet financial commitments.
For the trailing twelve months, the stock has $13.43 earnings per share, $125 revenue per share, and $6.02 free cash flow per share. At around $113 per share, the stock has a P/E of 8.4, a P/S of 0.90, and a P/FCF of 19. P/E and P/S suggests the stock is cheap, but the relatively high P/FCF suggest the stock is expensive. P/E less than 12-15, P/S less than 1, and P/FCF less than 10 are favorable ratios in general.
The book value is $66.55, based on the most recent quarter (ended June 2012), for a price to book ratio of 1.7. Although value stocks preferably have P/B less than 1, a P/B of 1.7 is not unreasonable. Of note, all of CVX's ratios are lower than those of the industry or the S&P 500, as can be seen here. The stock's indicated dividend is $3.60, which is 3.2% yield. CVX has a long history of increasing dividend payouts.
Looking at the stock's 10-year summary, we see that its P/E has ranged from a low of 7.3 to a high of 76.6 (an anomaly due to abnormally low earnings in 2002), with the stock currently trading at the low range of its valuation. The next highest P/E over the past 10 years was 13.4 in 2009. Not atypical for a cyclical stock, both of these times of high P/E turned out to be great times to buy. CVX's price to book ratio has ranged from 1.68 to 2.54 over the past 10 years, and the stock's current P/B of 1.7 is near the low range of its valuation. A low P/B is more strongly indicative of value for a cyclical stock.
The current payout ratio is $3.6/$13.43 = 27%. In general, the lower the payout ratio, the better, so the company can retain more cash for reinvestment and provide for future growth. Low payout ratio (less than 50%) also means that the dividend is less likely to get cut and there is more room for dividend increases. For the past 10 years, CVX's payout ratio has generally remained below 50%, evidence of a fairly safe dividend.
Overall, value for Chevron is a mixed picture. What about growth?
CVX's revenue per share has grown from $46.36 in 2002 to $127 in 2011, for a 11.8% compounded annual growth, which is pretty impressive. Free cash flow per share has grown from $2.19 in 2002 to $7.33 in 2011, for a 14.4% compounded annual growth, again very solid growth. Earnings per share have grown from $3.48 in 2003 (EPS of $0.54 in 2002 was abnormally low) to $13.54 in 2011, for a 18.5% compounded annual growth.
Chevron looks like a promising growth stock. The most important growth parameter, especially for a cyclical stock, however, is book value per share, which has grown from $14.79 in 2002 to $61.35 in 2011, for a 17.1% compounded annual growth, again a very strong growth rate. Even more impressive is that the book value has grown every year without a down year for the past 10 years. CVX looks very promising as a growth stock.
Discounted Cash Flow
Assuming the lowest of the growth rates above, which is 11.8%, over the next 5 years, and a slower growth rate of 7% over years 5-10, a terminal growth rate of 3% thereafter, and applying a discount rate of 12% (which is higher than the discount rate for the overall stock market to err on the conservative side, given the low predictability of Chevron's free cash flow), we get an intrinsic value of $134, which provides 15% margin of safety from the current price of $113. For a cyclic stock like Chevron, I would look to buy at a price that offers at least 30% margin of safety, which means $93 or less.
|Free Cash Flow||7.33||8.19494||9.161943||10.24305||11.45173||12.80304||13.69925||14.6582||15.68427||16.78217||17.95692|
A more important consideration than potential reward for an investment is safety, as evidenced by the company's financial strength. One of the most important ratios in evaluating financial strength is the debt to equity ratio. On the most recent balance sheet (period ended June 30, 2012), CVX had $9,872MM in long term debt and $129,997MM in equity, for a ratio of 0.08, which is very favorable. In general, a D/E ratio less than 1 is good, and the lower, the better.
Another important ratio is the interest coverage, or times interest charges are earned. Again, the higher this ratio, the better, and anything above 6 to 1 indicates significant financial strength. In 2011, CVX had no recorded interest expense; in 2010, CVX had operating income of $32,105MM and interest expense of $50MM, for an interest coverage of 642, a sign of strong financial health.
A third financial ratio to look at is the current ratio, which is the ratio of current assets to current liabilities. A company with a current ratio less than 1 may be at risk of running into liquidity problem in the short term. Unlike the two financial ratios mentioned above, a current ratio that is too high is also unfavorable, and may indicate that the company is letting too much cash sitting around idly. For the latest quarter, CVX has $56,008MM in current assets and $32,656MM in current liabilities, for a current ratio of 1.7, which is good.
Finally, assets to equity gives us the leverage of the company, which is $219,379MM/$131,289MM = 1.7 for CVX. Higher leveraged companies use more debt financing and are more susceptible during economic downturns. 1.7 is a relatively low leverage ratio, so overall Chevron appears very financially strong.
The cyclical nature of the business means that earnings are sensitive to economic factors, such as crude oil prices, and may be at a cyclical high right now. In fact, the company recently announced that 2012 Q3 earnings will be significantly lower compared to Q2. Fluctuations in earnings are to be expected, and should not impact the company's long term prospects. Lower earnings accompanied by lower stock price provide buying opportunities.
Chevron faces competition from Exxon Mobil (XOM), BP (BP), Royal Dutch Shell (RDS), Total (TOT), ConocoPhillips (COP), etc, mainly for natural resources for oil and gas production. Like any oil and gas company, Chevron may also be negatively also be negatively impacted by government regulations and liability risks. Compared to industry peers, CVX is selling at a slight premium overall (P/S 0.9 and P/B 1.8 compared to 0.7 and 1.5, respectively, for the industry, although P/E is lower than that of the industry), average growth rate and margins, but better financial strength than most.
In summary, Chevron's excellent financial strength and long history of solid earnings and dividends, along with satisfactory margins and growth prospects, make this stock an ideal candidate for long-term holding. As a cyclical company sensitive to economic conditions, however, a greater margin of safety should be sought for initial purchase of the stock. The current valuation ratios do not indicate good value overall. A conservative discounted cash flow analysis shows that CVX has an intrinsic value of $134; for a 30% margin of safety, investors should look for opportunity to buy the stock at $93 or less.