By Ishtiaq Ahmed
Chevron (NYSE:CVX) is the second largest integrated oil company in the U.S., behind Exxon Mobil (NYSE:XOM). It has reserves of 11.2 billion barrels of oil and a daily production of 2.7 million barrels. Furthermore, the company owns interests in mining, chemicals and power production businesses. The company owns 8,170 gas stations in the U.S. that operate under the Chevron and Texaco brands. Outside the U.S., Chevron owns 9,660 gas stations. The company also owns 50% of chemicals concern Chevron Phillips Chemical. In a major move in 2011, Chevron acquired Atlas Energy in a $4.3 billion deal.
Chevron pays extremely attractive dividends of $3.60 on an annual basis. The company has a long history of dividends, and has been increasing dividends on a consistent basis. Chevron has been increasing dividends for the last 24 consecutive years. Its history to pay substantial dividends attracts a lot of income seeking investors. In order to maintain its dividends, it is very important for a company to have a manageable payout ratio. Chevron has a near ideal payout ratio of 25%. Even during the financial turmoil of 2008, the company increased its dividends.
However, for the first time in six years, the payout ratio for Chevron went above 50% (51%) in 2009. Based on the closing price on November 1, the stock offers dividend yield of 3.23%. Dividend paying stocks are particularly attractive due to the poor rates offered by the debt market. However, it is important to pick stocks that can maintain dividends in the long term. In order to determine the dividend stability of Chevron, I analyze the earnings, debt and cash flows of the company.
Chevron reported earnings on Friday, November 2. The net income for the company fell to $5.25 billion, or $2.69 per share. The company reported $7.83 billion, or $3.92 per share for the same quarter last year. Revenues for the quarter stood at $56 billion, down from $61 billion for the same quarter last year. Analysts were expecting the company to report revenues of $63.9 billion and earnings of $2.83 per share. The company blamed Hurricane Isaac and operational issues for the poor results. High volatility in the oil prices contributed heavily to the fall in revenues and production levels. In addition, exchange rate movements also hurt the results for the quarter.
Chevron has demonstrated exceptional revenue growth over the past three years. The company reported revenues of $171.6 billion at the end of 2009, which grew to $253.7 billion by the end of 2011. Operating income for the company more than doubled in the same period from $18.5 billion to $47.6 billion. In the past three years, net income for the company want up by more than 160%. Chevron reported net income of $10.48 billion at the end of 2009, which went up to $26.89 billion by the end of 2011. However, declining oil and gas prices have affected the earnings of the company during the current year.
Chevron cash flows have followed the trend in earnings over the past three years. The company reported cash flows from operations of $19.3 billion at the end of 2009, which went up to $41.09 billion by the end of 2011. The company has shown exceptional growth in the cash flows. Chevron has also been investing heavily in the business. In the past three years, the company has spent a total of $65.9 billion in capital expenditures. At the end of 2009, Chevron had negative free cash flows of $470 million. However, by the end of 2011, the company had $14.58 billion in positive free cash flows. Chevron paid $6.1 billion in cash dividends during 2011, which are adequately covered with the free cash flows.
For the first nine months of 2012, the company has spent over $22 billion in capital expenditures. However, the expenditures include about $2.4 billion from the expenditures by affiliates, which did not require cash outlays by the company. For the same quarter last year, the capital expenditures were just under $21 billion.
It is a norm for energy behemoths to have elevated levels of debt. However, Chevron has extremely impressive debt figures. At the end of 2011, the company reported total debt and capital lease obligations of just above $10 billion. As I mentioned above, the company reported cash flows from operations of over $41 billion, and free cash flows of over $14.5 billion. Chevron debt is easily covered with the cash flows generated by the company. At the moment, the company has an extremely impressive debt to equity ratio of 0.1 compared to the industry average of 0.7.
Despite restrained global economic growth, major integrated energy companies reported fairly strong earnings and healthy price performances. In the short term, major oil company earnings are exposed to moderate global economic growth. Over the past decade, energy demand growth has come from the emerging economies. The current economic slowdown is weighing on global growth forecasts. Nevertheless, the company is vigorously chasing new projects, trimming poor business segments and growing gradually despite tepid global growth forecasts. Chevron's oil and gas development project pipeline is one of the best in the industry, which has large multi-year projects. Furthermore, the company has a strong balance sheet, which helps it capitalize on opportunities with the option to make strategic acquisitions.
With a P/E ratio of 8.1 -- considerably below the industry average of 9.4 -- shares are relatively inexpensive. The whole industry will face slow growth in revenues and earnings due to the current economic uncertainty. However, Chevron's long-term outlook remains stable, and its competitive position gives it an advantage. Even if the firm takes a hit in the future, there is a lot of room for Chevron due to low payout ratio.
The Biggest Threat:
Chevron inherited a massive environmental lawsuit for damages caused to the Ecuadorian rainforest when it bought Texaco in 2001. In February of 2011, the court in Ecuador ruled against the company. According to the initial judgment, the company had to pay $8.6 billion. However, due to the lack of a public apology, the Ecuadorian court more than doubled the figure to $18.2 billion. Chevron contested the judgment, and seemingly got away without paying when a New York judge issued a worldwide injunction to block the judgment. However, the ban was revoked on January 26 of this year. As a result, the company launched an appeal with the Supreme Court. Now Chevron has lost the appeal with the Supreme Court. However, the case is not over yet, and the company has challenged the judgment with the international arbitration panel. If, the company fails yet again; it can prove to be a massive blow to Chevron.
Energy companies provide a great opportunity to collect dividends. Chevron is one such company that offers extremely attractive dividends. The company just announced a quarterly dividend of $0.90 for its shareholders. A decline in oil and gas prices has hit the company during the current year. As a result, the earnings and cash flows will be less than the record figures the company reported last year. However, a conservative payout ratio and healthy cash flows will make sure the dividends continue. The company has a manageable payout ratio of 25% based on earnings, and 42% based on free cash flows. At the current level of payout ratio, there is still room for the company to increase its dividends. Based on its business prospects only, Chevron should be able to maintain its dividends. However, the Ecuadorian case remains a big threat, which should concern shareholders. For the time being, Chevron dividends look safe.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Ishtiaq Ahmed, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.