Chevron's 4% Yield Is Too Good To Pass Up

| About: Chevron Corporation (CVX)
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Summary

Chevron's stock has been pummeled since July on oil price declines.

The business is diversified and strong and should produce profits in any oil environment.

A reversion trade and the yield are enough to get me into CVX right now.

Shareholders of Chevron (NYSE:CVX) have had a tough go of it lately. Since the summer of this year, when crude oil began its epic swoon, CVX has seen its shares come down from $135 to $107, a gargantuan move for a company of this size and diversification. Not helping is the move down in natural gas in the same period; it's safe to say Chevron has been a victim of its circumstances. However, with the stock making new lows, is it time to jump in? In this article I'll take a look at Chevron to see if it is a contrarian play or if we are trying to catch a falling knife.

To do this I'll use a DCF-type model you can read more about here. The model uses inputs such as earnings estimates, which I've borrowed from Yahoo!, dividends, which I've set to grow at 3% annually, and a discount rate, which I've set at the 10 year Treasury plus a risk premium of 5.75%.

 

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

             

Prior Year earnings per share

 

$11.09

$10.09

$8.42

$8.85

$9.31

$9.80

x(1+Forecasted earnings growth)

 

-9.00%

-16.60%

5.20%

5.20%

5.20%

5.20%

=Forecasted earnings per share

 

$10.09

$8.42

$8.85

$9.31

$9.80

$10.31

               

Equity Book Value Forecasts

             

Equity book value at beginning of year

 

$82.60

$88.41

$92.42

$96.73

$101.37

$106.35

Earnings per share

 

$10.09

$8.42

$8.85

$9.31

$9.80

$10.31

-Dividends per share

 

$4.28

$4.41

$4.54

$4.68

$4.82

$4.96

=Equity book value at EOY

$82.60

$88.41

$92.42

$96.73

$101.37

$106.35

$111.70

               

Abnormal earnings

             

Equity book value at begin of year

 

$82.60

$88.41

$92.42

$96.73

$101.37

$106.35

x Equity cost of capital

8.00%

8.00%

8.00%

8.00%

8.00%

8.00%

8.00%

=Normal earnings

 

$6.61

$7.07

$7.39

$7.74

$8.11

$8.51

               

Forecasted EPS

 

$10.09

$8.42

$8.85

$9.31

$9.80

$10.31

-Normal earnings

 

$6.61

$7.07

$7.39

$7.74

$8.11

$8.51

=Abnormal earnings

 

$3.48

$1.34

$1.46

$1.58

$1.69

$1.80

               

Valuation

             

Future abnormal earnings

 

$3.48

$1.34

$1.46

$1.58

$1.69

$1.80

x discount factor(0.08)

 

0.926

0.857

0.794

0.735

0.681

0.630

=Abnormal earnings disc to present

 

$3.23

$1.15

$1.16

$1.16

$1.15

$1.13

               

Abnormal earnings in year +6

           

$1.80

Assumed long-term growth rate

           

3.00%

Value of terminal year

           

$36.01

               

Estimated share price

             

Sum of discounted AE over horizon

 

$7.85

         

+PV of terminal year AE

 

$22.69

         

=PV of all AE

 

$30.54

         

+Current equity book value

 

$82.60

         

=Estimated current share price

 

$113.14

         

As we can see the model produces a fair value of $113, about 7% higher than the $106 shares trade for as I write this. That is a decent discount and implies that Chevron is pretty cheap right now, but what are we looking at? The intent of the model is to provide investors with a price at which they can achieve a margin of safety when getting long. With the price a few percent lower than the fair value price, a moderate margin of safety should be present. That bodes well for the long case but let's look a little more closely.

I mentioned the moves in oil and gas prices since the summer and they have really taken a toll on oil and gas providers of all kinds. This chart sums up the pain of the oil and gas space with data from the EIA.

We can see oil (blue line, left scale) has done nothing but go down since July. After peaking at ~$107 the spot price of WTI crude has plummeted to just over $65 as I write this. That is terrific news for consumers and businesses that consume crude oil products like gasoline but for the producers, its crimping profits and turning once-profitable projects into money losers.

The move in natural gas has been much more muted but it's still not exactly lighting the world on fire. Again, great news for businesses and consumers that rely on gas for power but it is becoming increasingly less profitable to find and produce gas, just like oil.

I think with Chevron you have to ask yourself if you think $65 oil (or less) and $4 gas are here to stay. Chevron has many businesses so its fortunes are not completely tied to oil but to a large extent, they are. When I ask myself if $65 oil is the new normal I have to go with no. I can't see long term oil prices staying in the $65 area as much as I would like to from a consumer's perspective. I just don't think that's realistic because so many exploration and development methods can't make money at that price; eventually we'll run out of cheap oil.

Thus, I think Chevron is probably a nice contrarian play here on a bounce in oil. Chevron's earnings estimates are probably going to come down for next year, even further than they already have, but I think a lot or most of that is priced in already. With the stock moving down ~30% in six months I don't know what else could go wrong. And with Chevron, we're not trying to time the bottom; we're just trying to buy a great business for a good price.

We can also see that Chevron, as you would expect, has performed dreadfully against the rest of the Dow 30 (NYSEARCA:DIA) since July.

Chevron wasn't blistering before the oil price decline began but it was at least close to a market performer. Now, we've seen extraordinary underperformance as the Dow has powered to new highs without Chevron and the deficit has become undeniably awful. Again, I just don't think this can continue and I think we'll see a reversion to the mean in the coming months.

Given Chevron's position of power in the oil and gas industry I don't see the decline in prices threatening its profitability over time. Yes, this period of declining oil prices is hurtful and will cause lower earnings but this has happened before and it will happen again; it's part of the deal when investing in a commodities firm. Also bolstering CVX' long term value for shareholders is its robust 4% current yield. The crash in the company's share price has afforded dividend investors a terrific opportunity to pick up a world class franchise at a 4% yield. I think this and the reversion to the mean trade are two great reasons why CVX is worth a strong look right now. The storm will pass and Chevron will carry on making billions of dollars and the share price will recover; a 4% yield is a pretty nice consolation prize in the interim.

Disclosure: The author is long CVX.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.