Chevron Is Getting No Respect From This Market

About: Chevron Corporation (CVX)
by: Long Player

The current dividend yield is over 5% and it is well supported by a very reduced cash flow.

If the company splits up, the individual parts would gain visibility, thereby enhancing the value of each piece of the company.

The company does not present a lowest cost position in any of its commodity businesses, so a split up would enable each division to specialize in its business.

The company has excellent financial strength, even after the recent review by the credit agencies. So liquidity is not a concern.

Analyzing the effect of a project is hard because it is nearly impossible for an investor to tell how many divisions that project will affect.

Chevron (NYSE:CVX) is one of the largest companies in the world. Even after the latest review by the ratings agencies, its financial strength remains more than adequate to deal with the current adversarial business environment. Yet despite the history of the company and promises by management, there remains a market fear that the company will run up debt or cut the dividend (maybe both) to survive. As a result, the company emerging from the current round of challenges would be a shadow of the company that entered the current industry down turn.

Source: Chevron Fourth Quarter Earnings Call Presentation, 2015

As shown above (click on the earnings call presentation), the main concern appears to be the decrease in cash flow, and whether or not management can live within a much lower cash flow. This year the company borrowed nearly six billion and there was some assets sales. The market appears to assume that the company will continue to spend and the difference will be made up with more debt. Or maybe the company will cut back, but the dropping commodity prices will overwhelm the cutbacks and force a large increase in debt this year. Dividends cost about two billion dollars per quarter, and eight billion dollars a year. That is getting uncomfortably close to half of the cash flow this year. Plus the refining margins are cyclically contracting as well.

However, the fourth quarter cash flow calculates to an $18.4 billion annualized cash flow, which is really not that much lower than the $19.5 billion cash flow reported for the year. Cash flow may well decrease again in the first few quarters of the new fiscal year as declining commodity prices overwhelm company attempts to increase cash flow. However, the company is integrated, so several of the other divisions may well cushion some of that decrease. Last time that I checked with the repair shop, the Chevron products purchased by the auto repair shop have not decreased. Plus the company has several major projects coming online that will add to cash flow, and also help cushion the commodity price declines.

Source: Chevron Fourth Quarter Earnings Call Presentation, 2015

As shown above (click on the earnings call presentation), costs are coming down and efficiency gains are being emphasized. Nonetheless, sometimes a company becomes so large that there are no longer efficiencies gained from increasing size. For example, during the conference call, management noted the emphasis on decreasing costs on the tight oil plays. Management stated that operating costs were down two dollars per barrel of oil equivalent and more cost savings were on the way. If those unconventional leases were a separate company, that independent company might have responded far more quickly to cost issues than the parent company that has to deal with multiple divisions.

Management also stated that deep-water drilling times had decreased about thirty percent. Yet management was circumspect about the current costs of the material parts of the deep water business. With so little information to go on, its hard for the average shareholder to value the entire company, even when using a spread sheet program.

Even if all the oil and gas exploration and production projects were in one company there may be efficiencies to be gained from a spinoff. Management likes to boast how the company has low costs, yet there were writeoffs along with the rest of the industry in the latest commodity price downturn. Management never noted any one project where it has the lowest cost when compared to other operators. But it did note the emphasis on cost reduction, so management could be spread too thin among too many competing divisions.

In another article, it was noted how much Marathon Oil (NYSE:MRO) decreased its costs since the separation from the refining part of the company. Not only are shareholders now receiving far more detail from both divisions, but management for Marathon Oil has now stated that they can specialize in becoming the best exploration and production company out there (as well as the lowest cost producer). As a result the company now has several low cost or lowest cost projects that will benefit shareholders in the next industry cycle when commodity prices rally.

While post split, both companies are far more cyclical than they were, and maybe the financial rating in the beginning is not as good as it was for the parent company, investors can invest in both companies to obtain the same position that was available before the split. Plus both divisions are easier for the market to understand, and therefore their common stock will probably receive a higher value in the long run once the individual track records are established for each company.

Then there is the uncertainty of how to track cash flow. For example when the Gorgon project comes online this year (in pieces at six month intervals), several parts of the company will make money from this project. First the plant itself will show a profit or loss for processing the gas. But the wells that are currently shut-in will be producing. The profit of the production from those wells will probably assure a profit for the project as a whole and positive cash flow. If that company ships the liquefied natural gas to one of its refining plants that happens to need it, there will be another segment that shows profits and losses. This company constantly has segments selling to each other, so the whole chain of profits and losses needs to be analyzed before a conclusion can be reached about the profitability of a project. That analysis is fairly complicated for insiders and probably impossible for outsiders when a company is this large.

Source: Chevron Fourth Quarter Earnings Call Presentation, 2015

As shown above (click on the earnings call presentation), capital expenditures are remarkably flexible for this company, yet the company has yet to provide a minimum figure needed to keep facilities safe and production going. The company did state that if prices become low enough, it will stop any and all exploratory drilling, maintain a bare bones maintenance (and rework budget), and pay off debt or repurchase stock with its cash flow. Already, the budget is being guided lower than the figures shown above, yet still there are concerns that Chevron cannot live within its cash flow. Mr. Market appears to be worried that Chevron will pile on the debt, but historically that rarely happens for a diversified company of this size and financial strength.

There are some long term capital projects that will continue to completion, but the company has stated that it will not start any long term projects during the current industry conditions. Therefore, when prices recover, it could take several years before the benefits of large projects become apparent. The company is stating that it can maintain production somewhat through a continuing investment in the onshore unconventional leases that it has. However, a lack of the big (significant) long term projects could eventually slow the growth of the exploration and production division for several years.

The company currently has a market value of about $156 Billion (as of the market close on February 5, 2016) and the dividend yield is over five percent. With cash flow estimated at more than $18 billion using the fourth quarter numbers, the market is currently paying more than eight and one-half times earnings for an investment in this company. The company has stated that maintaining the dividend is a priority, so most likely the dividend will be maintained. The company has the cash flow to cover the dividend, it can sell assets if it chooses to, and it has the ability to borrow more money. Plus it has enough cash to pay the dividend for another year without borrowing any money.

But some of the divisions, such as specialty products, and the consumer division could command higher prices for their respective cash flow if standing alone. Since it is usually easier to grow a smaller company than a larger one, some of these divisions could be valued as growth companies leading to higher valuations still.

Then there is the consolidated corporate overhead which would most likely go away. Some positions, such as the accounting division for consolidating earnings into corporate earnings will not be needed. Splitting the company into at least three divisions (exploration and production, refining, and consumer products) would provide higher visibility to each division, and more information from each division for the investor to make far more informed investment decisions about this company.

As the company is currently configured, there is really a lack of specific cost information for the average investor about each division, let alone each material project. The company really does not advertise itself as a low cost producer on any of its presentations in any of its divisions, and that is probably a market concern. The company appears to be fairly profitable, even with the latest impairment charges, and obviously the ratings companies do not have much concern with the ratios of the company despite the recent down-grade.


The current company is low debt, and pays a relatively secure dividend. After a split of the company, the individual dividends could become far more volatile, or maybe individual managements would make a decision to invest profits in growing the individual divisions. Right now, all the competing interests are decided by a centralized management that may not be able to satisfy all the needs of each division (or product area) in a profit maximizing way. Mr. Market has concerns about the future of this company, and possibly one way to answer that future concern is to split the company into several more visible divisions. The individual divisions as separate companies should, as a group, outperform the current consolidated company. that would lead to increased profits for the investor.

The current company, with its five percent dividend merits the attention of the investor, as that dividend yield is high and well supported by cash flow. When commodity prices recover, this company will increase profits, and probably will increase profits from cost cutting once commodity prices stabilize. The products outside the exploration and production division could provide an avenue of growth for this company until commodity prices recover. Therefore, this stock is likely to rise about 50% at least over the next five years even without much of a change in the exploration and production division for a year or two. This company can outlast adverse industry conditions far better than most because of its integration, its diversification, and its financial strength. Slow liquidation of the exploration and production division combined with stock repurchases and debt reduction has already been stated by management as a possibility. Plus the company could divest the exploration and production division should it become too much of a drag. That possibility of spin-offs or split-ups should cushion any further price declines and possibly enhance future price forecasts.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.