Chevron: Solid Oil-Dividend Play

| About: Chevron Corporation (CVX)
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Chevron’s weak first quarter, largely caused by the upstream operations and sharp decline in oil prices, is water under the bridge.

Investors can expect better performance during the second quarter, as oil prices rose by more than 30%.

Chevron’s high dividend, solid balance sheet and relative undervaluation coupled with the expectation of higher oil prices in 2017 make it a solid buy for Dividend Investors.


Second Quarter Earnings on Tap. Chevron (NYSE:CVX) is slated to report its earnings on July 29. Analysts are expecting the Oil & Gas giant to report a profit of $0.32 per share, a decline of 61% from last year's profits but a sharp reversal from the $0.11 it lost in the first quarter. Chevron's first quarter loss was the result of weak results from its upstream operations, which lost $1.46 Billion due to a 35% decline in crude oil prices.

Chevron's second quarter performance should continue to reflect soft crude prices. While the average price for a barrel of Brent oil improved by 33% between the first ($35.21) and second ($47.03) quarters of this year, it is nearly 26% lower than in the second quarter of 2015.

Despite posting weak first quarter results and second quarter earnings that are expected to be lower than they were a year ago, Chevron's stock has put in a solid performance in 2016, rising by 14%. This got us wondering if CVX is a buy before the report tomorrow. Our conclusion: Yes it is - here is why.

Dividend and Outlook. Some of this can be attributed to associative bias: people (rightly) relate Chevron strongly with oil and to the extent that the market reflects the popular view of where oil prices are headed, investors are marking Chevron's share price accordingly. Thus, it shouldn't surprise anyone that, just as oil prices have rallied by 33% between the first quarter and second quarters, so too has Chevron's stock price rallied by 30% from its first quarter closing low.

Yet perhaps another reason that investors have marked-up the stock is that they've noticed that it's paying a huge dividend. Currently, Chevron shares carry a 4.1% dividend yield, meaning that an investor who puts $10,000 to work on the stock can expect around $400 in annual income just from holding it. This dividend is the best among all of the components of the Dow Jones Industrial Average.

Considering that Chevron's fortunes are still evolving, investors are right to wonder whether it can continue to each shareholder $4.28 a year to hold the stock. Chevron's management is certainly committed to it: Patricia Yarrington, its Chief Financial Officer, told investors during its first quarter earnings call that "preserving and growing the dividend is (Chevron's) first priority" and that "(Chevron's) intention is to be able to cover the dividend in 2017." That is a pretty unequivocal statement coming from a senior executive of the company. The question is, can she back it up?

In our view, she can. For one thing, Chevron's performance should improve along with more stable oil prices. The US Energy Information Agency (EIA) is expecting an average price of $48 per barrel of Brent - or slightly better than its average price of $47.08 in the second quarter of 2016. This forecast is also equivalent to the $48.02 average price of Brent in the second half of 2015.

Looking ahead to 2017, when Chevron's management has committed to covering its dividend, the EIA is forecasting an average Brent Price of $52.15 - an improvement of 24% compared to Brent's average price of $41.94 in the year-to-date. The forecast is the same for West Texas Intermediate (NYSE:WTI) oil prices, which Chevron uses for its US Upstream operations (it uses Brent for its International operations).

Perhaps unsurprisingly given the predicted rise in oil prices, analysts are forecasting 25.5% growth in Chevron's revenues in 2017. Interestingly, even as oil prices peaked to a shade under $53 a barrel in June, analysts subjected Chevron to 11 upward earnings revisions. Again, this shouldn't come as a shock to investors: Chevron is the everyman's betting instrument for oil prices.

Second, Chevron's Balance Sheet can support continued dividend payments. It currently has $1.12 for every dollar of liabilities and has only around $0.75 of leverage for every dollar equity. These ratios are on-par or better than the average for its peer group and certainly strong when compared to the energy sector as a whole.

Chevron has also generated $18.3 Billion of cash from operations over the twelve months ending in March - this was actually on the low side historically-speaking because of the dip in commodity prices. For instance, when oil averaged around $99.5 in 2014, Chevron generated $31.5 Billion in cash flow from its operations. All else being equal, healthier oil prices will mean better cash flow generation for Chevron. Indeed, Yarrington indicated that Chevron expects "cash generation to improve going forward… as prices move up." The danger, of course is a contraction in margins - something that BP demonstrated as a concern when it published its second quarter results.

Taken together, the outlook for Chevron and its current financial situation suggest that Chevron has the resources - whether from its existing pool or generated from its operations going forward - to sustain a $2 Billion quarterly dividend.

Is Chevron's stock attractive at current levels? That's a bit more difficult to say - because of Chevron's poor first quarter results, its trailing earnings are soft and its Price-Earnings ratio is at nearly 149x. This is far higher than the level for both the Dow and S&P500. However, on a forward earnings basis (i.e. excluding the impact of its sour first quarter), its P/E ratio comes down drastically to less than 21 times - still a bit higher than the forecast for the two major market indices but definitely within reasonable range - with the possibility to drift lower if oil prices improve and bring Chevron's profits up with them.

Moreover, by other valuation measures, Chevron is a bargain: its Price-to-Book and Price-to-Sales of 1.51 and 1.27 are, respectively, far lower than the averages for both its industry and the energy sector as a whole. They're also less than half the measures for the S&P500, which has an aggregate Price-to-Sales of 4x and Price-to-Book Value of 6.1x.


Ultimately, Chevron is a cyclical stock - its fortunes rise and fall with larger expectations surrounding the state of the global economy which, in turn, impacts the price of oil. This is clearly reflected in Chevron's Beta of 1.3x.

That's the bet: on the one hand, if a dividend investor believes that the Global Economy will accelerate and bring oil prices higher along with it, then now is a good time to buy Chevron. On the other hand, if an investor expects further headwinds from macro events like Brexit to curtail oil prices, then the safe bet is to wait out the volatility and possibly buy Chevron at a higher dividend yield.

We're in the former camp - we believe that oil hits its nadir in February and while it's probably not going to surge to the $100+ price per barrel of 2014 or even get close to that anytime soon, it's probably a good bet to say that faster global output in the coming will support a higher average oil price than in 2016, supporting not just Chevron but other giants like Exxon Mobil (NYSE:XOM).

Now is a good time to buy the stock that pays the best dividend in the Dow Jones Industrial Average.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CVX over 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.

Additional disclosure: Black Coral Research, Inc. is a team of writers who provide unique perspective to help inform dividend investors. This article was written by Jonathan Lara, one of our Senior Analysts. 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. Company financial data is taken from the company’s latest SEC filings unless attributed elsewhere. Black Coral Research, Inc. is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.