Chevron: Fasten Your Seat Belts

Summary

• Chevron has been successful in improving its revenues, earnings and cash flows.
• But the weakness in oil prices threatens to derail Chevron's turnaround.
• If prices stay weak, then the company could face a large cash flow deficit.

Chevron (NYSE:CVX) was hit particularly hard in the downturn, but it has been heading in the right direction. The San Ramon, California-based company managed to consistently grow revenues while significantly improving its cash flows. But the turnaround of the second-largest US oil company could lose momentum, thanks to the latest dip in oil prices. There will likely be pain ahead for investors in the short term.

Chevron's production profile is more liquids linked than that of its peers Exxon Mobil (XOM), Royal Dutch Shell (RDS.A, RDS.B) and BP (BP). In 1Q17, for instance, Chevron's total production was 64% liquids. Therefore, it was hit particularly hard by the slump in oil prices. But the company has been slowly making a comeback, driven in large part by the improvement in oil prices.

In 1Q17, Chevron managed to increase its revenues for the fourth time in a row on a sequential basis to $31.36 billion. It also swung to a profit of $1.42 per share from a loss of $0.39 per share in the year-ago period. Its cash flows from operations also surged to $3.88 billion from $1.14 billion a year earlier. With higher cash flows and lower CapEx, the company ended the quarter with positive free cash flows of $564 million. That improvement came as the average price of crude oil gradually improved to $51.77 a barrel in 1Q17 from as low as $33.18 in 1Q16.

	1Q16	2Q16	3Q16	4Q16	FY16	1Q17
Revenues ($Mn)	23,096	27,989	29,182	30,217	110,484	31,362
Earnings/share	-$0.39	-$0.78	$0.68	$0.22	-$0.27	$1.42
Cash flows ($Mn)	1,141	2,531	5,311	3,863	12,846	3,879
CapEx ($Mn)	5,566	4,469	4,065	4,009	18,109	3,315
FCF ($Mn)	-4,425	-1,938	1,246	-146	-5,263	564
Average spot WTI	$33.18/b	$45.41/b	$44.85/b	$49.14/b	$43.15/b	$51.77/b

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However, oil prices have come under pressure in recent weeks. The price of US benchmark WTI crude has tumbled from more than $50 a barrel in the final week of May to $44.24 at the time of this writing, thanks to mounting oversupply fears. Reports related to the increase in output from the US oil producers as well as OPEC have exacerbated investors' concerns. A weekly report from the US Energy Information Administration released on Thursday showed that the country's oil production climbed by 1% to 9.34 million barrels per day during the week ended June 30. At the same time, a report from S&P Global Platts said that OPEC's production climbed by 500,000 barrels per day in June to 32.49 million barrels - its highest in six months.

Following the bearish signs, a number of analysts have slashed crude oil price forecast for the current year from their previous estimate of mid-$50s to around low-$50s. Most recently, Bernstein Research has cut this year's oil price estimates for international benchmark Brent crude (which trades at a premium to WTI) from $60 to $50 a barrel for 2017.

In a weak oil price environment, Chevron's performance in the first quarter will become a tough act to follow. The company reported free cash flows in that period, but it could see a cash flow deficit for the full year.

Remember, Chevron has planned to reduce CapEx from $22.43 billion last year to $19.8 billion in 2017. Excluding equity affiliates, the CapEx is forecasted to drop from $18.11 billion in 2016 to $15.1 billion this year. In order to break even, Chevron will have to grow its operating cash flows by 17.5% from last year. That shouldn't have been difficult if oil prices were to average around $55 a barrel in 2017 which would have been 27% higher than last year's average.

However, if oil ends up averaging around $50 a barrel this year, which seems to be the new consensus, then that would be 15% higher than last year. In this case, Chevron might find it difficult to generate enough cash flows from operations to fully fund its capital expenditure. If Chevron manages to grow its cash flows by 15% as well to $14.8 billion, then it could still face a cash flow shortfall of around $327 million, as per my rough estimates. If cash flows stay flat, then Chevron might face a cash flow deficit (or negative free cash flows) of $2.25 billion. In this case, the company will likely rely on additional borrowings and asset sales to bridge the funding gap.

Although the above-mentioned deficit at flat cash flows would be considerably smaller than last year's shortfall of $5.26 billion, it will be a deficit nonetheless. Mr. Market might still punish Chevron due to its weak cash flows, particularly if its peer Exxon Mobil, which is a cash flow machine, continues to report strong levels of positive free cash flows. In this environment, Chevron's stock will likely perform poorly in the short term.

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Analyst’s 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.

I own shares of funds that may hold a long position in Chevron, Exxon Mobil and Royal Dutch Shell.