Comparing 4 Energy Majors: Chevron, Exxon, BP And Shell

Summary

• With oil and gas prices at historic lows, these four majors are reviewed for dividend coverage, leverage, liquidity, profitability, cash flow and valuation.
• The four are ranked for investment now by dividend investors, long-term investors and short-term investors.
• Oil and gas prices will likely recover within two years.  They can move much faster up or down than other mining commodities.
• If you believe the remedy for low prices is low prices, an investment here is worth a look.

In this article, I compare the four major integrated energy companies, Chevron (NYSE:CVX), Exxon (NYSE:XOM), BP (BP) and Royal Dutch Shell (RDS.A) (RDS.B), as an investment. This is not intended to be a comprehensive analysis. It should be considered part of a due diligence process or an idea generator.

Market overview

As I write this article, crude oil and natural gas prices are trading at close to historically low prices. Both are well below the break-even rate for most energy companies when maintenance capital expenses are factored in. Consensus estimates are it takes about $50 crude oil prices to break-even for the average E&P company. Crude is currently trading at $24. There is a glut of crude oil resulting in almost no storage facilities still available. Unconventional storage such as ships and pipelines are being used temporarily.

It is likely we will see a shakeout in the industry with many weaker players going under. We need this; there are too many of them adding too much supply. A shakeout eventually benefits the larger and stronger companies for several reasons. It creates numerous assets available for purchase cheaply. It will significantly reduce production bringing demand and supply back into balance. It may even create a shortage of supply once the pandemic recedes and demand increases.

There are other potential tailwinds too. Crude oil and natural gas prices generally correct more quickly than other commodities. It usually takes less time and money to drill or shut in a well than create or close a mine. Existing wells generally deplete faster than a mine. There is a longer lead time to develop a mine.

Another major tailwind for prices is the major capital expense cuts and production cuts which have been announced. The four majors reviewed here have recently announced capital expense cuts of 20-30% from what they previously guided for in 2020. The smaller energy companies are mostly announcing even bigger cuts. Some are cutting almost every capital expense in order to survive. Meanwhile, OPEC and Russia have announced massive daily production cuts of 10 million barrels. This is a more temporary cut than capex and can be quickly reversed since it is dealing with existing wells. Ramping capital expenses back up takes longer and is partially dependent on financing being available. Finally, a ramping up of economies around the world as the pandemic recedes will increase demand significantly. However, some of that increased demand will need to wait for a widely available vaccine, which is probably a 2021 event.

A major tailwind is lending will dry up to most weaker players and become more expensive for even many of the stronger players. There will be less private equity too. Two price collapses in five years will force them to adjust their return on investment models.

My base case

My base case is oil prices will return to $50+ within two years and probably sooner. I expect the U.S. and much of the world to be in a recession or double-dip recession for the next two years. Despite this, supply and demand of crude oil will reach a balance through supply cuts which are already happening. A V shape recovery would be even better but I find that unlikely for the reasons given in my article I linked to above. Government forces such as OPEC+Russia impact crude oil prices more than any other industry due to government control of production in many countries. In addition to that in oil, as the saying goes, the remedy for low prices is low prices. Production can be started and stopped more quickly than in most other mining-related commodities. The capital expense cuts being announced now will have an increasing impact later this year and even more in 2021.

Comparison of the Four Majors

The chart below compares the four major oil & gas companies reviewed in this article by operating results, segments, leverage, liquidity, valuation, capital expense cuts, reserves, and dividend coverage.

Source: Forms 10-K and 10-Q.

Business differences between the four

Shell and BP are much more downstream-oriented than Chevron and Exxon. That appears to make them less vulnerable in a period of low prices but demand for refineries and chemicals is also off significantly. BP has a $5.6 billion asset sale of Alaskan properties pending which should add cash. As of April 15th, it was still on. Shell has a heavier exposure to liquid natural gas.

Operating results

Based on the profit margins and EBITDA margins, Exxon and Chevron have been the most profitable over the last three years, followed by Shell. BP’s profit margin has been weak for quite a while, and it was not covering its dividend when times were better.

Exxon and Chevron are much more reliant on upstream revenues (exploration and production) than BP and Shell which get much more from refining and manufacturing. That makes Exxon and Chevron more vulnerable to the low crude oil and natural gas prices.

Leverage

The stock market has been very consistent the past 18 months in punishing those companies with the most leverage. In this group, Shell has the most leverage followed by BP. For that reason, it’s no surprise their stocks have fallen the most. Shell in particular has a high amount of goodwill and intangible assets. Its interest-bearing debt is 2.24x to EBITDA. BP is next at 1.80x. Exxon and Chevron have low to moderate leverage versus BP and Shell and also compared to most other energy companies. As such, they will have more flexibility to borrow and buy distressed assets.

Liquidity

All four companies were showing significant cash on December 31, 2019 and Chevron and Shell had large available lines. However, in a sustained below $35/barrel environment, that liquidity will likely be inadequate if they want to maintain their dividend into 2021. There are other sources of liquidity these companies have, though each also creates problems. The easiest is to cut capital expenses. All four have already announced a 20-30% cut to their prior 2020 guidance. That will reduce future growth and maybe even lead to lower production. The next easiest is borrowing more.

All four still are investment grade rated by the ratings agencies. That may not last for one or two, so the time to borrow is now. They can sell assets. Each has numerous fields, refineries, pipelines and factories that could be sold individually or in groups. The problem with selling now is there are few buyers so the price won’t be very good. Also, this being the second oil price crash in five years reduces the amount of vulture capitalists out there. They could issue a secondary offering of stock, which of course would dilute shareholders. That doesn’t make much sense if you are trying to defend a dividend as you are hurting the same shareholders you are trying to help. Another possibility is selling royalties or interests in their upstream production. Most likely we will see borrowings as the primary liquidity source once the cash runs low.

Dividends

Shell recently cut its quarterly dividend by 66%. That was its first cut since World War II so it wasn’t taken lightly. The dividend coverage shown above is before that cut. The other three have maintained their dividends. Incidentally, Shell has had by far the best dividend coverage ratio of any of the four majors. Its dividend coverage was significantly aided by asset sales. Without asset sales it still would have been 1.60x, just below Chevron. However, as noted above, it also has by far the most leverage. BP has not generated sufficient cash flow less capex the past three years to cover its dividend. Exxon has been running close to break-even in funding its dividend. That is primarily because its dividend has been higher than the others in relation to earnings and revenues.

With crude oil and natural gas prices at long-term lows, cash flow available for dividends will shrink significantly this quarter and probably for the foreseeable future. This is being partially offset by cuts to capital expenses but will probably also require borrowing and other actions if they want to maintain the current level.

Valuation

Chevron has maintained the highest valuation of the four as measured by price to revenues. It has also fallen less than the others. This is due to a combination of low leverage, a historically high profit margin and better dividend coverage. Exxon is next, with BP and Shell trading big discounts to the other two.

Which major to invest in

So, there is not one answer. It depends on your investment priority. Are you a dividend investor, long-term investor, or short-term investor? The majors have an unusually high level of dividend investors due to their high payout and long-term track record of increasing dividends. For that reason, let’s look at dividend investors first.

Dividend investors

BP, Exxon, Chevron and Total have all maintained their dividends while Shell has slashed theirs by 66%. All major petroleum companies consider their dividend as very important, even sacrosanct. That is in part because they have more investors there for the dividend than in most other industries. They are also in a mature industry where more capital goes to shareholders than for growth. These four have paid a higher than average dividend for decades without interruption. Chevron and Exxon have more than doubled their dividend in the last 15 years while the increases at BP and Shell have been much less. Dividends are even more important to investors now with bond yields so low. Investors are looking everywhere for yield.

The impact of a dividend cut can be seen by Shell’s decision. Its stock dropped about 17% over two days when it cut its dividend on April 30, but has since retraced half of that. I take the limited damage to mean the market was expecting the cut.

All of the majors will have insufficient cash flow to cover their current dividend as long as oil prices stay low for an extended time. They all have immediate liquidity in cash, but will need to borrow or further reduce capex once that runs low. Whether they cut the dividend then, will depend on how much the bleed is, how cheap the borrowings are, and where their priorities are. By priorities I mean is the long-term health and growth of the company more important than a dividend paid out in the short term.

My rankings for dividend-oriented investors are Chevron, Exxon, BP and finally Shell. I do not think BP can maintain their dividend if the current environment goes into 2021, though they may try. Again, a lot of this is up to management’s priority. Cash flow will be insufficient so it’s about how far management and the board are willing to let it go. If they try to maintain the dividend, the stock may get hurt by significant increased leverage, dilution, asset sales or capex cuts. So, either way, investors lose.

Chevron has a very good chance of keeping its dividend. It's already less a percentage of historical earnings than BP and Exxon. It also has less leverage than the others so it can add a lot of cheap debt without serious long-term issues. Exxon also has low leverage so it can borrow for a while too. I think it’s about a 60% chance they will maintain it. Shell is highly leveraged and has already cut so its yield is less than the others.

Long-term investors

For investors looking for appreciation and yield over a longer term, Exxon is my first choice followed by Chevron. Both have sufficient financial strength allowing them to buy significantly good assets at distressed prices. There is no need for them to grow capex over the next few years for that reason. Exxon, even if they cut their dividend, may still have a yield similar to Chevron. Meanwhile Exxon’s stock price has fallen 13% more than Chevron, so there is more apparent upside. Valuation is the reason I pick Exxon over Chevron.

As I mentioned earlier, I expect oil prices to recover within two years. All four companies are strong enough to survive that period though those with more leverage like Shell are likely to further slow growth efforts in order to reduce leverage. That makes them less appealing. BP has had lower profit margins than the others for quite some time giving it less cushion to absorb lower prices.

Short-term investors

This one comes down to how fast you expect crude oil prices to recover. If you think it will be this year, then go with the one down the most, Shell. It has the most upside. BP also appears to have a lot of upside, but there is an elevated risk it gets tripped up by a dividend cut. Exxon would be my number two here. If you don’t expect a rapid price recovery, I would not recommend a short-term investment in any of them.

Takeaway

Crude oil and natural gas prices will not stay down indefinitely. Renewables are still too far off to take their place. Consider an investment in one of the oil & gas majors that fits your investment profile.

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.