- Chevron shares have flown higher in recent months.
- But that move appears to be due to the move in crude oil, which has stalled.
- Chevron continues to cut capex and sell assets to pay its dividend, so the payout is safe.
- But the stock is fully valued at best and needs a period of digestion or a pullback.
Energy stocks as a sector were beaten down for several months following the initial panic of the pandemic. That made sense as air travel all but stopped, and tens of millions of people began working from home or were simply let go from their jobs, meaning demand for fossil fuels plummeted in an unprecedented move. But energy stocks have been all the rage since the vaccine news from last November came to light, and companies big and small in the space have seen big moves in their share prices as a result.
One company that has seen a massive upside move is oil/gas/chemical OG Chevron (NYSE:CVX).
We can see at the bottom of the chart just how horrible energy has been in the past couple of years, underperforming the S&P 500 by a staggering 48% during that time frame. To its credit, Chevron has done better, but even with +28% against its peer group, it is still well under just buying an index fund. Chevron could therefore be called a leading stock in a lagging group, which isn’t great but is better than a lagging stock in a lagging group. So there’s that.
Apart from that, I see lots of reasons why Chevron shouldn’t rally much further than it already has in the short and medium terms. First, Chevron hit $112 a few weeks ago and the rally abruptly ended. That’s no coincidence because we can see much of 2019’s trading was very near that level, meaning there is significant overhead supply of people that bought during those times. It will take a lot of momentum to get through that level.
Speaking of momentum, the PPO near the top of the chart shows that Chevron has seen a gargantuan move higher in momentum that isn’t generally befitting of a $200B+ energy company. Stocks like Chevron tend to move slowly and deliberately, but the move from $63 to $106 has been swift, and momentum looks very overextended to the upside. That does not mean Chevron must plummet to work off that condition, but the fact is that a PPO of 7 for Chevron is unsustainably high, so the best-case scenario is sideways trading. Combined with the overhead resistance in the area of $115, I simply don’t see any upside for some time to come.
Fundamental reasons to be cautious
The chart is not the only reason I’m cautious on Chevron, because for all the company’s efforts to diversify away from oil, the fact is that its fortunes are tied to oil for many years to come.
Source: Investor presentation
This chart from Chevron gives us an idea of just how leveraged Chevron is to oil and gives us two scenarios; one where Brent is $40 and another where it is $60. We can see that the former scenario sees Chevron with something like $80 billion in operating cash flows over a five-year period, whereas $60 Brent sees Chevron with ~$140 billion. That’s a huge gulf that if the former comes to fruition, means Chevron is going to have to borrow more and cut capex again. That’s pretty dire, whereas $60 Brent is all flowers and sunshine with significant “excess cash” generated. Thus, it makes sense to see which scenario is most likely, so let’s take a look at Brent crude.
This is a five-year weekly chart of Brent, and we can see that just before the vaccine announcement in November was made, Brent was $36. It subsequently doubled and has since pulled back to $63 today.
That’s a huge move, and again, it is no coincidence that Brent stalled where it did. The low-$70s is where several prior rallies stalled, so this area of resistance should surprise no one. The commodity should see reasonable support in the mid-$40s, however, so that’s something for the bulls to hang their collective hat on.
However, the momentum picture looks virtually identical to Chevron’s; the move from oversold conditions last year has resulted in extremely high PPO readings, unsustainably so. Brent’s PPO is usually between +5 and -5, but stands at nearly +10 today, highlighting just how extended this bull move is. At the least, Brent needs months of sideways consolidation, and at worst, the selloff from the highs accelerates. Either way, there is nothing to be bullish about here.
The problem with lower Brent is that Chevron very much needs high oil prices to fund its capex and produce cash to pay its dividend.
Source: Investor presentation
Upstream C&E has been cut repeatedly over the past decade out of necessity; Chevron’s capex budget used to be in excess of $30 billion annually, but it simply cannot afford to do that any longer, so it cuts the budget. That is not the sign of a healthy business, and we can see other signs in this slide.
Upstream earnings per barrel plummeted from 2018 through today, and while we may see a blip higher due to the massive run in Brent prices, the long-term trend appears to be down. Margins in the bottom right panel show the same thing. Chevron reckons it is an industry leader, but in an industry that is suffering, so that’s a hollow victory if indeed it is a victory at all.
Here’s what I’m on about; below we have capex and cash from operations for the past several years in millions of dollars. The difference between the two is FCF, which Chevron needs to return capital to shareholders via its dividend and share repurchases.
Chevron’s FCF is highly dependent upon oil prices, and its capex has dwindled over the years due to the fact that its operating cash flows have moved lower over time. Those cuts were necessary because Chevron would have otherwise had to have borrowed money to pay the dividend, which it did in years like 2013 through 2016. Only after capex was slashed to half its prior levels could Chevron actually afford to pay the dividend with FCF.
But with operating cash flow plummeting again, Chevron’s massive dividend is once again a problem. Chevron will continue to pay the dividend no matter what happens because I suspect that is the only reason most people buy this stock. Management has listed paying the dividend as a top priority for years, so I don’t doubt it will continue to be paid.
What Chevron must do to pay it is still up in the air, and as we can see, as management continues to raise the payout, the situation becomes more and more difficult to reconcile.
Capital returns are well in excess of $10 billion annually, even with token share repurchases. Remember that Chevron’s market capitalization is in excess of $200 billion, so $1.5 billion in share repurchases is nothing but a rounding error; it makes no difference. The ~$10 billion in dividends is what we’re interested in, but I do think the lack of meaningful share repurchases since 2014 shows that Chevron’s financing woes are meaningful, if not serious.
To its credit, Chevron has worked on this over the years by divesting unwanted assets and using the proceeds in part to pay down its considerable debt.
Unfortunately, that good work was completely undone with the Noble acquisition late last year, which saw Chevron add ~3% to its float, and take on Noble’s massive debt load in the process. Forty three billion dollars in debt is a lot for any company, but in particular, for one that spends just about every penny of cash it produces paying dividends to shareholders. I personally do not think there is any reasonable chance Chevron can make a dent in this debt in the foreseeable future given its FCF situation, and its massive dividend that management refuses to cut.
Given that interest expense was $697 million last year, it should be much higher this year.
That’s $700+ million that comes right out of earnings, and further reduces Chevron’s ability to pay its dividend and do the things it needs to in order to run the business.
The stock looks fully valued, too
As if that weren’t enough to worry about, Chevron looks fully valued on normalized earnings already, further lending credence to the idea that upside is very limited from here.
Source: Seeking Alpha
Shares are valued at 17.5 times next year’s earnings projections, which as we can see below, is full value for this stock.
Below we have price to forward earnings for the period of early-2018 to early-2020, which I’ve chosen because it was the only period where Chevron had normalized earnings for any meaningful amount of time, without massive drops that caused the PE multiple to soar or plummet.
At any rate, Chevron spent much of this time at 15X forward earnings or below but did see some moves towards 19X, although briefly. The point here is that over this period, which spans a couple of years of normalized conditions, the average was ~16X forward earnings, which is just below where Chevron trades today.
With Brent crude hitting resistance above and needing momentum to come way down from unsustainable levels, and Chevron shares themselves showing the same behavior, combined with a massive load of debt and $10+ billion in annual dividends owed, I simply don’t see a reason to buy Chevron here.
The stock should be valued closer to 15X or 16X earnings, which would be a double-digit decline from here just to get to what would be fair value in my view, based on the evidence above. I’m not outright bearish on Chevron because the company is continuing to pay the dividend, and that will draw buyers in. But upside looks very difficult from here, and I think Chevron needs a long pause or pullback to rectify the sheer magnitude of the momentum of the move we’ve seen in recent months.
In short, the party looks like it is over for now.
This article was written by
Josh Arnold has been covering financial markets for a decade, utilizing a combination of technical and fundamental analysis to identify potential winners early on in their growth cycles. Josh's focus is mainly on growth stocks. His goal is efficient and profitable use of capital, which overly rigid buy-and-hold strategies do not allow.Josh is the leader of the investing group Timely Trader where he focuses on limiting risk and maximizing potential reward. Features of Timely Trader include: real-time alerts, a model portfolio, technical charts, sentiment indicators, and sector analysis to find the best trading opportunities. Learn more.
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.
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