- Berkshire Hathaway dramatically increased its stake in Chevron, making it one of the company's largest positions.
- Chevron has a great management team and the company's share price has outperformed as a result of COVID-19.
- The company is generating a high-single-digit yield in an expensive crude price environment, and we expect that valuation to come back to earth.
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For nearly our entire history on Seeking Alpha, starting with the mid-2014 oil crash, we've been perma-bulls on Chevron (NYSE:CVX), its strong assets, and even stronger management team until our article here last month. We also espouse a value investing methodology similar to Warren Buffett (BRK.A) (BRK.B). That's why it surprised us to hear that Berkshire Hathaway has increased its Chevron bet to almost $26 billion.
As we'll see throughout this article, Chevron is a great, but overvalued company, and we recommend against investing it at this time.
Chevron 1Q 2022 Performance
Chevron had a relatively strong quarter.
Not surprising given how well oil prices performed, the company saw 14.7% ROCE with the buyback guidance raised to $10 billion annualized and ~725 thousand barrels/day in Permian production outlook. The company has announced additional lower carbon spend, which could enable the company to survive for the long run.
The company earned >$6 billion in annual earnings, implying a P/E of 12-13. The company's FCF was $5 billion, albeit with much lower capital spending versus its competitors. The company has a relatively low net debt ratio of just under 11%, implying roughly $30 billion in net debt. Higher share prices have dropped the company's dividend to <4% with additional repurchases.
Our concern for the company is its total yield. At current high prices, the company's guidance for dividends + share repurchases is just under 7% annualized. That represents the peak of the company's shareholder rewards in a high price environment of more than $100/barrel.
Chevron Financial Priorities
Chevron's financial priorities continue to be for substantial shareholder returns.
Chevron saw cash flow expand by $9 billion through the quarter, going down to $6.1 billion counting working capital and capital expenditures. It's worth noting that the company's capital spending is much lower than many of its peers. The company spent $4 billion on shareholder returns, however, it still diluted shareholders with option exercises.
The company also paid down $2 billion in debt, helping to reduce interest expenditures. A substantial part of this will compete with rising overall interest rates. Still, with the company guiding to $10 billion in annual share repurchases, we expect debt paydown to slow down. As seen above, even if the company's FCF continues, it's an 8% FCF yield at current prices.
The company's lower capital spending means there's less growth potential and we expect capital expenditures to remain mostly constant.
Chevron had strong earnings, however, in our view, the company and Warren Buffett's timed investment don't have the earnings required for an expensive market.
Our view is at current oil prices, in relation to historic oil prices, Chevron's fair cash flow yield at the current time would be 12-15%. That'd imply a downside of almost half the current price. Especially in a volatile industry, if you're going to keep holding onto your stock we recommend, at minimum, selling covered calls on the company's stock.
An interesting option for investors who are looking to sell covered CALLs is Jan. 2024 $200/share strike price. It's currently trading at roughly $10/share, it lets you capture 30-40% more upside, and in the case of downside, you get paid out 6% of your current investment today. It also lets you avoid the tax bill from selling.
The largest risk to our thesis is crude oil prices. With Europe-Russia battling it out over how much they're willing to pay for oil to defend democracy, prices have been and remain incredibly volatile. There's a chance that prices spike up from here, and in that case, Chevron could generate higher shareholder rewards from its current level.
Chevron has a unique portfolio of assets. Throughout the crude oil collapse, the company has consistently had one of the strongest management teams and its timing of a massive capital program early in the collapse has allowed its cash flow to remain strong. The company is continuing to generate substantial cash flow while keeping capital spending low.
However, the company continues to have a risk that the management premium won't carry it forever. Investors who invest at a higher valuation guarantee themselves lower shareholder returns in an expensive environment. At a minimum, we recommend selling covered CALLs given the company's current lofty valuation.
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This article was written by
The Value Portfolio specializes in building retirement portfolios and utilizes a fact-based research strategy to identify investments. This includes extensive readings of 10Ks, analyst commentary, market reports, and investor presentations. He invests real money in the stocks he recommends.He is the leader of the investing group The Retirement Forum with features including: model portfolios, macro overviews, in-depth company analysis and retirement planning information. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.