-Seven Year Revenue Growth: 7%
-Seven Year EPS Growth: 11.4%
-Dividend Yield: 3.03%
-Seven Year Dividend Growth: 10.5%
-Balance Sheet: Excellent
Overall, with a strong balance sheet, solid operations, a low valuation, but taking into account vulnerability to the volatile nature of oil prices and litigation risk, I find Chevron to be an acceptable buy at current prices in the low $100′s.
OverviewFounded in 1879, Chevron (CVX) is currently one of the largest oil and gas companies in the world.
In 2010, Chevron reported a net production of 1.923 million barrels of crude oil and natural gas liquids and 5.040 billion cubic feet of natural gas per day. Overall, 2010 production was up to 2.763 million oil-equivalent barrels from 2.704 in 2009, a 2.2% increase. Over the same period, net proved reserves of oil and gas liquids, and natural gas decreased 7.4% and 6.3% respectively.
BusinessesChevron is divided into a number of different businesses. Some of them are directly profitable while others are supplementary to meeting Chevron’s needs.
For 2010, $17.677 billion in income as attributed to upstream operations, $2.478 billion in income was attributed to downstream operations, and ($1.131 billion) was attributed to All Other. So upstream income was more than seven times downstream income. Even among supermajor oil companies, Chevron is particularly focused on upstream projects and therefore is most directly linked to the price of these resources.
Oil ExplorationChevron extracts oil from locations around the world, including from deepwater wells in the Gulf of Mexico and off of other coasts such as Brazil, from offshore wells in Europe and other locations, and on land from California, Africa, Kazakhstan, and other places, and oil sands operations in Canada.
Natural Gas ExplorationChevron’s natural gas portfolio stretches across six continents. Chevron has the ability to transport natural gas from production locations to user locations by means of pipelines, liquefied natural gas (LNG), and gas-to-liquid (GTL) technology.
RefiningChevron has the capability to turn its basic produced resources into finished materials ready for use. Seven refineries make up three-quarters of Chevron’s total fuel refining capability.
Supply and TradingChevron’s requirements to get materials from upstream projects to downstream projects is huge. Chevron has to develop and maintain logistics and partners to get products to where they need to be safely and for a low cost. For instance, Chevron markets aviation fuel at more than 875 airports and is the leading marketer of jet fuels in the US.
MarketingChevron operates the three brands of Chevron, Texaco, and Caltex to drivers across the world.
PipelinesChevron operates and invests in pipelines around the world. Significant projects are located in North America, Asia, and Africa.
LubricantsChevron markets lubricants on six continents.
ShippingHeadquarted in California, Chevron Shipping commissioned their first ship in 1895 and now ships crude oil, liquefied gas, and refined products to customers globally.
ChemicalsChevron’s chemical products are incredibly diverse, with uses in food packaging, electronics, to medicine.
MiningChevron operates three coal mines and a Molybdenum mine in the US.
PowerChevron’s produces gigawatts of power. Much of the power is derived from natural gas, while some is from wind. Chevron is the largest producer of geothermal energy in the world.
TechnologyChevron invests in emerging energy opportunities including solar projects, hydrogen projects, and bio-fuels products.
Revenue and EarningsChevron’s growth was strong until 2009 when the effects from the global recession took a significant chunk out of the revenues and profits of all big oil companies. Growth has since rebounded, but weakness is currently estimated for 2012.
MetricsPrice to Earnings: 7.9
Price to Free Cash Flow: 13.6
Price to Book: 1.8
Return on Equity: 22%
DividendsChevron has increased its dividend every year for two and half decades straight, currently yields 3.03%, and has a dividend payout ratio from earnings of only about 25%.
It’s worth noting that Chevron increased its dividend not once, but twice this past year. The company increased the quarterly payout from $0.72 to $0.78, but after two quarters of paying $0.78, they increased the quarterly amount to $0.81.
Balance SheetChevron is approximately tied with Exxon Mobil (XOM) as having the strongest integrated oil balance sheet. Total debt/equity is only 0.8, and the interest expense is negligible. Goodwill is nearly nonexistent on the balance sheet. Annual net income exceeds total debt by 2-3 times. Practically flawless.
Investment ThesisEnergy companies like Chevron face a changing world. Their proven energy reserves are huge, but finite, and increasing environmental concerns and backlash, along with increasingly cost-efficient alternative energy solutions are significant trends to be aware of. Chevron’s quantity of proved reserves has been flat to down over the last several years. Hydrocarbons are still among the most efficient energy sources, since the energy source consists basically of solar energy captured over long periods of time into energy-dense forms, but oil companies find themselves going to more costly methods to get oil, such as through capital intensive deep-sea drilling, or extracting it from oil sands over vast amounts of land in Canada. Chevron in particular specializes in deep-sea drilling.
Liquid Natural Gas (LNG) also plays a role in Chevron’s business. Natural gas uses up a lot of volume per unit of energy, and this is acceptable for pipelines, but to transport it to places without pipeline access is not cost effective. Chevron and other companies can now compress it into liquid form, ship it anywhere they want via specialized insulated ships, and then return it to its gas form on arrival. The Australian Gorgon LNG project is a significant development project.
Chevron acquired Atlas Energy, Inc. in 2011. The company now has access to the Marcellus shale; a very large U.S. reserve of natural gas.
Chevron Energy Solutions is a unit of Chevron that focuses on providing renewable power sources and maximizing energy efficiency for its clients. The size of their projects range from $1 million to over $100 million, and they are the largest installer of solar panels for educational facilities in the US as well as one of the largest developers of solar photovoltaic projects in California. Chevron is also the largest producer of geothermal energy in the world.
Although these alternative energy businesses are respectable, and their projects are valuable, they’re drops in the ocean of oil that is Chevron. Fossil fuels are where their money comes from. But, energy companies are aware of changing trends and the usefulness of a variety of energy sources. Big Oil companies are not just oil companies, but also some of the largest and most profitable corporations on the planet that employ an incredible number of scientists and engineers. The combination of enormous amounts of capital and technical prowess provides Chevron and similar companies the chance to grasp opportunities when presented with them. They’ve been undergoing shifts towards profitable natural gas growth, and can make other shifts as needed.
Over the last decade, Chevron has rapidly grown its asset base. The following table shows Chevron’s increasing company book value over the last seven years.
|Year||Total Assets||Total Liabilities||Shareholder Equity|
|Current||$204.1 billion||$83.2 billion||$120.9 billion|
|2010||$184.8 billion||$79.7 billion||$105.1 billion|
|2009||$164.6 billion||$72.7 billion||$91.9 billion|
|2008||$161.1 billion||$74.5 billion||$86.6 billion|
|2007||$148.8 billion||$71.7 billion||$77.1 billion|
|2006||$132.6 billion||$63.7 billion||$68.9 billion|
|2005||$125.8 billion||$63.1 billion||$62.7 billion|
|2004||$93.2 billion||$48.0 billion||$45.2 billion|
RisksEvery company has risks, and big oil companies certainly have their fair share of them. Chevron faces uncertainty in terms of currencies, geopolitics, litigation, and regulation. Litigation is an ever-present risk due to the large scale that a company like Chevron operates at and the drastic effects they have, some for better and some for worse, on communities around the world. I’ve personally known people from several countries that have described first hand the kind of damage the world’s need for energy has caused their communities.
The primary risk for the business is that of changing oil prices, which are outside of Chevron’s control and have the largest impact on their profitability. Chevron is even more susceptible to changing oil prices than its peers. Refining margins are volatile and can affect downstream profitability substantially in a given year. In addition, not too long ago, BP reminded investors of yet another risk that is always present in this type of company: catastrophic failures.
A long-term risk to be aware of is reserve management. Oil majors have to maintain or increase proved energy reserves over the long term if they expect to continue to grow in production and profitability. It’s worth watching for multi-year trends, since oil and other fossil fuels are rather finite.
The largest and most public litigation against Chevron is from Ecuador. Texaco spilled millions of gallons of oil, and dumped billions of gallons of toxic waste into the Ecuadorean Amazon rainforest in the 1960′s, 1970′s, 1980′s, and 1990′s. Texaco became part of Chevron ten years ago, so Chevron has inherited this old and sustained litigation. There have been back and forth legal battles; plaintiffs claim tremendous damage has been done and is still present, Chevron claims it paid a few million dollars that supposedly cleaned it up. Ecuador originally imposed a nearly $9 billion fine, but has recently doubled it to over $18 billion. A US court has upheld the fine, but the litigation continues. There have been reports of bribes, conflicts of interest, and the enormity of the mess is nearly unprecedented.
In late 2011, Chevron, along with everyone’s favorite offshore drilling contractor Transocean, were involved in an oil spill of thousands of barrels off of the Brazilian coast. Brazilian plaintiffs are currently seeking over $10 billion in damages. This is a potential risk, but I think that compared to the scale of the Ecuadorian damage, risk from major financial loss is larger from Ecuador than Brazil by a substantial margin.
In a more recent even, just days old, there has been a large fire on a Nigerian offshore drilling rig. The extent of effects are not currently known.
Comments on Litigation
There are a couple points to make regarding these.
The first is that these are the types of problems associated with oil. These types of energy sources often damage land, air, and water, so efforts to shift any political or environmental discussion purely towards the effects of carbon emissions detracts from these issues. Problems with hydrocarbons aren’t just on paper; they affect real lives all the time. Behind all the “We Agree” campaigns and solar installations is this reality. Events such as these cause not only tangible financial risk, but less tangible potential regulation changes down the road from all countries in which Chevron and other businesses operate.
The second is that Chevron is a legal giant. We could compare these to some large examples: the 1989 Exxon Valdez spill in Alaska, and the 2010 BP spill in the Gulf of Mexico. Exxon Mobil dragged litigation on for decades and although it has paid out billions, the awards were reduced and spread out through cleaning costs and fines. BP ended up getting hit very hard financially for their spill, but this had a few key points. One was that it was one of the largest oil spills ever. Only a few have ever been larger, and most of those were attributed to Iraqi forces purposely burning unfathomable amounts of oil in Kuwait during the Gulf War. The second was that BP’s spill affected primarily people from a highly publicized developed country, and shown center-stage on television for months. With Chevron’s litigation concerning Ecuadorian environmental damage from decades ago, I’m more inclined to expect it’ll play out more similarly to the Exxon Valdez oil spill litigation. But we’ll see; the world has a different view towards environmental concerns than it did in the 1980′s.
Let’s suppose it’s a worst case scenario for Chevron, which to be honest, is probably where justice should be. Let’s say they get hit with $20 billion worth of fines and legal fees for Ecuador and another $10 billion from Brazil; how large of a quantitative impact would this have on the company? Chevron has over $200 billion in assets, including over $20 billion in cash and other liquid funds. As previously described, the balance sheet is excellent. As for profitability, Chevron brought in $40 billion worth of cash flow over the past 12 months alone, and over $15 billion was free cash flow. Suppose after getting hit with $30 billion in litigation liabilities, they pay out $10 billion with cash and put the other $20 billion on as debt. Their total debt/equity ratio would increase to around 0.35. This would still be a strong balance sheet; comparable to the balance sheet of ConocoPhillips (COP).
So while the Ecuadorian and Brazilian litigation may be playing a part in Chevron’s lower valuation than COP or XOM, it’s something that the company could absorb (although it would be a major financial loss), and more likely may just continue to legally battle and delay. It’s no surprise that credit rating agencies aren’t particularly concerned with Chevron and have a high credit rating assigned to the company. There are certainly risks associated with Chevron, including litigation risks, regulation risks, and oil price risk, but as part of a diversified portfolio, Chevron’s risks are acceptable in my view.
Conclusion and ValuationIn my last Chevron analysis from 15 months ago when the stock price was in the low $80′s, I wrote that Chevron may be poised to offer investors a significant opportunity, and considered it a buy. After volatile upward movement, the stock is currently well over $100, although the valuation is lower than it was at that time. I’d caution, however, that there is likely less upside at this point, since oil prices have rebounded to substantial levels. Cyclical businesses sometimes have high P/E ratios during market bottoms and tend to have lower valuations during market tops, which can be counter-intuitive, as investors try to take into account the future.
I do think, however, that Chevron is currently a decent buy. I don’t consider it an extremely strong buy based on what its P/E of 8 might imply at first glance, but I do still think it would make a good long term investment at the current price. Litigation risks and relatively high current oil prices probably mean that Chevron’s valuation will stay low for a while. The low valuation, in my view, reasonably takes into account a potential reduction in oil prices or potential financial loss from litigation, as well as the industry-typical issue of having large capital expenditures (and therefore limited free cash flow). If Chevron had an earnings multiple equal to COP, it would be trading at $120/share right now. For investors looking for years of business growth, dividend growth, dividend reinvestment at a low earnings multiple, and solid total returns, I think Chevron can be a way to go. It’s important to factor in conservative oil prices, and make room for litigation problems, in order to have a margin of safety.
Full Disclosure: At the time of this writing, I own shares of CVX and XOM.
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