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Difficulties at Chevron Do Not Scare Grantham

March 25, 2014 | About:

There are a few industries that highly liable to court judgments. The oil & gas industry is one of them, and most charges are related to environmental degradation. In this sense, the Exxon Valdez litigation has been a landmark due to the reparations paid and the ensuing legislation reforms. Most importantly, J. P. Morgan created the credit default swap to reduce the amount of reserves the financial institution to secure the credit requested by the firm to pay reparations. Now, Chevron (CVX) is confronting an important legal battle with the Ecuadorian government due to actions committed by Texaco. The company inherited the issue after acquiring the Texan based oil producer and the revival of the legal battle in the early 2000’s by those damaged. According to the last court judgment expressed by U.S. District Court for the Southern District of New York, Steven Donziger, the lead American lawyer behind the Ecuadorian lawsuit against the company, violated the federal Racketeer Influenced and Corrupt Organizations Act.

A Troubled Present

Chevron announced in its last full year report that 2013 earnings were $21.4 billion ($11.09 per share – diluted), down 18 percent from $26.2 billion ($13.32 per share – diluted) in 2012. The greatest loss has been identified on downstream operations, registering a 3 billion dollars decline in revenues. On the other hand, the upstream activities lost 2 billion representing a 45% decline in revenues for the sector. Hence, it is no secret that the company is not performing as before.

The weaker present has however, not been hidden by Chevron’s management. “Global crude oil prices and refining margins were generally lower in 2013 than 2012,” recognized Chairman and CEO John Watson. Specifically, Mr. Watson pointed to lower gains on asset sales and higher operational expenses. Nonetheless, the company continues to enjoy of a strong financial position and healthy cash generation during 2013.

To counter the current declining trend, Chevron has focused on a few activities. First, the Gorgon and Wheatstone projects have seen important progress and continue moving forward towards completion. Second, new investment at the Vaca Muerta shale and Kitimat LNG Project are seen with great enthusiasm. The four projects together, are expected by management to help overturn the current declining performance, while offering important growth opportunities.

Shareholders continue to be rewarded by Chevron. During 2013 the company repurchased $5 billion worth of outstanding shares and a raise on quarterly dividends at the end of January. In other words, the strong cash flow has allowed management to revalue the positions of shareholders. Nonetheless, cash flow has declined by 3 billion and the decline should be addressed in the short-term to secure a prosper future.

Strategy and Prospects

Besides continuing progress on ongoing projects, Mike Wirth, executive vice president, Downstream and Chemicals, added that the "strategy is to deliver competitive returns and grow earnings, including integration opportunities with our upstream business." 2013 is certainly not a good example of the strategy when looking at declining earnings. However, last year has to be interpreted as a transition year.

Most importantly for Chevron is a favorable market condition. Specifically, current oil prices are five times higher than a decade ago. Today, $100 per barrel price tag has replaced the historic $20 per barrel price tag. This has granted oil producers the necessary to embark in more ambitious projects. Currently, the company has four projects underway and continues to look for new opportunities. A characteristic highlighted by analysts at Zacks, when talking about the firm’s project pipeline quality.

Another good note for Chevron has been the divestiture of non-core and high-cost assets in order to rebalance the company’s asset portfolio. Trading at 10.5 times its trailing earnings, slightly above the 10.4 for the industry average, the stock is fairly valued. However, revenue and net income have declined over the last three years. And cash flow has been overtaken by debt during the last year.

Given the recent drop on stock price and undergoing projects, Jeremy Grantham (Trades, Portfolio)’s position increment is not trivial; especially when shareholders continue to be rewarded thanks to a strong cash flow. Hence, taking a long-term position in Chevron at this point is recommendable.

Disclosure: Damian Illia holds no position in any of the mentioned stocks.

About the author:

Damian Illia
A fundamental analyst at Lonetreeanalytics.com constantly looking for value and income investments.

Visit Damian Illia's Website


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