In part 25 of the 54 part Dividend Aristocrats In Focus series, I take a look at the growth prospects and competitive advantage of Chevron (CVX, Financial). Chevron is the fourth-largest publicly traded oil corporation in the world (and 18th largest overall) based on market capitalization. The company has increased its dividend payments for 27 consecutive years, and has paid dividends for over 100 consecutive years. The company’s operations are examined in detail below.
Business Operations Overview
Chevron operates in two business segments; upstream and downstream. The upstream segment has been responsible for 87% of operating profits through the first half of 2014, while the downstream segment has contributed just 13% of operating profits to the company.
Chevron’s significantly larger upstream business is what has driven growth for the company over the last 100 years. The business of finding and producing oil has been extremely lucrative since oil began replacing less efficient forms of energy (like whale oil) in the 1860’s, prospecting and producing oil has been a high profit margin industry. It has produced many of the largest corporations we see today. The four largest have a combined market cap of over $1.2 trillion. These four are:
- Chevron with a market cap of $219 billion
- PetroChina (PTR, Financial) with a market cap of $231 billion
- Royal Dutch Shell (RDS-B) with a market cap of $234 billion
- ExxonMobil (XOM, Financial) with a market cap of $399 billion
Competitive Advantages
Major oil corporations have long enjoyed subsidies from their respective home governments. Energy production is a ‘national interest,’ and therefore the largest oil and gas corporations have a history of working with government. In 2013, U.S. federal and state governments provided $21.6 billion in subsidies for oil production and exploration. Chevron does its part to make sure favorable oil legislation is passed in the U.S. The company spent $10.5 million on lobbying in 2013, and has spent another $5 million in 2014 so far. This is not a political article and does not take a stance on whether oil subsidies and corporate lobbying are right or wrong, this is simply the society in which we live. Chevron has a significant and lasting competitive advantage by having influence over and relationships with the most powerful organization in the world, the U.S. government.
In addition to its government-based competitive advantage, Chevron is also a low-cost producer of oil and natural gas. The company has managed to invest more in low production cost projects than high production cost products. As a result, the company has had the highest upstream earnings margin per barrel of any major integrated oil corporation. The image below shows the company’s earnings margin relative to peers:
Source: October Investor’s Presentation
Chevron has a scale advantage over smaller competitors. The sheer size of the $200+ billion corporation allows it to take on operations and projects that smaller corporations simply do not have the size, money, and scale to achieve. Chevron regularly partners with other major integrated oil and gas corporations to tackle extremely large projects together; spreading capital expenditures over several companies and sharing in the rewards. This reduces the risk of the company’s portfolio while still taking upside in projects throughout the world.
Growth Prospects
Unfortunately for Chevron (and the rest of the world), oil is not a renewable resource. The company must continually work to replace exhausted reserves to grow production. Chevron has managed to replace its exploration resources over the last decade:
Source: October Investor’s Presentation
The company is well diversified across the world. Currently, Chevron produces the most in North America, and second most in the Asia Pacific region. The image below breaks the company’s oil and gas production down geographically:
Source: October Investor’s Presentation
Chevron’s future growth over the next several years will come from the projects it is currently developing. The company has operations throughout the world. The more important projects the company is working on are listed below:
- Permian Basin, with 17,000 well prospect sites
- Argentina, currently producing 20 MBOED, with additional exploration and production opportunities planned
- Deep water Gulf of Mexico operations; Jack/St. Malo project has 177 MBOED capacity, Big Foot project has 79 MBOED capacity, and Tubular Bells project has 44 MBOED capacity
- Australian Gorgon and Wheatstone projects will add 450 MBOED to the company’s production at peak operating capacity
The image below gives a visual representation of the company’s planned exploration projects which will propel growth over the next several years.
Source: October Investor’s Presentation
The story global scope presented above may seem impressive, but Chevron is not a fast growing business. The company has managed to increase revenue per share at just 3.4% per year over the last decade. Analysts project the company will grow revenue per share at around 4% to 4.5% over the next five years. I believe these projections are in line with the company’s history and current prospects. As a result, I would expect growth slightly faster than the preceding decade for Chevron, on a revenue per share basis.
Dividend Analysis
Chevron currently has a dividend yield of 3.7%. The company’s high yield should appeal to income-oriented investors. The company has a payout ratio of about 40%, giving it significant room to increase its dividend payments faster than overall company growth.
Chevron has done just that over the past decade. Despite mediocre overall company growth, Chevron managed to grow its dividend payments at about 10% a year over the last decade. I expect the company to continue growing its dividends between 7% and 10% per year for the next several years as it rewards shareholders with the strong cash flows it produces.
The company’s yield on cost if shares were purchased now in 5 years is shown below at several different dividend growth rates to give investors an idea of future income from Chevron:
- Yield in 5 years at 7% dividend growth rate: 5.2%
- Yield in 5 years at 8% dividend growth rate: 5.4%
- Yield in 5 years at 9% dividend growth rate: 5.7%
- Yield in 5 years at 10% dividend growth rate: 6%
Valuation
Chevron has historically traded a significant discount to the S&P 500’s PE ratio. Over the past 5 years, the company has averaged a PE ratio of about 0.6x of the S&P 500’s PE ratio. At the market’s current price, this implies a PE of 11 for the company. Chevron currently trades at a PE of 11.
While the company may be fairly valued on a historical basis, it appears undervalued based on its cash flow and growth potential. I believe the company is at least fairly valued, and most likely undervalued. I believe the market has put an unfair discount on Chevron despite its long dividend growth history and solid if unspectacular growth prospects going forward. If the company’s relative PE ratio rises even to 0.8x of the market’s PE, shareholders will be rewarded. In the meantime, you get “paid to wait” from the company’s high dividend yield.
Recession Performance
Chevron’s earnings per share dipped from $16.69 in 2008 to $11.26 in 2009. The company’s EPS fell in the Great Recession of 2007 to 2009 due to lower oil prices brought on by reduced demand for oil. Despite this, the company did not lose money; it only saw earnings decease by about 1/3 through the worst of the recession. By 2010, the company’s EPS had rebounded to $16.10, and had reached new highs of over $20 per share by 2011.
Final Thoughts
Chevron is a high quality business with a long history of rewarding shareholders through dividend payments and share repurchases from the significant cash flows it generates. It currently trades at a PE ratio of just 11, which seems low for such a shareholder friendly business.
Chevron is a Top 30 stock based on the 8 Rules of Dividend Investing due to its high dividend yield and fairly low payout ratio. The company has medium price volatility for a Dividend Aristocrat, and unimpressive growth. Despite this, I believe Chevron makes a sound investment for those looking for high current income and future dividend increases. The company will likely have a yield on cost of over 5% in 5 years, which may appeal to those nearing retirement.
