With the stock down 40% off its highs of $133 a share last July, Chevron (CVX) stock is uncharacteristically volatile for an integrated oil/gas major. Other integrated oil majors for example haven't suffered the same fate as Chevron over the last 12 months. Exxon (XOM) is down 25% and Royal Dutch Shell (RDS.A)(RDS.B) only 35%.
What’s going on?
A different business model
Chevron's business model is more focused on its upstream division. Exxon Mobil, for example, has a far bigger downstream division, which is why it has suffered less in this downturn. Accordingly, investors have traded Chevron strictly like an upstream company compared to other integrated oil majors. Only until oil bottoms will this bearish attitude change.
Renewed fears over the health of the Chinese economy have also made investors sell their shares in an attempt to secure profits and to de-risk their investment portfolios. While Chevron has made it through past oil market downturns without cutting its dividend, its yield is at all-time highs with profits plummeting. Things may not end as well this time around, even if the company continues to operate for decades to come.
When is production growth a bad thing?
Production is predicted to go from 2.6 million barrels of oil per day to 3.1 million-plus by the end of 2017. Surprisingly, this is a major reason why investors are disenchanted with the company’s growth strategy.
For example in Australia, the company is rolling out a $55 billion-plus LNG project. The project started out with an estimated cost budget of $37 billion, but equipment malfunctions and severe weather conditions quickly inflated the cost to $55 billion-plus. This project is now the most expensive LNG project in the world and comes on during a massive supply glut.
The company’s Big Foot development in the Gulf of Mexico is also experiencing its fair share of problems. A few weeks ago, the company pushed back its anticipated completion date to 2018, a delay of two years. While Chevron expects gaining 200 million recoverable barrels of oil with producing 75,000 barrels of oil per day from this project, a major delay is the last thing it needs with earnings and cash flow plummeting.
While the company urges investors to think long term, this hasn’t helped keep the share price afloat during the latest oil/gas company rout. While most peers are slashing capex by as much as 40% (e.g., Occidental Petroleum [OXY]), Chevron has less financial flexibility given its need to spend on finishing up multiple large projects. It has turned to less attractive options such as selling off assets (during an industry bear market) and cutting employees.
While production growth is typically attractive, having so many projects at an advanced stage when the oil rout started in June of last year put Chevron in a tough position.
Think long-term
Chevron’s cash flow profile should improve as many of its major projects are nearing completion. As mentioned the company is currently finishing several major projects. Assumingly, the company will go from funding projects to generating cash from them as production starts. Capex peaked in 2013 at $38 billion, dropping to $32 billion this year, $28 billion next year, and low $20s in 2017. This means that even in a $40 to $45 price environment, the company should be free cash flow positive by 2017, although the years between that shift may be rough.
Investors pick up a lot of yield and can lock in 5.3% for several years. Given its balance sheet, refineries, and capex needs, Chevron is still a durable company that should do fine in a low oil price environment with room to improve as prices rise. Long-term investors willing to forgive the company’s troubles over the next 12-24 months should be very interested.
