Shares of Chevron Corp. (CVX, Financial) have railed more than 37% over the last year as the company continues to see the double benefit from higher demand from the ongoing recovery of the Covid-19 pandemic in combination with a lower supply. This has driven prices for energy products higher.
The company recently reported what may have been its best quarter in many years.
Even with the stock making several new 52-week highs since the earnings report, Chevron still appears to be attractively valued while also offering a high dividend yield.
Let’s dig deeper to see why the stock looks appealing.
A rundown of earnings highlights
Chevron reported third-quarter earnings results on Oct. 29. Revenue surged 83% to $44.7 billion, beating Wall Street analysts’ estimates by nearly $4 billion. Adjusted earnings of $5.7 billion, or $2.96 per share, compared extremely favorably to adjusted earnings of $340 million, or 18 cents per share, in the prior year.
Reported earnings of $6.1 billion, which includes a benefit from asset sale gains and foreign currency tailwind, was the highest since the first quarter of 2013.
Higher average energy prices helped drive results. Brent averaged $74 for the quarter, up from $43 per barrel in the prior year due to increased demand. OPEC and Russia production cuts remain in effect, helping to keep a lid on supply.
Another tailwind for the company was a 7% increase in oil production to just over 3 million barrels of oil equivalent per day from the prior year. Much of this growth came from the company’s completed purchase of Noble Energy on Oct. 20, 2020.
Both upstream and downstream businesses performed very well. Upstream earnings swung from $235 million to $5.1 billion, while downstream earnings were up more than 400% from the prior year.
U.S. Upstream benefited from higher crude oil prices as well as increased volume as demand as improved greatly since the prior year. The average price of crude oil and natural gas liquid nearly doubled to $58. Natural gas averaged $3.25 per thousand cubic feet, compared to just 89 cents in the prior year. Production topped 1.1 million barrels per day, mostly due to a contribution from Noble Energy. Natural gas production increased 13% to more than 1.7 billion cubic feet per day.
Pricing and volume were also a tailwind for International Upstream. Price per barrel reached $68 from $39 year over year while natural gas averaged $6.28 per thousand cubic feet compared to $3.89 a year ago. Oil-equivalent production was up 3% to 1.9 million barrels per day. Net liquids declined 6% to 915,000 barrels per day. Natural gas production grew 13% to 5.95 billion cubic feet per day.
U.S. Downstream saw higher margins on the sale of refined product as well as higher volumes. The company’s ownership stake in Phillips Chemical Co. also aided results. Refinery crude oil input was up 9% to 895,000 barrels per day, with refined product volume climbing 18% to nearly 1.2 million barrels. International Downstream had a 2% increase in crude oil input to 584,000 barrels per day, while refined product sales improved 8% to 1.39 million barrels. Both U.S. and International saw increase in demand for gasoline, diesel and jet fuel.
The production increase coupled with higher prices helped to deliver a company record free cash flow of $6.7 billion. This additional free cash flow was used in part to pay dividends, but also to reduce debt by $5.6 billion. As a result, Chevron’s net-debt-to-capital ratio reached 19%, which is below the company’s long-term target of 20% to 25%.
The additional free cash flow will also be put toward share repurchases, of which Chevron expects to make $750 million of during the fourth quarter.
According to analysts surveyed by Yahoo Finance, Chevron is expected to earn $8.04 in 2021, which compares to a loss of 20 cents per share in 2020. This would also be a nearly 30% improvement from 2019 as well as the company’s best result since 2014 if achieved. Those same analysts expect earnings per share of $9.27 in 2022, which would be a 15% improvement from this year’s estimate.
Takeaways and analysis
Chevron’s results easily beat estimates on the top and bottom lines, though this was against one of the company’s weakest quarters in recent memory as the prior period felt the pressure of the Covid-19 pandemic.
However, going back to the pre-pandemic third quarter of 2019, results were still impressive. Compared to that quarter, revenue grew 24% while adjusted earnings and adjusted earnings per share both nearly doubled.
Upstream and downstream both had sizeable gains in the quarter. Looking again at the third quarter of 2019, upstream and downstream earnings were higher by 89% and 58%.
Downstream benefited from higher jet fuel sales as international travel continues to pick up. With more countries allowing international visitors, including the U.S. as of Nov. 8, this business should continue to improve.
The company also expects its assets to see strong production growth rates into the middle of the decade. For example, the Permian Basin produced 575 million barrels of oil equivalent per day last year, but this is expected to rise to more than 1 million over the next three years.
Another way that Chevron can expand its revenue base is by making inroads into renewable energy as the world focuses on reducing emissions. For example, the company recently sold its first sustainable aviation fuel to Delta Air Lines Inc. (DAL, Financial) at the Los Angeles International Airport. This fuel, produced from the company’s El Segundo refinery, is being used by one airline at one airport, but this does demonstrate that Chevron is at least aware of the increasing importance of renewable sources of energy.
Another example of the company’s efforts to reduce emissions and raise the contribution from renewable energy to results is its joint venture with Bunge Ltd. (BG, Financial), which happens to be the largest oilseed processor in the world. Half of the joint venture will be owned by each company, with Chevron investing $600 million into biofuel. This also gives the company another avenue for growth as renewable energy becomes more important to the world.
Earnings growth has been wildly inconsistent over the past decade as the company has had to navigate steep declines in energy prices several times. In fact, even reaching analysts’ estimates for this year puts Chevron far short of results seen in 2014. To put this in perspective, earnings per share reached a 15-year high of $13.44 in 2011, but swung to a loss of $2.96 last year.
As you can imagine, this has led to wild swings in valuation, from the high single digits to the high 30 times earnings range over this period of time.
Shares of the company trade at $114 presently, putting the stock within 2% of its most recent 52-week high. Using analysts’ expectations for the year, Chevron has a forward price-earnings ratio of 14.2.
Much can happen in 12 months, but the calendar is now close enough to 2022 that there is some more visibility for the company into next year. Energy prices remain high and OPEC and Russia appear committed to production cuts even as Chevron hopes to grow its production. Demand is also likely to remain high as the economy opens up and travel becomes more normalized.
Using next year’s earnings estimates, Chevron is trading with a forward price-earnings ratio of just over 12. This valuation would be among the lowest if shares were to average it for an entire year.
While earnings growth has been erratic, Chevron has managed to raise its dividend for the past 34 years, the second-longest streak amongst the major energy companies. The dividend has a compound annual growth rate of nearly 6% since 2011.
According to management, the company’s collection of assets allows it to fund its dividend even if the price of oil is close to $40. With prices well off this figure, the dividend looks to be extremely safe.
The free cash flow payout ratio supports this stance. The company distributed $2.6 billion in dividends last quarter, leading to a free cash flow payout ratio of 46%. Over the last year, the free cash flow payout ratio expanded to 70%, in line with the three years prior to the pandemic.
Shares yield 4.7% today, more than three times the average yield of the S&P 500 Index.
Final thoughts
Chevron turned in its best quarter in more than eight years, with excellent results across its segments. Even against more normalized comparable periods, the company still had high revenue and earnings growth rates.
The increased demand for energy products as the Covid-19 recovery takes place, combined with limited supply, has caused energy prices to return to levels not seen in years. Chevron leveraged this combination to generate record free cash flow, which was used to improve its balance sheet.
The stock trades with a low valuation when considering next year’s expected earnings per share. If the company is able to put together several quarters with similar results to this past quarter, then it could be that estimates are too conservative.
With a reasonable valuation and a nearly 5% dividend yield, Chevron appears to be an undervalued stock that offers a safe and high level of income.
