Most oil companies have been hit hard by low crude prices. The majors, however, have mitigated some of the impact due to diversified business lines and low costs of production. Still, Chevron (CVX) has underperformed its similarly sized peers such as Exxon (XOM), Royal Dutch Shell (RDS.A)(RDS.B), and BP (BP) over the past 12 months.
What’s with the lag?
Expansion Isn’t What the Market Wants Right Now
With low crude prices, most investors and analysts are focusing on free cash flow generation. For example, Exxon popped last month when Goldman Sachs (GS) forecasted that the company would still be able to grow free cash flow at single digits rates even with low oil prices. Chevron and BP meanwhile would have flattish growth per Goldman estimates.
Despite the fall in prices however, Chevron has a goal of of tapping 3.1M bbl/day of oil and gas by 2017. Even as its cash flow sinks, the company is focusing on new, multibillion-dollar projects (namely a $54-billion natural-gas export plant in Australia) aimed at boosting its oil and gas output by roughly 20% within two years.
“Multiple efforts to improve future earnings and cash flows are underway,” Chevron said in a statement. “We are focused on getting current projects under construction online, which will provide incremental production and cash generation.”
Wall Street is clearly unhappy with this strategy, with one analyst from IHS Energy stating that:
"The most important thing to preserve is value, even if it means they have to sell some of their crown jewels, or small slivers of them, to raise billions of dollars and help maintain the balance sheet and the dividend, that’s what they should do."
According to a recent WSJ article:
“Chevron continues to outspend Exxon, which generates twice as much revenue. If oil prices stay low, as many energy economists are now predicting, Chevron might have to sell more of its holdings to pay its dividend. Such a move could jeopardize the oil behemoth’s goal of tapping 3.1 million barrels of oil and gas a day by 2017.”
Chevron is Betting Oil Prices Improve
Chevron is more upstream-oriented than other integrated companies, meaning it will suffer more in an oil downmarket. Should oil prices improve, investors should expect it to outperform. However, there’s reason to believe the Chevron is in dire straits if conditions don’t get better. This is in contrast to peers like Exxon, which are still expected to grow free cash flow and support the dividend even if we experience prolonged periods of depressed crude prices.
Below is a chart depicting Chevron’s historical free cash flow, capex spending, and dividend payments. Currently, all are negative (between $7-9 billion annually each). Additionally, we’ve seen capex roll off over the past year or so with the wrapping up of several major projects. This provides little ability to roll back those expenses further. The last 12 months of capex spending is already close to 5-year lows and is clearly on a long-term downtrend due to the rising costs of production.
This means the Chevron is betting that its current projects are going to improve cash flow significantly. To break even, the company would need to generate $8.5 billion in free cash flow just to support its dividend, not to mention covering the billions in maintenance capex per year to support the current output. Last time the company generated this much free cash flow was in 2013, when oil prices were >$100.
Conclusion: Stay Away if You’re Not Bullish On Oil
Unless you’re anticipating a big oil correction back to the likes of >$80, it’s tough to believe that Chevron is capable of growing overall shareholder value. Sure the company may skimp on future spending or sell of some assets to support the dividend, but investors will surely hurt overall.
Management is currently setting up the business for a reversal in oil prices. If you’re invested in the company, you better expect the same.
For more ideas like this one, check out GuruFocus’ High-Yield Dividend Stocks List or the rest of R. Vanzo’s Articles.
