Dividend Aristocrats Part 33: Chevron Corporation (CVX) by Ben Reynolds, Sure Dividend

Chevron (CVX) stock currently has a dividend yield of nearly 5%. When I last analyzed Chevron in July, I though Chevron was undervalued.

Since that time, the stock has fallen an additional 8.4%

Now is one of the best times to buy Chevron stock since the mid 1990’s. The image below shows the company’s historical dividend yield.

Chevron Corporation (CVX)

This article examines the history of Chevron, whether or not its dividend is safe, and expected total returns from Chevron stock.

Chevron’s History: The Story of How Chevron Was Created

Chevron story goes back to 1879 when the Pacific Coast Oil Company was formed.

Dividend Aristocrats Part 33: Chevron Corporation (CVX)

Source: Oldgas Forum

In 1900 Rockefeller’s Standard Oil acquired the Pacific Coast Oil Company. The combined company did not last for long.

The Supreme Court forced Standard Oil to break up in 1911.

Source: Rare Newspapers

One of the company’s created in the forced break-up of Standard Oil was Standard Oil of California – which changed its name to Socal.

Socal grew in size from 1911 through 1977. In 1977 the company merged with 5 other domestic oil and gas businesses and renamed itself Chevron.

Chevron’s Diversification in Upstream & Downstream

The oil industry’s definitions of upstream and downstream are different than the common definition. In the oil industry, upstream and downstream have nothing to do with rivers.

Definition of upstream: Operations involved in the search, recovery, and production of oil and natural gas. Upstream operations include everything needed to bring oil to ground level.

Definition of downstream: Operations involved in the refining, selling, and distributing of oil and natural gas. Downstream operations prepare oil and natural gas into products and get them to the end user.

Chevron operates in both upstream and downstream segments.

The company’s downstream businesses tend to be more profitable with lower oil prices, while the upstream division is more profitable with higher oil prices.

Chevron is not evenly balanced between upstream and downstream. The bullet points below shows profits from each division (in millions) in the company’s results for the first 9 months of 2015 versus the first 9 months of 2014:

9 Months Fiscal 2014 9 Months Fiscal 2015
Upstream Gain of $14.2 billion Loss of $0.6 billion
Downstream Gain of $2.8 billion Gain of $6.6 billion

The upstream division is far more profitable than the downstream division when oil prices are high.

When oil prices are low, the downstream division sees profits grow. It is important to note that downstream growth does not offset upstream declines during periods of low oil prices.

Are Chevron’s Dividends Safe?

Are Chevron’s dividends safe?

That depends on what the definition of ‘safe’ is. Are Chevron’s dividend payments as secure is Coca-Cola’s (KO) or Johnson & Johnson’s (JNJ) or Procter & Gamble’s (PG)? Of course not. With that said, there is a very high likelihood Chevron does not cut its dividend payments.

First, oil prices are highly volatile. They are down now, but they will come back up eventually (then they will fall again, then they will rise again). Oil prices are extremely depressed right now. Here’s how Chevron can weather the storm of low oil prices over the next 2 years:

The company pays out around $8 billion a year in dividends. Additionally, the company announced a planned capital expenditures budget of $26.6 billion in 2016. Of the company holds its dividend constant and capital expenditures are around the same level in 2017 as planned 2016 expenditures, then Chevron will need around $61 billion over the next 2 years to finance its dividend, operations, and growth.

Chevron plans to generate between $5 and $10 billion over the next two years from asset sales. After accounting for asset sales, the company will need between $51 and $56 billion over the next 2 years from operations and new debt.

Operating cash flows in Chevron’s latest quarter were $5.4 billion. The average price of oil was around $49 in the company’s 3rd quarter in fiscal 2015. Operating cash flows in the first 2 quarters combined totaled $14.9 billion, with an average oil price of around $56 a barrel.

At current oil prices of around $35 a barrel, Chevron will generate little or no profits from its upstream division. Fortunately, the company’s downstream segment will help carry it through these difficult times. I expect the company to continue generating around $5 billion a quarter from operating cash flows at current prices. This comes to $20 billion a year, or $40 billion over the next 2 years.

After accounting for asset sales and operating cash flows, Chevron will still need between $11 billion and $16 billion in cash over the next 2 years. In addition, the company has around $7.5 billion in debt coming due over the next 2 years. This means that Chevron must finance between $18.5 and $23.5 billion over the next two years.

The company currently has about $13 billion in cash on its balance sheet. Subtracting that out means Chevron will need to raise between $5.5 billion and $10.5 billion in debt over the next two years. It is very likely that the company will be able to issue debt of between $5.5 billion and $10.5 billion over the next two years. The company issued $6 billion in debt earlier this year, with an interest rate of under 2%. The debt was rated AA.

Does management have the will to maintain its dividend payments? I believe the answer to that question is a “yes” as well (unless management pulls a ‘Kinder Morgan’). Here’s what Chevron’s CEO John Watson said in the company’s 3rd quarter earnings call:

“I would like to start by reinforcing that our priorities – financial priorities are unchanged. Our first priority is to maintain the dividend and grow it as the pattern of earnings and cash flow permit. As Pat mentioned, we announced our quarterly dividend earlier this week and are very proud of the fact that we’ve increased the annual per-share payout for 28 consecutive years. Back in March, we committed to delivering free cash flow to cover the dividend in 2017. At that time, the futures market was envisioning $70 prices in 2017. Today, the futures market is lower, but our intent remains the same.”

In an unprepared response to a questions, Watson said the following:

“But there is some uncertainty on price, and, look, I know my shareholders value our dividend. I know our shareholders value increases in the dividend. And I know they value us investing in high-return projects, and so there is some uncertainty on price. And we want to be sure that – we’ve kept our balance sheet in good condition, and we want to be sure we just strike that right balance to continue to pay and grow the dividend and invest in good projects. So we’re just working through the cycle and kind of living within our means while we take cost down.”

The bottom line is that projections are difficult (and often inaccurate). We don’t know what oil prices will do over the next 2 years, but Chevron’s management is prepared to continue cutting costs and managing cash flows to pay rising dividends. To be fair, I’d expect 1% growth or so over the next two years – just enough to continue making the claim the company can pay rising dividends – but management does prioritize the dividend.

Expected Total Returns

Chevron has grown earnings-per-share at an average of around 7.5% a year over the last decade. I expect Chevron to continue growing earnings-per-share in the 6% to 8% a year range over full economic cycles.

Obviously the company won’t be growing when oil prices are collapsing. Over the long-run, oil prices will stabilize. The company’s growth will come from a mix of increased energy demand, above-industry-average production growth, and share repurchases.

In addition to this earnings growth, Chevron offers investors a dividend yield of nearly 5%. The company’s dividend yield combined with its long-term expected growth rate gives investors expected total returns of between 11% and 13% a year over the long run.

Chevron’s Competitive Advantages

Major oil corporations get massive government subsidies because energy production is a ‘national interest’. The largest oil corporations (like Chevron) have a history of working with the United States Government.

The image below shows how important government positions often lead to lucrative roles in oil companies (including, of course, Chevron):

Source: Geke Econo Memes

In 2013 alone the United States federal and state governments provided $21.6 billion in subsidies for oil production and exploration. Chevron spent over $8 million in 2014 on lobbying.

Chevron Corporation (CVX)

Source: Open Secrets

Chevron has a significant and lasting competitive advantage by having influence over and relationships with the most powerful organization in the world, the United States government. 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.

In addition to its government based competitive advantage, Chevron is also a low-cost producer of oil and natural gas.  Chevron’s large size allows it to invest in the largest and most profitable oil and gas ventures. 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.

Recession Performance

The last time oil prices fell precipitously was the Great Recession; in 2009. Chevron’s earnings-per-share through the Great Recession and subsequent recover are shown below:

  • 2007 earnings-per-share of $8.77
  • 2008 earnings-per-share of $11.67 (high at the time)
  • 2009 earnings-per-share of $5.24 (recession low)
  • 2010 earnings-per-share of $9.48
  • 2011 earnings-per-share of $13.44 (new high)

While Chevron sees earnings decline significantly during periods of low oil prices it remains profitable. A similar outcome is likely in today’s low oil price environment.

Final Thoughts

Chevron is currently trading at just 6.4x its peak earnings (from 2011). The company appears deeply undervalued at this time.

Chevron is cheap due to oil price declines. If oil prices rise Chevron shareholders could see large gains from both increased earnings and a higher price-to-earnings ratio.

Chevron has an above average range using The 8 Rules of Dividend Investing. The company’s extremely high dividend yield, low valuation, and solid growth prospects should provide market-beating returns for dividend growth investors who can withstand the stock’s high volatility and above average risks.