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On July 20th, Chevron Corporation (CVX) announced an agreement to acquire Noble Energy, Inc. in an all-stock transaction valued at $5B, or a total enterprise value of $13B when debt is included.
Summary
- On July 20th CVX announced an agreement to acquire Noble Energy, Inc. in an all-stock transaction valued at $5B, or a total enterprise value of $13B when debt is included.
- I expect CVX will continue to benefit from its oil-leveraged portfolio that has led to peer-leading margins and returns on capital.
- CVX has accumulated U.S. unconventional acreage through smaller deals and has, to date, avoided overpaying and destroying value like some of its peers.
- CVX's preferred method of returning cash to shareholders is through dividends. The current investment plans provide it with flexibility in the event of volatile oil prices which gives some reassurance that dividend growth will continue.
- I have a long-term positive outlook on CVX and have used the opportunity to acquire additional shares while CVX's share price is under pressure.
Introduction
As a long-term investor seeking to acquire fairly valued/undervalued shares in high quality companies, I readily admit that current market conditions are highly unfavorable. In previous articles I have expressed my concern that the value of many companies in which I would like to increase my position, or initiate a position, appears to have become detached from reality. As a result, I patiently hope for another broad market pullback similar to that experienced in March at which time I was able to acquire shares in several high quality companies; articles in which I disclosed my purchases in March and April can be found here. Subsequent to that article I have limited my purchases, other than by way of automatic dividend reinvestment, to a handful of companies.
Following Chevron Corporation's (CVX) July 20th announcement of its agreement to acquire Noble Energy, Inc. (NBL) in an all-stock transaction valued at $5B, or a total enterprise value of $13B when debt is included, I decided to acquire additional CVX shares.
Details of NBL Acquisition
While the transaction has been unanimously approved by the Boards of Directors of both companies and is expected to close in Q4 2020, the acquisition is subject to NBL shareholder approval and regulatory approvals and other customary closing conditions.
Details of the transaction can be found here and the presentation which accompanies the announcement can be found here.
CVX Demonstrates Discipline
Acquisitions are often fraught with risk. Projections on which a takeover bid was made may not materialize, the integration of the acquired company may not go smoothly, or some unexpected major event may arise (eg. COVID19) which throws a wrench in even the best laid plans. This is why it is extremely important for a company to exercise discipline when acquiring a company. In my opinion, CVX has demonstrated that it is quite capable to 'walk away from the table' when it is of the opinion its acquisition target has become too richly valued because another company has tossed caution to the wind and has bid up the value of the acquisition target to a level where there is no/little margin of safety.
You may recall that CVX announced in April 2019 its agreement to acquire all of the outstanding Anadarko Petroleum Corporation shares in a stock and cash transaction valued at $33B; terms of the agreement assigned a $50B total enterprise value for Anadarko. Occidental Petroleum Corp. (OXY), however, stepped into the picture and offered to acquire Anadarko for $38B at which time CVX exercised discipline and backed away from its offer deeming OXY's bid overpriced and not worth matching.
Anybody who has followed OXY subsequent to the closing of the Anadarko purchase is well aware how poorly that acquisition has fared to date. Moody's has downgraded OXY's long-term debt further into non-investment grade territory and S&P Global has OXY's long-term debt under review with negative implications. We also see from OXY's stock chart that the share price has dropped from ~$47 at the time OXY completed the acquisition in early August 2019 to the current ~$15.70/share. Furthermore, OXY's dividend has been cut....not once...but TWICE! Clearly, OXY shareholders have fared poorly from this grossly overvalued acquisition.
By comparison, CVX shareholders have also taken a hit subsequent to early August 2019 as shares have dropped from ~$120 to ~$85. Its long-term credit ratings, however, have remained steady at Aa2 (Moody's) and AA (S&P) - both are the middle tier within the High Grade category, and the quarterly dividend was raised from $1.19/share to $1.29/share when the Q1 dividend was declared January 29, 2020.
Financial Results
CVX is scheduled to release Q2 and YTD2020 results on July 31st. Until such time as these results become available I encourage you to review Q1 2020 results.
In my February 4th article I included a link to CVX's November 2019 Investor Presentation; CVX updated its Investor Presentation in May 2020.
Looking at CVX's financial position it appears that its capital discipline has positioned the company to weather what could potentially be a prolonged period of weak prices for its output. There is no disputing that an extensively long weak pricing environment could most certainly have a detrimental impact on CVX's financial position but this is the nature of the business in which CVX operates. Investors in companies which operate in this space need to prepare themselves for some very lean periods. This is why I highly encourage investors to stick with the strongest industry participants with CVX certainly ranking very close to being the 'safest'.
Credit Ratings
Moody’s rates CVX Aa2 with a stable outlook and S&P Global has assigned an AA rating; S&P has the currently assigned rating under review with negative implications. These ratings are the middle tier of the high grade category and are satisfactory for my conservative investment nature.
Free Cash Flow (FCF)
FCF (and its trend) is a key metric I look at when analyzing a company because it represents the cash a company generates after cash outflows to support operations and to maintain its capital assets. Unlike earnings or net income, FCF is a measure of profitability that excludes non-cash expenses reflected in the income statement (eg. depreciation, amortization, and writedowns) and includes spending on equipment and assets as well as changes in working capital.
Looking at CVX's FCF for 2010 - 2019 we see the following results in BILLIONS of dollars: $12, $15, $8, -$3, -$4, -$10, -$5, $7, $17, and $13. As you can see, there can be some very lean years and there can also be a few consecutive lean years. Companies within the peer group CVX has reflected in its May 2020 Investor Presentation (XOM, RDS, BP, TOT) have either experienced years of negative FCF or VERY wide swings in FCF from year to year.
Dividend and Dividend Yield
CVX’s dividend history can be accessed here.
At the time of my February 4th article, CVX had just closed at $106.86 and with the new $1.29/quarter/share dividend, investors were receiving a ~4.83% dividend yield. As a Canadian resident who holds shares in a couple of different non-registered accounts I incur a 15% withholding tax thus reducing my quarterly dividend to ~$1.10 for a dividend yield to ~4.12% ($4.40/$106.86).
With shares now trading at $85.27, investors are earning a dividend yield of ~6.05%. In my case....~5.1%.
Valuation
CVX earned $1.93 in Q1 2020 versus $1.39 in Q1 2019 but the world has changed dramatically subsequent to March 31st. I am, therefore, very reluctant to try and estimate CVX's current valuation.
I do take comfort, however, that CVX has undertaken the following actions in response to current conditions:
- Maintaining safe and reliable operations;
- Reducing short-cycle capital - capital & exploratory expenditures reduced from $20B reflected in the FY2020 budget to $14B;
- Driving operating costs savings;
- Guarding its balance sheet - this includes suspending the share repurchase program and protecting the dividend;
- Preserving long-term value - complete projects already under construction and defer short-cycle investments.
Final Thoughts
In this section of my February article I explained why I had just increased my exposure to CVX. My position has not changed and with the drop in CVX's share price subsequent to publishing that article I have acquired a few more shares.
My daughter and her boyfriend do not currently have exposure to any integrated oil and gas company in their respective investment accounts. Once they build some cash which can be deployed I would recommend they each consider initiating a position in CVX.
I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long CVX, XOM, and TOT.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
