Chevron Corporation – Buy While Undervalued

In my January 12, 2021 Chevron Corporation (CVX) post, I disclose my periodic acquisition of CVX shares. In this post, I disclose the purchase of an additional 100 CVX shares within a 'Core' account in the FFJ Portfolio.

CVX is scheduled to release Q2 and YTD results on July 30th so there is little point in reviewing Q1 results. I, however, provide links to the Q1:

to aid you in your review of the company.

Chevron Corporation - Supply Outlook

I think the world stands on the cusp of an oil supply crisis and envision an increase in oil and gas prices over the coming decade.

Over the last 7 years, there has been insufficient investment in offshore mega-projects. In addition, the:

  • end of hyper-growth in the US shale space; and
  • a shift by global supermajors to preferentially invest in alternative energy over traditional hydrocarbons

have resulted in an oil industry that lacks the ability to meaningfully grow its production in the years ahead.

I think the delusion of an imminent peak oil demand is having a profound impact on the willingness of companies to invest in large and extremely expensive projects that often take 4 - 6 years to come onstream and a further 4 years to recoup the initial investment. The uncertainty about oil and gas demand a decade into the future is leading to peak supply because it is increasingly difficult to justify sanctioning multi-billion dollar projects that take 8 - 10 years to reach payout.

As noted earlier, there has been insufficient investment in offshore mega-projects over the past 7 years. Given the highly capital-intensive nature of the industry, global offshore production (~1 in 4 barrels produced) has now entered a period where new projects cannot offset existing declines. At best, production will stay flat for the next several years.

The significant loss of future capacity means the burden falls on US shale and OPEC to satisfy demand growth. Therein lies the challenge.

In recent years, we witnessed hyper-growth in the US shale basins. This, however, ended up being a failed experiment of unbridled spending due to unlimited access to external capital. Literally, hundreds of billions of dollars of shareholder equity were wiped out.

The old model of massively outspending cashflow and chasing growth has evolved to the return of capital to investors in the form of dividends and share buybacks. When we combine this change with the depletion of much of the higher quality drilling inventory we now have, a US shale future growth rate will be a fraction of historical levels.

We are now at a turning point because had it not been for the rise of US shale over the past 5 years, non-OPEC production would have been flat. Global demand, however, grew by ~6 million barrels/day.

With US shale expected to, at best, meet half of future demand growth and with no global offshore growth, the burden falls on OPEC. OPEC countries, whose very ability to remain going concerns and satisfy their sovereign needs, have struggled for years with insufficient revenue due to weak oil prices. Many countries have had to deplete foreign exchange reserves, sell stakes in crown corporations, and cut social spending.

The market is currently concerned with the eventual return of ~6 million barrels/day of voluntarily curtailed OPEC production. However, the stronger-than-expected rebound in global oil demand leads me to believe these volumes will be easily returned without disrupting oil balances by early 2022.

Since sovereign needs supersede the investment in new capacity once this voluntarily curtailed production returns, OPEC is likely to exhaust its spare capacity. In addition, OPEC lacks the ability to significantly grow in the years ahead

Chevron Corporation - Demand Outlook

Although governments throughout the world are racing toward decarbonization, an eventual carbon-neutral future is no replacement for our current energy reality.

Before COVID-19, the world's daily consumption was 102 million barrels of oil; projections are for this level of consumption to be restored by the end of 2021.

Of these 102 million barrels, ~60% is used for transportation and the remaining ~40% is used for things such as petrochemicals, lubricants, and agriculture for which there is no real alternative.

The electrification of various modes of transportation will likely take decades to reach high penetration rates. By the time this occurs, the number of internal combustion engine vehicles will have grown significantly. Furthermore, the displacement of diesel by hydrogen is likely to only become a factor by the mid-2030s.

We also need to factor into the picture the projected growth in the world's population. Projections call for growth from the current ~7.8B people to ~9B by 2040. This will very likely lead to a ~25% increase in total energy demand. Most of this population growth is expected to be in emerging countries whose citizens seek the energy-intensive lifestyle of the West and whose priorities are energy access, affordability, and reliability. Achieving net-zero emissions status is not their priority!

Interestingly, Raj Kumar Singh, India's Energy Minister lambasted the richer world's carbon-cutting plans at a major climate conference earlier in 2021. He called long-term net-zero targets, 'pie in the sky' and stated that poor nations want to continue using fossil fuels and the rich countries 'can't stop it'.

Clearly, economic development and not decarbonization is a priority for poorer countries with a growing population.

Population growth coupled with the very long timeline for electrification/hydrogen to reach scale means that global oil demand will very likely grow for at least another decade at which time it may crest and slowly fall.

Chevron Corporation - Buy While Undervalued - Credit Ratings

In multiple posts, I indicate my unwillingness to assume unnecessary investment risk. Furthermore, I am cognizant that as an equity investor I assume a greater level of risk than debt holders. I, therefore, shy away from companies where the unsecured debt is non-investment grade.

CVX's senior unsecured domestic currency debt ratings are:

  • Moody's: Aa2 (this is the middle tier of the high-grade investment-grade category).
  • S&P Global: AA- (this is the bottom tier of the high-grade investment-grade category).

Both ratings define CVX as having a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.

Chevron Corporation - Dividends and Share Repurchases

Dividend and Dividend Yield

Looking at CVX's dividend history, we can expect the second $1.34 quarterly dividend to be declared at the end of July.

Based on the current ~$99 share price, the dividend yield is ~5.4%. This yield is reduced to ~4.6% if shares are held by a Canadian resident in a taxable account because of the 15% withholding tax.

Share Repurchases

CVX continues to reduce its share count with the diluted weighted average shares outstanding in FY2011 - FY2020 (in millions) of 2,001, 1,965, 1,932, 1,884, 1,875, 1,873, 1,898, 1,914, 1,895, and  1,870. This share count increased in Q1 2021 to 1,916 but I expect a resumption in the reduction of CVX's share count over the remainder of FY2021.

Details of CVX's share repurchases in Q1 are on page 38 of 46 in the Q1 10-Q.

Chevron Corporation - Buy While Undervalued - Valuation

I expect the 27 brokers who have provided adjusted diluted EPS guidance for FY2021 and FY2022 will revise their figures upwards following the release of Q2 results. However, based on a ~$99 share price and current estimates, which vary significantly, I come up with the following adjusted diluted PE levels.

FY2021: mean of $6.32 and a low/high range of $4.95 - $8.50. The forward adjusted diluted PE using the mean estimate is ~15.66 and ~14 if I use $7.

FY2022: mean of $7.23 and a low/high range of $5.05 - $10.44. The forward adjusted diluted PE using the mean estimate is ~13.7 and ~11 if I use $9.

I view these levels as attractive.

Chevron Corporation - Buy While Undervalued - Final Thoughts

I think the demise of the oil and gas industry is greatly exaggerated. In fact, I believe we are at the beginning of a multi-year oil bull market.

The world no longer possesses short-cycle supply and it has become increasingly reliant on long-cycle supply from:

  1. the supermajors who are no longer willing to sufficiently invest;
  2. state-owned oil companies facing financing constraints due to other sovereign spending priorities.

Global oil inventories have already nearly healed from the COVID-19 demand shock. Secondly, challenges with future production growth rates suggest to me that we are on the verge of a supply crisis. This will very likely lead to much higher oil prices in the coming years.

Given CVX's current depressed valuation and what I expect will be a coming boon in its cashflow, I think investors can expect a strong probability of shareholder returns that exceed those of recent years. On this basis, I have acquired another 100 shares at ~$99/share.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long CVX.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.

I wrote this article myself and it expresses my own opinions. I do not receive compensation for it and have no business relationship with any company mentioned in this article.