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I continue to have a positive outlook on Chevron Corporation's (CVX) long-term potential.
Summary
- CVX released Q4 and FY2019 results on January 31, 2020 in which it reported in excess of $27B in cash from operating activities and in excess of $13B in Free Cash Flow (FCF).
- FY2019 EPS was negatively impacted by $10.4B in writedowns in its US and International Upstream portfolios. These writedowns do not impact FCF.
- CVX communicated a quarterly $0.10/share (8.4%) increase in its dividend effective with the dividend payable March 10th.
- CVX has indicated it will continue to repurchase shares at the rate of ~$5B/year.
- CVX is currently reasonably valued and provides investors with an opportunity to invest in a high quality company which has fallen out of favor with the broad investment community.
Introduction
In my FFJ Portfolio – January 2020 Report I indicated there would be a dearth of articles on this site over the next ~1.5 months as I will be travelling during most of this timeframe.
Although my priority is to pack for our impending trip to Costa Rica, I am providing this brief article to disclose the purchase of more Chevron Corporation (CVX) shares for one of the ‘Core’ accounts within the FFJ Portfolio.
Regretfully, we continue to witness ‘irrational exuberance’ following the broad market pullback we witnessed January 31st; I cannot possibly imagine how the value of many companies can increase by billions of dollars within a couple of trading sessions!
If we look at Tesla, Inc. (TSLA), for example, it has yet to generate a profit and it has incurred over $8B in negative Free Cash Flow subsequent to FY2013! Investors, however, still pile into TSLA to the degree which is reminiscent of the ‘dot.com’ craze.
I readily acknowledge some investors will make a fortune with their speculative TSLA ‘investment’ but I think TSLA is a game of musical chairs. The probability of many investors losing a LOT of money on TSLA is almost a 100% certainty.
In addition, to ‘cash burners’ like TSLA, you also have a gamut of companies which are profitable and which generate strong Free Cash Flow (FCF). The problem with many of these companies, however, is that their valuation is in the ‘nosebleed’ level. Several of the companies on my ‘watchlist’ currently have Price/Earnings multiples well in excess of 30:1.
In the case of CVX, however, you have a company generating billions in cash from operating activities and in FCF. It has also just announced an attractive increase in its quarterly dividend and it has reaffirmed its intent to repurchase ~$5B of its shares in FY2020. Despite these ‘positives’, CVX’s share price is under pressure which brings me to my decision to acquire additional shares.
Q4 and FY2019 Results
On January 31st, CVX released Q4 and FY2019 results. Details can be accessed here. The presentation which accompanied the earnings release and conference call with analysts can be accessed here.
In addition to these recently released results you may wish to review the November 2019 Investor Presentation.
FY2020 Guidance
Management is optimistic CVX is positioned to succeed in any environment. While commodity prices and/or margins are challenging, management has indicated that as a result of its high quality portfolio, capital discipline, low execution risk and financial strength, the company is well positioned for FY2020.
CVX is committed to maintain organic capital spending at $20B; CVX will maintain its commitment to capital discipline and in FY2020 the capital budget will be flat for the 3rd consecutive year.
Chevron's capital program is also unlike that of its peer group. The spend profile has low execution risk and is focused primarily on short cycle, high return investments that are expected to sustain and grow the enterprise over the long-term.
The plan is to return significant cash to shareholders through dividends and share buybacks.
Credit Ratings
In my opinion, far too many investors focus on the potential return of an investment and pay insufficient attention to risk.
Sticking with my TSLA example, I see that Moody’s rates the long-term debt as B3 and that S&P Global rates its debt B-. These ratings are equivalent and are the lowest tier of the highly speculative category.
These are debt ratings and we know that common shareholders have even less protection than debt holders. As a result, if you are a TSLA shareholder, you are taking on substantial risk.
On the other hand, Moody’s rates CVX Aa2 with a stable outlook and S&P Global has assigned an AA rating. These ratings are the middle tier of the high grade category and are satisfactory for my conservative investment nature.
In case you are wondering….there is 12 rating categories between AA2/AA and B3/B-.
Free Cash Flow (FCF)
I have indicated in many articles that FCF is one of the key metrics I look at when analyzing a company.
The reason I pay so much attention to FCF is 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.
CVX’s FY2019 results are a good example of why I view FCF as a key metric.
Were we to base our investment decision on the basis of CVX’s diluted EPS, we would likely be concerned with CVX’s FY2019 results since it reported $1.54 in diluted EPS versus $7.74 in FY2018. What we need to take into consideration is non-cash related impairments & write-downs of $10.4B and non-recurring asset dispositions which generated $1.2B.
Looking at page 18 of the Q4 2019 Earnings Presentation, we see that CVX generated $13.197B of FCF. This explains, to some extent, how CVX was able to disburse $9B in dividends and to repurchase $4B of shares outstanding while repaying ~$7.8B of debt (page 4).
CVX’s dividend history can be accessed here.
On January 29th, CVX’s Board of Directors declared a quarterly dividend of $1.29/share, payable March 10th to all holders of common stock as shown on the transfer records of the Corporation at the close of business February 18th. This is a ~8.4% increase from the previous $1.19/share quarterly dividend.
If you look at CVX’s dividends in FY2014 – 2017 you will see the dividend was briefly frozen at $1.07. When dividend increases resumed, the quarterly dividend was only increased by $0.01.
Over time, there have been many companies where, in hindsight, a dividend freeze/cut was essential but was never made. In the case of CVX, however, a freeze was warranted a few years ago and the Board made the difficult and unpopular decision to do so. The fact CVX’s Board has recently approved a $0.10/share dividend increase suggests to me there is strong degree of confidence that the new quarterly dividend is sustainable.
With CVX’s share price having closed at $106.86 on February 4th, the new $1.29/quarter/share dividend provides investors with a ~4.83% dividend yield. Should you be a Canadian resident like me and you hold CVX shares in taxable accounts, you incur a 15% withholding tax. This reduces the quarterly dividend to ~$1.10 thus reducing the dividend yield to ~4.12% ($4.40/$106.86).
Looking at the weighted average number of diluted shares outstanding (in millions of shares) for FY2019 and FY2018 we see a slight reduction to 1,895,126 from 1,914,107. As previously indicated, management has recently reiterated its plan to repurchase shares totalling $5B/year.
Valuation
The significant write-downs in FY2019 have distorted CVX’s earnings. Rather than rely on the $1.54 in diluted EPS to determine CVX’s valuation I am using $6.27 in adjusted diluted EPS which excludes special items and FX. With shares trading at $106.86 we get an adjusted diluted PE of ~17.04.
The mean FY2020 adjusted diluted EPS guidance from 22 analysts is $6.78. Using this guidance and the current share price we get a forward adjusted diluted PE of ~15.76.
This forward valuation is slightly better than when I wrote my August 17, 2019 and November 29, 2019 articles.
Final Thoughts
If we look at the world’s projected energy mix for the 2018 – 2040 timeframe, we see that ‘Other Renewables’ is expected to experience significant growth. Oil and natural gas, however, are still expected to be dominant.
In addition, OPEC and its allies are not about to easily give up on what has generated trillions of dollars of revenue over the years. If the demand for oil plunges, you can be rest assured oil supply will be adjusted to prevent oil prices from plunging.
I do not deny many existing oil and gas and natural gas companies may fall by the wayside over the upcoming years. CVX, however, strikes me as one of the companies which will survive and thrive.
Given my long-term outlook for CVX and the fact its valuation is reasonable since it appears to be out of favor with the broad investment community, I have increased my CVX exposure.
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.
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.
