Chevron Corporation – Zig When Others Zag

As a long-term investor seeking to invest in undervalued / fairly valued companies, the current market environment has significantly reduced the number of investment opportunities. This is a market of stocks and not a stock market, however, so there are some companies which do appeal to me.

Companies in the oil and gas sector have been challenged over the past few quarters given that the law of supply and demand has not been in their favor. Industry participants have been reporting abysmal results but this is a volatile industry where profitability and free cash flow can exhibit wide swings.

I think the demise of oil and gas is overblown but I do not think every industry participant is going to survive. I am, therefore, periodically acquiring additional shares in Chevron Corporation (CVX), one of the industry's strongest participants.

Summary

  • 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.
  • Although CVX's preferred method of returning cash to shareholders is through dividends I think that in late January, when CVX announces its next quarterly dividend, the dividend may be kept steady at the current $1.29/share/quarter level.
  • The oil and gas industry is somewhat volatile so I prefer to invest in the 'best of the best' in this space.

Introduction

I have mentioned in several previous articles that I am of the opinion many stocks are in bubble territory. While many of these companies might be wonderful they do not necessarily make great long-term investments if we pay 30+ times forward earnings. As a result, I have been accumulating some cash which I will deploy when the valuation of these high quality companies become more reasonable. Although I have been accumulating cash I have also been 'nibbling' and acquiring shares in a few companies I think are reasonably valued.

I have also mentioned in recent articles that I am favoring the purchase of shares in companies where I already have exposure as opposed to initiating new positions; this August 16, 2020 article is the most recent article in which I disclosed my top holdings.

In keeping with my plan to acquire shares that are reasonably valued and/or out of favor with the broad investment community, I have acquired additional shares in Chevron Corporation (CVX); shares are held in two different 'Core' accounts within the FFJ Portfolio.

In this July 2020 article I indicated I had acquired additional shares in CVX. Subsequent to that article I have acquired several more shares via automatic dividend reinvestment.

Financial Results

CVX is scheduled to release Q4 and FY2020 results on January 29th and its 2021 Investor Day is to be held March 9th.

I am dispensing with any analysis of CVX's financial results since the oil and gas sector is in such a state of flux I don't think it adds any value to review the Q3 2020 results which were released October 30, 2020.

If an investment in CVX is of remote interest to you, however, I encourage you to review the November 2020 Investor Presentation.

Credit Ratings

In early October, I received an inquiry from a reader as to whether it was an opportunistic time to acquire shares in Suncor Energy (SU.to) given that shares had been beaten up. At the time, shares were trading at ~$16 CDN. They have subsequently appreciated to ~$23.50 CDN as I compose this article so the return on a SU investment would have been pretty reasonable over such a short timeframe.

I concluded my SU article stating that I would PASS on a SU investment and that CVX would, in my opinion, be a better investment if one wished to have exposure to the out of favor diversified oil and gas space. At the time, CVX was trading at ~$72 USD and shares are now trading at ~$92. Although the percentage appreciation is greater for SU shares than CVX shares since early October, I don't just look at the potential return. I invest with the intent of holding shares in perpetuity, and therefore, am probably more inclined to look at a company's risk than would a very short-term investor.

In the case of SU, Moody's rates the long-term debt Baa1 and S&P Global rates it BBB+. Those ratings are the top tier of the lower medium grade and are investment grade...albeit only 3 notches above non-investment grade....and those are debt ratings so as an equity investor you are assuming even greater risk.

Contrast SU's ratings with those of CVX which are Aa2 from Moody’s and AA from S&P Global. These ratings are the middle tier of the high grade category and are 5 notches better than those of SU. To each their own but, in my opinion, CVX is a far better company than SU and the risk is lower.

Dividend and Dividend Yield

CVX’s dividend history can be accessed here.

CVX has historically announced its Q1 dividend at the end of January. Given the challenging business conditions I think it would be reasonable that CVX elects to keep its dividend steady at $1.29/quarter. In fact, we see that CVX held its quarterly dividend at $1.07/share and $1.08/share for more than 4 consecutive quarters within the past decade.

I have acquired an additional 50 shares @ $93.149 so the $1.29/quarter/share dividend provides me with a ~5.54% dividend yield. These acquired shares are held in a non-registered account so as a Canadian resident I incur a 15% withholding tax thus reducing my quarterly dividend to ~$1.10 for a dividend yield to ~4.72% ($4.40/$93.149).

Valuation

I do not dispute that CVX's results have been abysmal in recent quarters. In fact, YTD results as at the end of Q3 2020 are so poor you can't even determine CVX's valuation based on GAAP EPS because the company has lost money. I think CVX's earnings will remain under pressure for the next few quarters and so will the results of all the other major players in CVX's space. I am not, however, investing for the next few quarters. I am investing for the long-term and even though there is trend is away from oil and gas related products I think it would be naive to think the world will suddenly stop relying on oil and gas any time soon.

The oil and gas space is certainly volatile, and therefore, it is important to invest in the 'best of the best'. Speculative plays in this space can lead to huge wins but then you are also setting yourself up for heartbreak if a recovery takes much longer than anticipated.

While I think it is far too difficult to accurately determine CVX's valuation I continue to take comfort that CVX is taking the appropriate measures to ensure it will continue to be one of the key industry participants well into the future. Such actions include but are not limited to:

  • Maintaining safe and reliable operations;
  • Reducing short-cycle capital;
  • 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

To say we are living in interesting times is somewhat of an understatement. I don't think anybody can consistently accurately determine what will happen in the short-term and this is why I think it is extremely important to invest from a long-term perspective.

CVX is certainly experiencing headwinds but when a great company falls out of favor with the investment community I think it is an opportunity to pick up shares that will very likely be far more profitable several years into the future.

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.