Contents
I view Chevron Corporation (CVX) as the premier major integrated oil and gas industry participant.
CVX is certainly experiencing headwinds but the company has a strong balance sheet and is being well managed to weather the difficult business environment.
Summary
- CVX is navigating its way through a difficult environment.
- It is arguably the premier major integrated oil and gas company in the world.
- Management has indicated a key priority is to protect its balance sheet.
- I think CVX's share price will trade within a narrow range over the short-term.
- I have written short-term out-of-the-money covered calls which I think will expire worthless so as to skim additional income.
Introduction
In this January 12th article I disclosed that I had acquired a few additional Chevron Corporation (CVX) shares. While CVX has certainly experienced its challenges over the past several months I view it as the best major integrated oil and gas company and my intent is to increase my position over the long-term.
On January 29th, CVX released its Q4 and FY2020 results. It is clear the company will continue to face uncertainties and challenges in the short-term but with the acquisition of Noble, which was completed in early October 2020, the acquisition added geographic diversity and played to CVX's strengths.
Based on CVX's recently released results and my short-term outlook on CVX, I have written covered calls on a portion of my CVX holdings. I wrote 11 contracts to expire March 19, 2021 with a $100 strike price. In exchange for writing these contracts I have collected $0.67/share (excludes nominal commission) for option income of $737.
Financial Results
On January 29th, CVX released its Q4 and FY2020 results.
Looking at page 9 of 11 of the Q4 Earnings Release we see full-year operating cash flow of $10.6B and $3B of proceeds and deposits related to asset sales and returns of investments were insufficient to cover $9.9B in capital expenditures and other investing activities (primarily borrowings of loans by equity affiliates) and $9.7B of common stock dividends. This shortfall along
with assumption of Noble debt (~$9B) resulted in the net debt/capital ratio rising to 23% from 13% at the end of 2019. On the January 29th call with analysts, management indicated that CVX does not have a specific target net debt ratio range but management's previous guidance has included a 20% - 25% range. If CVX is heading toward the upper end of this range, senior management wants to be confident that it can work its way back to the lower end of the range.
Management indicated on its January 29th call with analysts that 2020 was the year with the greatest and most rapid change in market conditions. The company's refining personnel had to figure out how to make as little jet fuel as possible, even though just weeks before jet fuel was the fastest growing refined product. In addition, the upstream team had to quickly and safely demobilize dozens of rigs and reduce other production activities. Despite this, CVX's upstream delivered more than 3 million barrels per day for only the 2nd time in the company's history.
At the company's 2020 Investor Day, management indicated the company's capital program was flexible. Within weeks after this Investor Day, the company proved it. Looking at page 9 of the Q4 Earnings release we see that CAPEX was reduced to $8.9B from the prior year's $14.1B. This demonstrates the company's ongoing cost and capital discipline.
In early 2020, CVX increased its quarterly dividend over 8% and share count was reduced (see page 7 of 11). When the COVID-19 crisis hit and cash from operations decreased, the company halted the share buybacks, and asset sales were completed. Now, CVX has one of the strongest balance sheets amongst the major integrated oil and gas producers.
Credit Ratings
The credit ratings reflected in my January 12th article remain unchanged.
Dividend and Dividend Yield
In my previous article I indicated 'it would be reasonable that CVX elects to keep its dividend steady at $1.29/quarter' given the challenging environment. Looking at CVX’s dividend history (see here) this is exactly what has happened.
On the basis of an ~$87 share price, the dividend yield is ~5.9%. I hold shares in non-registered accounts so I incur a 15% withholding tax on my CVX dividend income thus reducing my quarterly dividend to ~$1.10 and dividend yield to ~5.1%.
Valuation
FY2021 guidance has not been provided but looking at at page 6 of 25 of the Q4 Investor Presentation we see that guarding the balance sheet is of utmost importance.
Looking at one of my sources of information I see that FY2021 adjusted diluted EPS estimates from 25 analysts are a mean of $3.69 and a low and high range of $1.51 - $6.00. Clearly, the analysts are all over the map when trying to forecast CVX's FY2021 earnings.
If we use $3.50, which is somewhat more conservative than the $3.69 mean level, and the current ~$87 share price we get a PE of ~25. In my opinion, this is an elevated level but I am hesitant to make my investment decision based on FY2021 analyst estimates. Since I can not reasonably determine CVX's valuation my CVX related invetsment decisions are being made on the basis that CVX's senior management will do what is best for the company and its shareholders and the fact I think we will witness an improved macroeconomic environment as the year progresses which should lift commodity prices and margins.
Option Trade
Earlier in this article I disclosed the option trade I placed. While CVX's share price could rise between now and the March 19th option expiry date I think the share price will remain under the $100 strike price between now and expiry. If this ends up being the case I will retain the underlying shares and 100% of the option premium I collected.
As we approach expiry, I could close out my position if I think the share price is likely to close above $100; it is not my intent to part with my shares. The options have a short duration and the time value of these options will start to rapidly evaporate in about a month from now which will work in my favor. Depending on circumstances in a few weeks, I could close out my position and write new covered calls...once again going with a relatively short expiry (May 21st for example).
The $1.29 dividend is payable March 10th to shareholders of record as at February 17th. That is less than 2 weeks of trading days and I think my risk of having shares called away because of a sudden dramatic increase in CVX's share price within 2 weeks is remote. As a result, I am reasonably confident I will at the very least, be the recipient of the March 10th dividend.
There are ~45 days to the option expiry date meaning I could repeat this trade ~8 times/year (365/45). I have collected option premium of $0.67/share so on the basis of the current ~$87 share price my yield is 0.0077. Repeat this trade 8 times/year and my annualized return is ~6% (0.0077 x 8 times). This yield is negligible but I did not execute this trade to 'hit one out of the park'. I am merely trying to scrape additional income while keeping the risk of having to take action on my call position to a minimum.
Final Thoughts
I think CVX's share price will very likely trade within a narrow range for quite some time. I would like to see this occur so I can acquire additional shares which I think will be far more valuable several years into the future. I also would like to repeat this relatively low risk short-term out-of-the-money covered call option trade so as to skim additional income a few times during the year.
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.
