As Oil Heats Up, Chevron Is Set For Big Earnings Growth

With 2020 in the rearview mirror, Chevron
CVX
today laid out its plans to solidify its new position as America’s premier oil company. Indeed the year of Covid-19 was a bad one for all oil companies, and Chevron was no exception, posting an annual loss of $5.5 billion. That may look like a big hit in absolute terms, but in a year that saw oil prices fall below zero at the height of the pandemic panic, it was all about relative performance. ExxonMobil
XOM
by comparison suffered through an annus horribilus culminating in a net loss of $22 billion, while Occidental Petroleum
OXY
, reeling from its disastrous acquisition of Anadarko Petroleum
APC
in 2019 lost $15 billion. 

With the reflation trade having pushed oil prices up to $67 per barrel in recent days, all of a sudden life is looking good for Big Oil again, and especially for Chevron. Analysts figure that if oil prices averaged “just” $60/bbl over the next five years Chevron will end up sitting on more than $25 billion in cash after dividends (the stock yields 4.7%) and capital investment (of $16 billion a year). That would go a long way toward paying down Chevron’s debt load, which at a current $37 billion against $175 billion in capital is near the lowest levels in the industry. 

And it could get even better than that. According to Manav Gupta at Credit Suisse
CS
, for each $1 higher oil price, Chevron will collect an additional $500 million in incremental annual cash flow. 

No wonder Warren Buffett likes Chevron stock. During 2020 Berkshire Hathaway accumulated 48.5 million Chevron shares worth $5.3 billion. It’s significant that Buffett bought Chevron rather than ExxonMobil, which at its nadir in 2020 had shed 50% of its equity value to the point that its market cap temporarily fell below that of the considerably smaller Chevron — arguably making it the better value opportunity. 

Buffett didn’t mention Chevron once in his recent letter to shareholders, perhaps because he didn’t want to embarrass management of Berkshire’s other big oil holding — Occidental Petroleum. In 2019 Chevron and Oxy engaged in a bidding war for Anadarko Petroleum. Chevron CEO Mike Wirth wisely backed down, accepted a $1 billion breakup fee, and allowed Oxy CEO Vicki Hollub to overpay tremendously for the company. In the height of ignominy, Hollub, unable to raise enough capital to close the $57 billion deal, made a pilgrimage to see Warren Buffett, who extracted a pretty penny in exchange for his backing. Berkshire put up $10 billion in exchange for preferred stock in Oxy that pays 8% in cash or common stock ($800 million a year!) for 10 years, plus an out-of-the-money option to buy roughly 10% of the company. Paying Uncle Warren is an enormous drag for Oxy, which now has a crushing debt load of $36 billion — nearly as much as Chevron despite less than half the assets. 

Chevron’s Wirth, meanwhile, is heralded for his capital discipline — last year at the bottom of the cycle Chevron acquired Noble Corp.
NE
for $5 billion in stock plus the assumption of $8 billion in debt, in the process gaining a complementary 92,000 acres in the Pemian Basin, a leading position in Colorado, and big offshore gas fields in the eastern Mediterranean. 

Chevron’s investor day presentations underscored a continued dedication to conservative growth — with executives emphasizing a $16 billion “hard cap” on capital spending no matter how high oil prices go, with only $2 billion earmarked for drilling in the Permian Basin. Chevron continues to fund its $22 billion investment at the Tengiz project in Kazakhstan and upgrades to its $60 billion in Australian LNG ventures. Chevron indicated that it was in no hurry to invest in a new multibillion ethane cracker on the Gulf Coast via its CP-Chem joint venture, but will continue moving forward with an $8 billion petrochemical project in Qatar, to be completed circa 2025. Chevron total output is 3.1 million barrels per day of oil and gas equivalents. 

Analyst Paul Sankey of Sankey Research notes that Chevron’s outperformance against ExxonMobil has been a long time coming. Since 2001 when the merger of Exxon and Mobil closed, that company has returned a total of 160%. Compare that with the 391% total return of Chevron (besting even the S&P 500). 

There’s more reason to continue to prefer Chevron over Exxon — its renewable energy approach. Chevron has earmarked $300 million of investment this year into renewables, but rather than try to big foot into the crowded wind and solar space, it is largely focusing on renewable natural gas. Partnering with Brightmark, Chevron is buying methane captured from bovine manure at dairy farms in Michigan and Arizona, which it will market as compressed natural gas. In another partnership with Clean Energy Fuels, it will sell this “carbon negative” CNG to trucks at the ports of Los Angeles and Long Beach. Chevron is also making renewable diesel at its California refinery, and recently announced another venture (with Microsoft
MSFT
, Schlumberger
SLB
, and Clean Energy Systems) to build a novel plant in Mendota, Calif. that will burn 200,000 tons per year of agricultural biomass to generate electricity while capturing the carbon dioxide emissions, which will get injected deep into the ground. 

All told, Chevron says it intends to invest $3 billion on such energy transition ventures, with an aim toward boosting renewable natural gas volumes 10x by 2025 and cutting its overall carbon intensity 35% by 2028. Thanks to government subsidies and incentives these investments should be massively profitable. Wirth said today that in order to properly incentivize reductions in carbon footprint that he would prefer to see a government-set price on carbon.

And although low-carbon energy is all the rage, analyst Sankey stresses that the world is far from done with oil: “We strongly feel that the market conflated a massive cyclical downturn, with a secular change in energy consumption that simply has not occurred on an underlying basis.” Before the pandemic the world was using 100 million barrels per day. Despite prognostications of peal oil demand, we likely will again. 

Analyst Gupta at Credit Suisse has a $126 price target on Chevron, justified by an enterprise value (equity plus net debt) of 10.5x Chevron’s projected $26 billion in 2021 debt-adjusted cash flow [which is tortuously defined as: cash flow from operations + financing costs (after tax) + exploration expenses (before tax) +/- working capital adjustment], a metric justified when valuing an outfit with relatively low levels of debt]. 

For those who prefer a more traditional valuation measure, Chevron at today’s $109.63 trades for 31.5 times expected 2021 earnings per share of $3.50. That might look rich, but is supported both by Wirth’s intention to boost return on capital from roughly 3% this year to 10% by 2025. Further support: Chevron’s $5.16 per share annual dividend payout — currently implying a 4.7% yield.

MORE FROM FORBESWarren Buffett Backs Oxy’s Vicki Hollub In $57 Billion Bid For Anadarko PetroleumBy Christopher Helman