On Aug 8, 2013, we retained our Neutral recommendation on San Ramon, Calif.-based energy giant Chevron Corp. (CVX). Our investment thesis is supported by a Zacks Rank #3 (Hold).
Why the Reiteration?
Chevron is one of the largest integrated energy companies in the world and has an impressive business model. Its current oil and gas development project pipeline is among the best in the industry, boasting large, multiyear projects. Additionally, Chevron possesses one of the healthiest balance sheets among peers, which helps it to capitalize on investment opportunities with the option to make strategic acquisitions.
However, due to its integrated nature, Chevron is particularly susceptible to the downside risk from any weakness in the global economy. We are also concerned by the company’s high level of capital spending, which may result in reduced returns going forward.
Detailed Analysis
Chevron is one of the six super major oil and gas companies in the world and the second-largest energy firm in the U.S. behind Exxon Mobil Corp. (XOM). As a vertically-integrated oil entity, it is engaged in oil and gas exploration and production, refining and marketing of petroleum products, manufacturing of chemicals, and other energy-related businesses.
Driven by the big Australian liquefied natural gas (LNG) projects (Gorgon and Wheatstone), as well as deepwater developments in the U.S. Gulf of Mexico, Chevron is targeting volume growth of 25% by 2017.
The company’s financial flexibility and strong balance sheet are real assets in this highly-uncertain period for the economy. Chevron remains in excellent financial health, with more than $20 billion in cash on hand and an investment-grade credit rating with a debt-to-capitalization ratio of just over 12%. Management has established quite a track record of conservative capital management and cash returns to shareholders. It also pays a growing dividend, currently yielding an attractive 3.3%.
Chevron has targeted quarterly buybacks of up to $1 billion of its common stock since late 2010. We believe that the repurchase program not only highlights the company’s commitment to create value for shareholders but also underlines Chevron’s confidence in commodity prices.
However, as is the case with other companies engaged in the business of exploration and production, Chevron’s results are directly exposed to oil and gas prices, which are inherently volatile and subject to complex market forces. Realized prices could differ significantly from our estimates, thereby affecting the company’s revenues, earnings and cash flows.
Chevron has pegged its 2013 capital budget at $36.7 billion – up more than 7% from the $34.2 billion it invested in 2012, which is quite high by industry standards and puts its expenditure right next to that of industry leader ExxonMobil. This is expected to substantially increase Chevron’s leverage and deteriorate its credit metrics. Additionally, the increasing capital intensity of its operations may result in reduced returns going forward.
Stocks That Warrant a Look
While we expect Chevron to perform in line with its peers and industry levels in the coming months and advice investors to wait for a better entry point before accumulating shares, one can look at Cabot Oil & Gas Corp. (COG) and Matador Resources Co. (MTDR) as good buying opportunities. These North American energy explorers – sporting a Zacks Rank #1 (Strong Buy) – offer tremendous value and are worth buying now.
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