San Ramon, CA-based energy behemoth, Chevron Corporation CVX, has had a healthy run on the bourse with its stock price nearing the 52-week high mark.
Shares of Chevron have risen 13.4% in the past three months, outperforming the broader industry's 10.6% and larger rival ExxonMobil’s XOM 2.2% over the same time period.
While its forecast-topping earnings performance on the back of recovery in commodity prices, production gains and the success of its cost savings initiatives have recently piqued our interest, we do not believe there are ample reasons for this mega-cap stock – with a market cap of roughly $222.7 billion – to surge higher.
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Chevron’s Zacks Rank #3 (Hold) also suggests that any upside from here may be limited.
Catalysts Behind the Gain
Commodity Price Rebound: The improving supply-demand narrative has brought much needed stability to the market with prices set to improve steadily. Multinational oil enterprises (like Chevron), on the back of greater certainty, will now be able revive spending on drilling activities. In fact, being one of the most oil-weighted majors, Chevron is likely to outperform its peers in case of the commodity's rebound as per our expectations.
Strong Pipeline: Chevron’s existing oil and gas development project pipeline is among the best in the industry – targeting volume growth of 4-9% in 2017 – driven by the big Australian LNG projects (Gorgon and Wheatstone), as well as deepwater developments in the U.S. Gulf of Mexico and the Permian operations. In particular, with increasing amounts of capital spending devoted to the lucrative unconventional play over the coming years, production from the Permian region is expected to be strong.
Estimates Moving Up: Annual estimates for Chevron have moved north in the past 30 days, reflecting analysts’ confidence on the stock. In this period, the Zacks Consensus Estimate for 2017 has increased by around 2% to $4.02 per share. The Zacks Consensus Estimate for 2018 has also moved up 1.5% to $4.59.
Sound Q2 Performance: Chevron reported adjusted earnings per share of 91 cents in the second-quarter, up 90% from 48 cents per share in the prior-year quarter and higher than the Zacks Consensus Estimate of 89 cents.
Positive Earnings Surprise History: Chevron has outpaced the Zacks Consensus Estimate in three of the trailing four quarters, delivering a positive average earnings surprise of 19.4%.
Prudent Expenses Management: As a result of Chevron's focus on well planning and execution, the company continues to reduce its operating costs with underlying expenses down almost 10% year-to-date compared to 2016. Capital expenditures for the first six months of the year are also down 25%.
Asset Sale on Track: The recent divestment of downstream assets in Canada to fuel distributor Parkland is part of Chevron's strategy to exit noncompetitive projects, while lowering cost and capital expenditure. Apart from a leaner business model, it will also help Chevron to progress toward its $5-$10 billion divestment goals during 2016-2017.
Healthy Growth Prospects: The Zacks Consensus Estimate for revenues is at $133.3 billion for 2017, reflecting 16.4% year-over-year growth. The estimate for 2018 of $140.5 billion projects 5.4% annual growth. The Zacks Consensus Estimate for earnings for 2017 is pegged at $4.02, depicting growth of 302.4%. The estimate for 2018 reflects year-over-year growth of 14.2%.
The stock has an estimated long-term earnings growth rate of 23.9%, higher than the industry average of 7.9%.
Despite these key driving factors, we advise investors to wait for a better entry point before buying shares in the oil major. Here’s why:
The Headwinds
Cash Flow Issues: In the first six months of 2017, Chevron generated just $8.9 billion in operating cash flow, while shelling out around $12.9 billion in capital expenditures and dividends. The trend is expected to continue for the next few quarters, with the company relying on asset sales and debt to plug the deficit.
Dependence on Few Large Projects: Chevron targets to grow volume by 4-9% in 2017. This is largely dependent on few big projects. However, sudden and unforeseen damage may reduce the company's planned net increase in output. In particular, Chevron's high-profile Gorgon LNG development in Australia is suffering from mechanical issues that may restrict its ramp-up.
Nigeria Exposure: Chevron's exposure to production in the vulnerable and violence-prone regions in Nigeria poses additional risk.
Stocks to Consider
Better-ranked stocks in the energy space include Lonestar Resources US Inc. LONE and Transocean Ltd. RIG. Lonestar sports a Zacks Rank #1 (Strong Buy), while Transocean carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Headquartered in Fort Worth, TX, Lonestar is oil and gas exploration and production company with primary focus on the Eagle Ford Shale in South Texas. The 2017 Zacks Consensus Estimate for this company is a loss of 62 cents, some 79.7% narrower than 2016. Next year’s average forecast is a loss of 34 cents, pointing to another 45.2% improvement on the back of accretive acquisitions and attractive well economics.
Switzerland-based Transocean, Inc., with an apt NYSE ticker of RIG, is the world’s largest offshore drilling contractor and leading provider of drilling management services. Transocean has an excellent earnings surprise history. It has a 100% track of outperforming estimates over the last four quarters at an average rate of 441.5%.
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