Chevron: Pumping Profits

Summary:

• Chevron has seen very strong performance so far this year, which does not come unexpected.
• Unlike past booms, the sector at large including Chevron shows real capital discipline.
• I like the long-term performance and capital allocation, yet see no need to chase shares here.

My last take on Chevron (NYSE:CVX) dates back to July 2020 when the company used its financial strength to acquire Noble Energy during a period of turmoil. That deal has worked out well, as few could have imagined how strong of a year 2022 would become, for the wrong reasons, allowing Chevron to enjoy a new profit boom, rapidly deleveraging the balance sheet along the way.

Some Perspective

Little over two years ago the world, including Chevron, was still dealing with the initial effect of the pandemic. Despite very low energy prices, which hurt a juggernaut like Chevron as well, the company used its strength to acquire Noble Energy in a $13 billion deal.

The deal was driven by Chevron’s desire to add Noble’s assets in Israel, West-Africa as well as the DJ Basin and Permian Basin, bringing diversity, production, capital flexibility, reserves and cash flows. These reserves were quite substantial while some $300 million in synergies were seen as well.

While a $13 billion transaction was almost a bolt-on deal for a giant like Chevron, at the time commanding a $183 billion enterprise value, the 7% pro forma valuation was substantial given the sign of the times.

Pro forma net debt would increase to $32 billion, albeit that leverage would remain in check. The Noble deal would add about 11% to pro forma production, based on which the contribution looks outsized, but of course Chevron has large midstream and downstream activities as well. On the other hand synergies and relative large reserves were to be added as well, as overall the deal worked out just fine.

Despite the uncertainty and lower earnings power in 2020, I was upbeat at $85 per share, as I like the discipline of management at the time, after barking on the Anadarko deal. Think of Chevron among the best-led energy businesses out there, I believed that Chevron was a long term value creator in a cyclical and difficult industry, as I was happy to stick to an existing long position at the time.

Stagnating and Doing Well

Shares of Chevron actually fell a bit later in 2020 but hit the $100 mark again in March 2021, still trading way below the pre-pandemic levels. Shares still only traded around the $120 mark at the start of the year yet the war between Russia and Ukraine made that shares rallied to the $180 mark in May. Despite a pullback to $130 this summer, shares are now trading near their all-time highs at $180 again.

Fast forwarding to January of this year, Chevron posted its 2021 results. The company posted a spectacular increase in sales and earnings with full-year revenues surpassing the $162 billion mark on which net earnings of $15 billion and change were reported, although that the fourth quarter run rate was quite a bit higher already. Net debt was reduced to $25 billion already as 1.92 billion shares traded around $120, translating into a $230 billion equity valuation, or a $255 billion enterprise valuation. With earnings posted at $8 per share, the resulting multiple came in around 15 times earnings, albeit that earnings trended at $10 per share already based on the fourth quarter results.

In February, Chevron announced the next bolt-on deal with a $3.15 billion purchase for Renewable Energy Group, giving Chevron access to renewable fuels production and feedstock capabilities.

First quarter operating sales rose to $52 billion as a more than $6 billion net profit number was aided by some equity gains as well, but then again the macroeconomic conditions only impacted the results for a part of the quarter. Second quarter sales rose to $68 billion with prices spiking as the company posted incredible net earnings of nearly $12 billion, or just a few pennies short of the $6 per share mark. These earnings resulted in a rapid deleveraging of the balance sheet, with net debt down to $14 billion.

With prices down a bit, third quarter sales came in at $66 billion and change as net earnings topped the $11 billion mark, equal to $5.78 per share. While the company earmarked some money for buybacks and of course dividends, net debt is down to $8 billion. The 1.94 billion shares now trade at $180, pushing up the equity valuation to around $350 billion.

The strong momentum is driven by all operations, both production and downstream, at home in the US and cross the rest of the world. Contrary to the past, capital spending is minimal, trending at just $11-$12 billion per year here, lagging deprecation charges of $16 billion, and coming in far below the $30 billion invested a couple of years ago, notably into Australia.

These investments are low, creating a huge cash machine of Chevron here. EBITDA currently trends around $80 billion as net debt is minimal, leaving ample room for shareholder payouts to investors, as it seems that contrary to past cycles, capital discipline is demonstrated upon, by most of the sector. This includes capital spending and share buybacks by the way.

What Now?

With earnings currently trending around $20-$25 per share, valuations are non-demanding at 7-9 times earnings, all while leverage is very much under control. That being said, of course such earnings are not really representative through the cycle. After all, earnings power was stuck around $6-$7 per share ahead of the pandemic when the shares traded at $120. The $60 move higher added over $100 billion to the valuation and while net debt has been cut by around $25 billion, and earnings are likely to remain strong for some time to come, investors are arguably fearing a reversal in earnings, at least to some extent.

With the purchase of Noble the company has done a nice deal at the outset of the pandemic as the purchase of Renewable Energy shows its willingness to alter the business as well, showing that Chevron remains disciplined and is moving along with the sign of the times. While it’s very much obvious that oil is here to stay for a longer period of time, this should still weigh on potential multiples down the road, but then again, the sector at large has seen capital spending discipline, which is very encouraging.

In a concluding remark I continue to like Chevron as a long-term play, yet I see no reason to either increase or reduce my position here. Chevron remains a solid long term play, likely benefiting from above average prices for a while, is well led and is surprisingly conservative with its finances today, while showing capital discipline.

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Disclosure: I/we have a beneficial long position in the shares of CVX either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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