On Aug 26, 2014, we issued an updated research report on U.S. energy giant Chevron Corporation (CVX). The company reported strong second-quarter results on higher oil prices. Its current oil and gas development project pipeline is among the best in the industry. However, we are concerned about the company’s high level of capital spending, which may result in reduced returns going forward.
This balanced view is reflected in Chevron’s current Zacks Rank #3 (Hold) which implies that it will perform in line with the broader U.S. equity market over the next one to three months.
Chevron’s current oil and gas development project pipeline is targeting volume growth of 20% by 2017 (from 2013 levels) supported by big Australian LNG projects (Gorgon and Wheatstone), as well as deepwater developments in the U.S. Gulf of Mexico. Hence, we expect the company to earn significant cash flows in the coming years from the pending projects.
Moreover, Chevron’s financial flexibility and strong balance sheet are real assets in this highly uncertain economy. The company remains in excellent financial health, with more than $13 billion in cash on hand and an investment-grade credit rating with a debt-to-capitalization ratio of just over 13.3%.
Chevron is also divesting its non-core and high-cost properties. Recently, it divested a 25% non-operated interest in an oil producing acreage located in southern Chad, in addition to a stake in the related pipeline system for about $1.3 billion. Chevron sold the assets to the Republic of Chad.
However, we remain concerned as Chevron set its 2014 capital budget at $39.8 billion. This huge spending is expected to substantially increase the company’s leverage and deteriorate its credit metrics. The increasing capital intensity of its operations may also result in reduced returns going forward.
Additionally, 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. As oil has been trading significantly below $100 per barrel throughout August, the company’s third quarter earnings might be hampered.
Key Picks in the Industry
Currently, we prefer to remain on the periphery regarding Chevron. Better-ranked players in the energy sector include Patterson-UTI Energy Inc. (PTEN), Cameron International Corporation (CAM) and Sanchez Energy Corporation (SN). All the stocks sport a Zacks Rank #1 (Strong Buy).