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Chevron: It's Cheap But Doesn't Look Cheap

Richard Saintvilus

NEW YORK ( TheStreet) -- It's not unusual for investors to proclaim to anyone who cares to listen his or her favorite stock is cheap. But when that stock is also at a 52-week high, it's time to raise eyebrows at the logic.

Somehow, Chevron , which fits this criteria, is still flying under the radar despite gaining more than 17% for the year to date.

Even though rival Exxon Mobil , which we talked about a couple of weeks ago, garners the lion's share of the media coverage, Chevron has never lost its status as a major oil company that consistently delivers solid profitability. It has consistently maintained one of the best balance sheets of any company in any sector.

But how is it possible, with Monday's close of $124.78, for Chevron to still be cheap?

Chevron didn't knock the cover off the ball this quarter. But given the broad weakness that has hit the entire sector due to weak oil prices, the company didn't have to. Management only needed to show that Chevron's production growth was still progressing. Even though revenue was down 6% year over year (as reported), Chevron still delivered where it mattered.

As disappointing as the revenue number sounds, the Street didn't flinch. Unlike the tech or financial sector, revenue details are not weighed upon too heavily among the energy bigwigs. Investors are more interested in production. Chevron was cheered for the company's 1% year-over-year production growth.

Here, too, Chevron's performance stands out, especially since Exxon just posted its seventh consecutive quarter of year-over-year production decline. Meanwhile, Exxon is still considered the leader in this sector.

Chevron had a 6% revenue decline compared to Exxon, which posted a sales decline of 12% -- I think this supports the idea that perhaps Chevron shares are undervalued. From the standpoint of operating margin, Chevron should command a higher P/E, all things being equal.

On a segmental basis, the Chevron's upstream business was far and away the bread winner this quarter despite upstream profits falling 4% year over year to $1.13 billion due to a combination of lower crude oil prices and higher operating costs.

However, on a sequential basis, upstream profits jumped 8%, helped by a slightly better-than-expected average price per barrel of crude and natural gas liquids in the U.S. of $94. Here, too, Chevron outperformed Exxon and peers ConocoPhillips and Hess .

For the downstream business, profits in the U.S. fell more than 70% from $459 million last year to $135 million. Here again, higher operating expenses was the major culprit. But Chevron was able to offset this weakness with better profitability in international operations, with profits of $566 million, up 64% year over year.

The more I study Chevron's business, it gets progressively easier to like the stock, even as shares soar higher. But in this sector, growth and profitability hinge on production and exploration, which require significant ongoing capital investments. As seen by the higher expenses seen in the upstream/downstream businesses, management seems committed to growth.

It's easy to look at Chevron's books and see that the company is not lacking in capital. But should oil and gas prices stay lethargic, it's easy to kiss these investments in production and exploration goodbye. To that end, Chevron's current projects, which includes construction on the Gorgon and Wheatstone LNG in Australia, are progressing well. As are other initiaves, including Big Foot deepwater projects in the Gulf of Mexico, which management said are still on track for a 2014 kickoff.

Bottom Line

Exxon Mobil will likely remain the Street's favorite because Exxon is immense. But Chevron is no slouch in areas like returns on capital and production assets. In that regard, given Chevron's production outperformance this quarter along with better profitability, this stock could command a valuation north of $140, especially since Chevron's fiscal 2014 estimates suggest the stock is trading at a P/E that is a full point below Exxon.

Although the Street sometimes cringes at increased capital expenditure budgets, Chevron's prospects are as bright as ever. With improving production growth, this company belongs on the list of the best stocks to own for the next three to five years.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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