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 (within 5%).
Shares of Chevron have risen 11.5% in the past three months, outperforming the broader industry's 8.3% but has lagged larger rival ExxonMobil XOM 14.3% 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.
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.
Stellar Permian Operations: Production at Chevron, the nation's largest oil and gas producer, remains strong. The company's 2018 production was 2,930 thousand oil-equivalent barrels per day (MBOE/d), up 7.4% from a year ago and up 13% over the 2017 output.
The company’s substantial Permian holdings of 2.2 million net acres have already realized production growth of 71% in the past year with Chevron targeting a CAGR of 30-40% through 2020. Investors should also note that Chevron's Permian production of 377,000 barrels per day in the fourth quarter was up significantly from the 205,000 barrels per day in last year's corresponding period.
Estimates Moving Up: Annual estimates for Chevron have moved north in the past 7 days, reflecting analysts’ confidence on the stock. In this period, the Zacks Consensus Estimate for 2019 has increased by 2.3% to $6.71 per share. The Zacks Consensus Estimate for 2020 has also moved up 2.5% to $7.85.
Sound Q4 Performance: Chevron reported earnings per share of $2.06 in the second-quarter, surging more than 182% from 73 cents per share in the prior-year quarter and higher than the Zacks Consensus Estimate of $1.87.
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 7.5%.
Enough Free Cash Flow: Chevron’s free cash flow has gone up significantly. In 2018, the company generated $30.6 billion of cash from operating activities while shelling out $13.8 billion on capital expenditures for record free cash flow of $16.8 billion. During the same period, Chevron paid out $8.5 billion as cash dividends to its shareholders.
In other words, the company’s dividend appears safe for the foreseeable future. Using $4.76 as the dividends to be received in the next 12 months (after taking into consideration the recent hike) and based on 1.91 billion diluted shares outstanding, the total payout comes to a little over $9 billion annually, much lower than the free cash flow.
Effective Cost Control: Chevron's low-cost structure has played a pivotal role in making the supermajor a capital and cost-effective company. Over the past few years, Chevron's strategy has involved the divestiture of lower-margin assets, while significantly lowering the average cost of production - from approximately $18 per barrel in 2014 to $10 per barrel now.
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
Downstream Issues: The drop in Chevron's downstream segment earnings (partly attributable to higher operating expenses in U.S. operations) is a concern. In the most recent quarter, income from the refining division came in at $859 million, 33% lower than the profit of $1.3 billion in the year-ago period. For full year 2018, profits slumped 27% to $3.8 billion.
Dependence on Few Large Projects: Chevron targets to grow volume by 4–7% in 2019. 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.
High Capital Spending: The integrated oil and gas industry is highly capital intensive with billions of dollars in expenditure required to fund massive projects that often take a number of years to come online. While Chevron prudently cut its capital expenditures when oil prices were low (like all its peers), the company will spend approximately $20 billion in 2019 - quite high by industry standards and the first upward revision in four years. Apart from high execution risk, the large capital expenditure is expected to place a substantial burden on the company’s leverage and credit metrics.
Climate Change Risks: Oil and gas majors, including Chevron, are facing increasing investor pressure concerning climate change. The publicly-held fossil-fuel companies have often been accused of being perpetrators of global warming and climate change. Certain investors are urging management to be more transparent on policies that would help reduce greenhouse gas emissions.
Stocks to Consider
While Chevron is expected to perform in line with the broader U.S. equity market over the next one to three months, one can look at Zacks Rank #1 (Strong Buy) stocks like Royal Dutch Shell plc RDS.A and ConocoPhillips COP.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The Hague-based Shell is a major international integrated oil and gas company that divides its operations into four major segments: Upstream, Downstream, Corporate and Integrated Gas. Over 30 days, the company has seen the Zacks Consensus Estimate for 2019 increase 1.5% to $5.26 per share.
ConocoPhillips — headquartered in Houston, TX — is one of the largest oil and gas exploration and production player in the world. Over 30 days, the company has seen the Zacks Consensus Estimate for 2019 increase 2.9% to $3.56 per share.
Zacks' Top 10 Stocks for 2019
In addition to the stocks discussed above, would you like to know about our 10 finest buy-and-holds for the year?
Who wouldn't? Our annual Top 10s have beaten the market with amazing regularity. In 2018, while the market dropped -5.2%, the portfolio scored well into double-digits overall with individual stocks rising as high as +61.5%. And from 2012-2017, while the market boomed +126.3, Zacks' Top 10s reached an even more sensational +181.9%.
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