Unsurprisingly, Chevron (NYSE:CVX) has not been immune to the oil bust. Even with recent robust sessions, Chevron stock has lost 36% of its value so far in 2020.
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To some investors, the plunge no doubt looks like an opportunity. Chevron remains one of the world’s great energy companies. It’s a dividend aristocrat: an 8.4% increase in its dividend in January marked 33 consecutive years in which the company had raised its payout. That dividend now yields an attractive 6.8%.
But investors buying Chevron stock on the dip need to keep one thing in mind: the world has changed. Indeed, Chevron itself shows just how much the energy industry has changed.
With an understanding of those changes, the opportunity in CVX stock isn’t quite what it appears. The stock should be attractive for energy bulls betting on a rebound. But investors simply looking for a “cheap” quality name likely have better opportunities elsewhere in the market.
Security Analyst Meeting
On Mar. 3, Chevron held its Security Analyst Meeting. At the time, energy stocks already were struggling. Soft fourth-quarter earnings from both Chevron and Exxon Mobil (NYSE:XOM) dented optimism toward the sector. Chevron stock traded at a four-year low. XOM stock, incredibly, had touched its lowest level in 15 years.
But Chevron sounded optimistic regardless. The company outlined a plan to return $75 to $80 billion to shareholders over the next five years through dividends and share repurchases. That figure was nearly half Chevron’s market capitalization of roughly $175 billion.
Adjusted free cash flow was expected to double by 2024, with return on capital employed clearing 10%. To any energy investor looking to buy the dip, the outlook made Chevron stock look exceedingly cheap.
Five days later, Saudi Arabia started an “all-out price war” in crude oil. Oil prices plunged. Unsurprisingly, so did Chevron stock, which declined over 15% on the news.
By Monday’s close, it had declined another 44% from where it closed the day before its analyst meeting. Shares touched a 14-year low.
With Brent crude below $30, Chevron’s outlook is quite different. Just three weeks after guiding for annual shareholder returns averaging over $15 billion, the company suspended share repurchases altogether. Chevron will keep its dividend — chief executive officer Michael Wirth told CNBC that the payout “is our number one priority” — which suggests 2020 returns under $10 billion.
Guidance for 2020 capital and exploratory spending is being cut 20%. Production in the Permian basin is coming down by the same amount. Operating costs are being cut as well.
Chevron is retrenching. It’s going to cut costs, lower production, and look to wait out this cycle.
But the impact is severe. It’s worth going back to the fourth quarter report on Jan. 31, itself not all that long ago. In its earnings presentation, Chevron noted that a $1 move in the per-barrel price of Brent crude would hit cash flow by roughly $450 million.
Brent crude has fallen about $24 per barrel since then. That’s a hit to cash flow of over $10 billion. Lower production will only add to the pressure.
In 2019, Chevron generated operating cash flow of $27.3 billion. Capital expenditures were $14.1 billion, and still are guided to about $16 billion in 2020.
Cut $10 billion off that operating cash flow and free cash flow is almost totally erased.
The Decline in Chevron Stock
Looked at from that perspective, the broader decline in Chevron stock is not an overreaction.
To be sure, Chevron still will be profitable in this oil price environment. It’s not going to go bankrupt.
But Chevron also has a market cap back over $100 billion. The dividend is going to see pressure going forward if oil prices don’t recover. Indeed, payouts from Exxon and ConocoPhillips (NYSE:COP) are at risk. As Tezcan Gecgil wrote for InvestorPlace this week, the same is true for BP (NYSE:BP). We’ve already seen a big dividend cut from explorer Occidental Petroleum (NYSE:OXY), though its disastrous acquisition of Anadarko Petroleum is to blame.
With run-rate free cash flow likely to be relatively thin going forward, Chevron stock actually is pricing in a rebound in oil prices. And, to be fair, it’s possible that rebound will come. There is growing skepticism that Saudi Arabia can hold the line in the price war. Russia may give as well.
But that doesn’t mean Chevron stock is undervalued here. Rather, it’s another piece of evidence to suggest that the market’s response has been somewhat rational. In a “lower for longer” environment, Chevron’s earnings will plunge. So will its free cash flow.
That’s why Chevron is scrambling to cut costs and lower production just three weeks after it was giving an optimistic five-year outlook. The oil business has changed dramatically. It only makes sense that the Chevron share price would do the same.
Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any securities mentioned.
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