Shortly after this note, we will start a small position in an energy giant Chevron (CVX). This purchase will represent roughly 1% of the portfolio.

The broader markets have had a tough few days as investors struggled to estimate the impact of the omicron variant. Yesterday, we got a strong rebound from the lows, indicating positive sentiment in the market. We think it’s a good time to brush off the playbook we outlined in the weekly roundup last week. In our note, we recommended looking for companies with strong balance sheets, healthy dividend payments, and consistent share repurchase programs as stocks to buy. Companies with all three usually can withstand and find support in volatile markets. We pulled the trigger on Morgan Stanley earlier in the week, and now we're looking to buy a different name. 

Chevron just reported a fantastic third quarter with record free cash flow generation. Compared to pre-Covid levels, Chevron is generating so much cash because its operating costs are down, its upstream production is higher, and they have become much more capital efficient. The crystal ball in all of this is that Chevron generated more free cash flow in the third quarter than in any of its strongest quarters in 2008 and 2011 when oil prices were well over $100 a barrel. Think about this: Chevron’s focus on cost efficiency and capital efficacy means that the company can still make a lot of money if WTI crude hangs out around $70 per barrel here, and we see plenty of leverage to the upside should oil prices move higher.

Attractive capital allocation policy

Chevron can work in many monetary environments. When interest rates are low, this can be viewed as positive for stocks with big, cash flow-backed dividend yields because the dividend payments become more attractive relative to the 10-Year. The dividend yield on CVX as of Monday’s close was 4.67% and we believe it is well covered by the company’s free cash flow. Chevron’s dividend has grown 12% since before COVID, representing the biggest increase in the sector.

On top of dividend payments, Chevron’s capital return program recently just got even better through the resumption of its buyback program. Management bought back $625 million worth of stock in the third quarter and has already said they plan to buy back roughly $750 million in the fourth quarter. We would not be surprised to see Chevron’s buyback activity increase in the future. Management is on the record of saying that it will increase the buyback range when Chevron’s net debt ratio is “comfortably” under 20%. Well, Chevron ended the third quarter with a net debt ratio slightly under 19%, meaning that the balance sheet is quickly approaching the level where management will increase the buyback range. Keep in mind that Chevron’s focus on capital discipline means that the majority of the excess cash will be returned to shareholders via dividends and buybacks.

Sustainability push

We view this purchase of CVX as the beginning of a long-term investment, core holding and not a trade, so let's dive into sustainability next. One reason why we like Chevron over the other oil and gas giants is its leadership in this field. Chevron’s focus is clear. They want to be the leader in efficient and lower carbon production of traditional energy, which they believe is in high demand today and will continue to be for years to come. Equally important, a goal of Chevron is to grow its low-carbon business. What this means is that Chevron isn’t going after crowded areas in renewables like wind and solar. Instead, they want to be the leader in fuels of the future and reduce the carbon intensity of these products. Think hydrogen, renewable diesel, sustainable aviation fuel. This is so important because one goal of every industry is to lower the carbon footprint of their operations. You can find Chevron’s full climate change resilience report here. 

We are putting on a starter position in Chevron at roughly 1% of the portfolio. As always, we never like to buy all at once when putting on a new stock position. Our entry point may not always be the best price, and we plan to accumulate more shares into weakness. Also, the omicron variant has added a layer of volatility to the markets, and we want to be sure that we leave plenty of room to scale in.