Chevron has emerged from the pandemic as a stronger company positioned to benefit from a higher pricing environment. The oil giant’s operating costs are down even as production is up, meaning that it has become more capital efficient. The result of this efficiency improvement: Chevron can generate more free cash at current prices than ever before. For some perspective, Chevron just reported record free cash flow in the third quarter of 2021, more than any of its strongest quarters in 2008 and 2011, when oil prices were more than $100 a barrel.
Capital Returns
Capital returns are incredibly important when trying to decide where to invest in the energy sector. We prefer companies that generate a ton of free cash flow and return the bulk of the cash to shareholders. Chevron does just that. The standout with Chevron is its dividend, which currently pays a yield above 4%. This dividend is very attractive with interest rates where they are today. And by the way, Chevron’s dividend payout has increased 12% since before Covid. That’s higher than any of their peers.
But Chevron does more than paying a fat dividend: it also consistently buys back stocks. Late last year, Chevron raised its annual share buyback guidance to the range of $3 billion to $5 billion per year, up from $2 billion to $3 billion. Looking forward, we think this number may prove to be conservative if energy prices remain elevated.
And Chevron’s capital return model is stress-tested for a lower pricing environment. Their break-even is probably closer to $50- $60 a barrel — a level well below the current price — Chevron says it can generate $25 billion of excess cash over five years. And excess means on top of their capital spending program and the dividend, representing resiliency in the event of a downturn.
ESG
The goal of every industry should be to reduce the carbon footprint of its operations, and under Chevron’s strategic framework, it will be part of the solution to this problem. The company’s goal is to become more efficient in their production of traditional energy and also grow its low-carbon businesses. To accelerate that, Chevron announced last year it will triple its total planned capital investment to $10 billion through 2028, including $2 billion to lower the carbon intensity of its operations.
Chevron’s goal is to be the leader in the fuels of the future and reduce the carbon intensity of these products. Think hydrogen to supply industrial, power, and heavy-duty transport customers, renewable fuels to meet the growing demand for renewable diesel and sustainable aviation fuel.
They plan to increase renewable natural gas production and carbon capture too. Chevron can support these investments thanks to its industry leading balance sheet.
Potential Catalysts
Increase in energy prices, strong execution from management to deliver record profits, and a step up in cash returns to shareholders.
Risk factors
Lower energy prices due to reduced demands/ surge of supply, political and regulatory scrutiny of oil companies, and management mis-steps.
Bottom line
Management’s commitment to capital discipline and efficient operations has turned Chevron into a free cash flow machine and powerful share repurchase return story.
Price target
We have a 225$/share price target for Chevron, arrived at by applying a 10-year average of ~15x forward P/E multiple on 2023 estimated earnings of $15.04/share. However, in our view, this forward P/E multiple is conservative, given the energy dynamic in the next 10 years is vastly different from the energy dynamic in the past 10 years. We think in the best case scenario, the multiple can be 20x.