An Oil Stock for All Seasons

04/21/2009 12:00 pm EST

Focus: STOCKS

Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Stephen Biggar, Standard & Poor’s global director of equity research, says Chevron is extremely well managed and diversified and should come back nicely as oil prices rise.

Chevron (NYSE: CVX) is the third largest integrated oil company in the US and the fifth largest in the world—as well as the fifth largest natural gas producer in North America. The company has a strong global presence in refining, marketing, and transportation—with retail marketing under the Chevron, Texaco, and Caltex brands.

While the company's exploration and production earnings have been hurt by the sharp drop in crude oil and natural gas prices, its diversification into downstream businesses has helped offset these losses, and lower crude oil feedstock costs have benefited its refining and marketing businesses.

We believe Chevron will benefit from improved industry fundamentals and higher commodity prices through its exploration & production (E&P) activities. We expect Chevron's oil and gas production will increase about 4% in 2009, and we look for annual production growth of 2% to 3% between 2007 and 2012.

We have a positive outlook for Chevron's E&P (“upstream”) business based on our view of its strong array of exploration and development projects; contributions from its 2005 acquisition of Unocal, and its upstream development projects in Angola, Kazakhstan, Nigeria, the Gulf of Mexico, and Australia. The company is also expanding into nonconventional oil production from Canadian oil sands to global liquefied natural gas (LNG) projects.

About three-fourths of Chevron's refining capacity is located in areas that are expected to account for about half of the world's growth in energy demand. Many of its refineries are complex and capable of converting significant volumes of lower-quality heavy and sour crude into a variety of low-sulfur, higher-value, refined petroleum products.

We believe the drop in oil prices over the past months was excessive. We estimate that WTI spot oil prices will average about $40 per barrel in 2009, $53 in 2010, and $61 in 2011, and expect West Texas Intermediate (WTI) oil prices [to average] above $90 per barrel in 2014 and thereafter.

We expect after-tax operating earnings will drop 38% in 2009 on lower projected oil and gas prices before rising about 5% in 2010 on our higher price forecast and an improved economic outlook.

The stock recently traded [below $64]. Our 12-month target price for Chevron's shares of $95 represents potential appreciation of about 45% from current price levels and an expected enterprise value of 7.5x our estimated 2009 earnings before interest, taxes, depreciation, and amortization (EBITDA), a discount to Chevron's US supermajor oil peers ExxonMobil (NYSE: XOM) and ConocoPhillips (NYSE: COP).

The company's high degree of earnings and dividend growth and stability (it has an A- ranking under the S&P Quality Ranking system) justify a higher multiple than Chevron's stock currently receives. The shares recently had a dividend yield of about 4.0%.

The stock carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy). We believe Chevron's corporate governance practices are above average for companies within the S&P 500 and S&P energy sector.

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