Chevron: Patient Buy for Growth and Yield

01/04/2016 8:00 am EST


John Eade

Chairman and CEO, Argus Research Group

Over the long run, the time to buy high quality stocks is when sentiment is against them and valuations are attractive, suggests John Eade of Argus Research.

We are thus moving Chevron (CVX) to the buy list, with a target price of $105. CVX has outperformed the industry over the past year; it has also outperformed the industry on a five- and ten-year basis as well.

Though we expect free cash flow to be negative in 2015 due to the recent sharp drop in oil prices and still heavy capital spending, management has outlined its plans for the next three years and we believe that the company’s period of heavy investment will pay off.

Over the next three years, while global oil growth catches up with global oil supply, the company expects to reclaim its position as the number one upstream super major in terms of production growth and per-barrel profitability.

In addition, as the capex program winds down and the company focuses on cost reduction, it expects free cash flow to turn positive by 2017. The clear risk to the thesis is the volatile price of oil.

However, we think oil prices are near the bottom of their forecast trading range for 2016 and we expect them to trade higher over the year. The current yield on the CVX shares of 4.8% pays investors to be patient.

Based on the falling price of oil, which is falling faster than management can cut costs, we are once again lowering our 2015 EPS estimate. Our new 2015 estimate is $3.35 per share, down from $3.51. We are also lowering our 2016 EPS estimate to $3.25.

The dividend remains Chevron’s highest priority for cash. We thus expect management to fund the dividend by taking on additional debt, divesting assets, and drawing down its cash balance.

We note that the company has also suspended its $1.25 billion quarterly share buyback in order to conserve cash.

CVX shares appear attractively valued. The shares generally, but not always, are a leading indicator for the price of oil on the way up and a lagging indicator on the way down. As such, the recent move in CVX from $75 to $90 may potentially turn out to be a bullish signal.

From a fundamental standpoint, the shares are trading at 27-times our 2016 EPS estimate, above the five-year historical average, though we note that our earnings estimate is depressed due to the sharp drop in oil prices.

The shares are trading toward the low end of the five-year range for price/cash flow, though. And we note that CVX’s dividend yield of 4.8% is above the peer average of 2.7%.

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