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Using the Value Line Page: Chevron September 10, 2010
The BP (BP) oil spill has left a cloud over the entire oil industry, as it has exposed investors to the risks of drilling for oil. This simple fact seems to have faded from memory after the Exxon Valdez disaster in 1989 last brought the issue to the forefront and, in the process, dragged down the share price of what is now Exxon Mobil (XOM – Free Analyst Report), not to mention the rest of the oil industry.
Although the large companies involved in this business are, generally speaking, financially sound and well managed, the industry in which these companies operate is technologically challenging and often requires working with volatile governments throughout the world. These are risks that are unlikely to go away. Investors willing to accept these risks, however, may find some compelling opportunities in the sector. One of the often-overlooked oil giants that appears to be trading at an appealing price is Chevron (CVX – Free Analyst Report).
As the Business Description on the Value Line page states, Chevron is the world's fourth largest oil company based on proven reserves. Daily gross production in 2009 was 1.846 million barrels crude oil and Natural Gas Liquids and 4.989 billion cubic feet of natural gas. The company’s net proved reserves as of December 2009 were 6.973 billion barrels of oil and 26.049 trillion cubic feet of natural gas. Chevron also has over 4,000 owned or leased gas stations, mainly in the United States. It supplies over 11,000 other stations, as well.
Although the company is massive, sporting a market capitalization of almost $150 billion (which can be found in the Capital Structure Box on the left of the page), it is about half the size of Exxon Mobil. In fact, the production figures noted above are also about half the size of Exxon Mobil’s, too. You can view the Analyst Report on Chevron for free by clicking here for use with this article. (A free copy of the Exxon Mobil report is also available, for comparison purposes by clicking here.)
As the Analyst Commentary points out, a large percentage of Chevron’s production stems from the Gulf of Mexico. Exploration in that area has been curtailed because of the BP disaster. This could pose a problem for Chevron if the current government limitations imposed on the region aren’t lifted in a timely fashion. Indeed, if drilling doesn’t resume, the company could see its production levels fall, which is a longer-term negative.
The flip side of this, however, is that Chevron wouldn’t be alone in this predicament, which could ultimately cause oil prices to move higher—which could benefit the company in the near term. In addition, should the U.S. government materially raise the liability that drillers face in light of the BP disaster, smaller players may not be able to absorb the added costs and fold or sell themselves to larger players. Chevron is large enough that added costs won’t likely be a make-or-break concern and, as such, it could benefit from reduced competition. It is also large enough to acquire well-positioned, smaller competitors.
In fact, the company’s financial position is top notch. As the Capital Structure Box shows, debt makes up just a small fraction of the company’s capital structure. Moreover, the company receives the highest possible score for Financial Strength, found in the Ratings Box at the bottom right of the page. The shares also receive solid scores for Price Stability and Price Growth Persistence. Earnings Predictability is the one score in the Ratings Box that doesn’t stand out. However, the volatile nature of commodities plays a material role in the company’s top- and bottom-line results, which largely accounts for this seemingly out of place score. (Note that all of the above measures are proprietary Value Line ratings.)
The high scores for Financial Strength, Price Stability, and Price Growth Persistence, coupled with a solid balance sheet, help to explain the top-notch Safety Rank that has been in place since 1991, which can be seen in the Ranks Box at the top left of the page. Add to this the company’s long history of increasing its dividend distribution, which can be seen in the historical section of the Data Array, and the company seems appropriate for conservative investors who understand and are willing to accept the industry risk associated with this company.
Moreover, the company’s current dividend yield, which is listed in the Top Label, is at the high end of its historical range (this comparison can be made by looking at the Data Array), suggesting the shares are priced relatively cheaply. Both the current price to earnings ratio and the relative price to earnings ratio also suggest compelling valuation (like the dividend yield, these ratios can also found in the Top Label and in the Data Array, facilitating historical comparisons).
Another point of interest on the valuation front is Chevron’s price relative to its cash flow line, also called the value line, another proprietary Value Line measure. As can be seen in the Graph, the company’s shares have traded at about six times cash flow (the determinant of the cash flow line, as the Legend on the graph illustrates) since 2003. Based on our estimates and projections, that relationship doesn’t appear to be holding at present, with the shares trading below that multiple. Note that prior to 2002, the company’s shares traded above the cash flow line.
Large negative events often leave a lingering impact on an industry. Although the final impact of the BP spill is impossible to predict, Chevron is likely to thrive no matter what happens because of its size and financial strength. With what appears to be a compelling long-term valuation and a nice current dividend yield, patient, risk-averse investors willing to take on some industry risk might find this a compelling time to buy Chevron.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.