A Compelling Oil Play With A 5% Dividend Yield

Legendary investor Warren Buffett does not miss out on many value investment opportunities. Recently, Berkshire Hathaway announced a $4.1 billion stake in Chevron Corp. (CVX).

Over a one-year period, CVX stock has underperformed the market. However, the stock is up around 21% year-to-date and as investors look for value, CVX could continue to perform well.

The energy sector faced significant headwinds last year as the pandemic triggered a collapse in oil demand. Nevertheless, as economic activity continues to improve, the supply-demand gap has narrowed on a relative basis. Production cuts by OPEC have also supported oil prices at higher levels with Brent already trading above $65 per barrel.

Let’s discuss the factors that make Chevron one of the best picks from the oil and gas exploration sector.

A Strong Credit Profile

As oil and gas companies emerge from the crisis, there are several names with a stressed credit profile. Besides asset quality, strong fundamentals are a key screener to pick quality businesses from the industry.

Chevron stands out from a balance sheet perspective. The company reported a net-debt-ratio of 22.7% as of FY2020 which gives it ample headroom to leverage for growth if the industry recovery sustains.

Furthermore, as of Q4 2020, the company reported $5.6 billion in cash and equivalents, and with access to nearly $10 billion in committed credit facilities, Chevron has a liquidity buffer of $16 billion. The company is clearly well-positioned for aggressive capital expenditure.

Another important point to note is that Chevron reported operating cash flow (OCF) of $10.6 billion for FY2020, despite depressed oil prices. For FY2019, the company’s OCF was $27.3 billion.

If Brent is able to sustain above $60 per barrel, it’s very likely that OCF for the current year will be around $20 billion. This is important as the company has guided for capital expenditure of $14 billion for the year. In all probability, the company will be free cash flow positive.

Given the cash buffer and potential cash flows, dividends and share repurchases are likely to continue. Furthermore, if oil continues to trend higher, Chevron will be well positioned to de-leverage.

High Quality Assets For Sustained Growth

Besides the financial profile, Chevron has assets that can deliver strong EBITDA margins and cash flows. One of the key positive triggers is that the company has low break-even assets and as oil trends higher, cash flows will swell.

For example, the company’s Permian asset was free cash flow (FCF) positive in FY2020. With the company having significant proved developed reserves (27% as of FY2020) in the US, the asset will continue to deliver positive FCF.

Chevron also has a geographically diversified asset base with a presence in Brazil, Mexico, Gulf of Mexico, Australia and Kazakhstan. Overall, with 71 billion barrels of oil equivalent (BBOE) of 6P resources, the company has a multi-year production and exploration inventory.

Through FY2024, Chevron has guided for production growth of 3%. Higher oil prices coupled with sustained production growth is likely to translate into incremental cash flows.

It’s also worth mentioning that Chevron acquired Noble Energy in July 2020 for an enterprise value of $13 billion. With a strong cash buffer and a net-debt-ratio of 22.7%, the company is well positioned for opportunistic inorganic growth.

What Is The Street’s Call On CVX?

Consensus among Wall Street analysts is a Moderate Buy based on 10 Buy and 4 Hold recommendations. The average analyst price target of $106.69 implies that CVX has upside potential of around 4% from current levels over the next 12 months. (See Chevron stock analysis on TipRanks)

Takeaway

The House of Representatives has already passed Joe Biden’s $1.9 trillion stimulus package. Once the Senate passes the bill, the stimulus will have a positive impact on GDP growth. As governments globally continue to focus on expansionary fiscal policy, economic revival is likely to sustain, which is positive for crude oil.

Even if Brent trades in the range of $60 to $70 per barrel, Chevron is well positioned to deliver strong cash flows. In FY2020, the company increased dividends for the 33rd consecutive year and the current annualized dividend of $5.16 makes CVX stock attractive for income investors.

The stock has already outperformed the index this year, and in addition to attractive dividends, there seems to be scope for further capital gains.

Disclosure: On the date of publication, Faisal Humayun did not have (either directly or indirectly) any positions in the securities mentioned in this article.

Disclaimer: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities.