America’s second-largest energy producer, Chevron Corporation (CVX), has returned to profitability in its second quarter of Fiscal Year 2021, which has caused a great deal of excitement among analysts.
Rediscovering Profitability
The company’s return to profitability can mainly be attributed to global Oil & Gas operations returning to capacity after initial pandemic lockdowns disrupted upstream operations.
Chevron’s earnings per share of $1.60 beat expectations by $0.11, and its $36 billion in revenue came in $1.15 billion ahead of consensus estimates. Net income was $3.08 billion.
Value Drivers Remain Intact
Gross margins have been given some relief, as crude oil is currently trading in the $65 – $75 range, approximately $25 above Chevron’s breakeven point.
Also adding significant substance to Chevron’s results is the Noble Energy takeover, which is starting to pay off. The subsidiary has strengthened its foothold in the Permian Basin while expanding its operations in the D-J Basin and Eagle Ford.
Chevron holds a strong balance sheet with $7.11 billion in cash and equivalents. The company’s AA- debt rating assists with borrowing rates. Chevron, therefore, seems well-positioned to expand, given its ability to take advantage of distressed assets.
Inflation plays into Chevron’s hands as institutional investors generally seek vertically integrated companies and dividend aristocrats in inflationary environments.
The theory is that vertically integrated companies are less susceptible to suppliers’ price elasticity because they possess their own supply.
Investors tend to opt for dividend aristocrats during inflationary environments because value stocks tend to outperform growth stocks when there is inflation. The dividend factor plays its part because stocks that pay higher dividends are generally considered more valuable.
Shareholder Compensation
Chevron’s stock has lagged the S&P 500 index over the past 10 years, but this could be about to change as the company has opted for a more flexible shareholder compensation plan.
Chevron announced in its second-quarter report that it would revive its $30 billion share repurchase plan. Chevron will likely reduce its payout ratio soon, as its dividend coverage ratio of 1.22 and its payout ratio of 82.74% seem unsustainable.
If the payout ratio reduces while shares are being repurchased, we’ll most likely see EPS continue its positive trajectory and the stock price should follow suit.
Share repurchases will almost definitely see Chevron’s stock appreciate. The earnings yield has recovered beyond the 1.57% cost of debt and is well on its way to the pre-pandemic 5% mark. For as long as the earnings yield dominates the after-tax cost of debt, we can consider EPS as accretive during a share repurchase program.
Alternatively, if you’re valuing the company based on assets, a decrease in shares outstanding will increase the company’s asset base per share, which means that intrinsic value will most likely be elevated.
Wall Street’s Take
Wall Street remains optimistic, with an average CVX price target of $127.75. Devin McDermott of Morgan Stanley set the highest price target of $149, maintaining an overweight position. Bank of America’s Doug Leggate upgraded his price target from $125 to $130 at the beginning of August, citing Noble Energy’s acquisition as key to the company’s potential upstream success.
The overall consensus on Wall Street is that CVX is a Strong Buy. The stock has been given 10 Buys ratings, and 3 Hold ratings over the past three months.
Disclosure: On the date of publication, Steve Gray Booyens held a long position in Chevron.
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.
