Chevron Deserves A Better Valuation

By Stephen D. Simpson, CFA | February 03, 2013 AAA

Like other energy majors, Chevron (NYSE:CVX) is trapped in a Wall Street catch-22. Analysts and investors are quick to complain about the low expected production growth rates in the sector, but they complain even louder when the companies announce higher capex budgets to exploit and develop their sizable reserves. Even so, Chevron looks too cheap when compared to peers like Exxon Mobil (NYSE:XOM) and ConocoPhillips (NYSE:COP). Sizable investments have pressured recent returns, but the long-term growth and value-creation potential at Chevron looks better than just worthwhile.

Guide To Oil And Gas Plays: We've got your comprehensive guide to oil and gas shales in North America.

Respectable Fourth-Quarter Results
All in all, Chevron had a pretty solid fourth quarter. Revenue increased about 1%, while the company's reported operating income improved about 20%.

Unlike Exxon, Chevron managed to show production growth, albeit not very much at just 1% growth on a barrel of oil equivalent (BOE) basis. Segment earnings for the S&P business fell 4% (down 15% in the U.S. business), as unit profits fell 6% from the year-ago period. Even so, at more than $22 per BOE, Chevron's E&P unit profitability is one of the best in the business.

Chevron also saw considerable reported growth in its refining profits. Up over 5,000% on a reported basis, Chevron is still not especially successful on the basis of profits per barrel of throughput.

SEE: Understanding Oil Industry Terminology

Paying the Cost to Be the Boss
One of the near-constant worries about Chevron (and the energy majors in general) is the cost of developing major projects like Gorgon. To that end, costs on Gorgon are increasing, and the company's portfolio of deepwater assets are also going to require substantial capital to develop - drilling a horizontal well in Texas can cost anywhere from $1 million to $10 million, while deepwater wells can approach (and sometimes exceed) $100 million.

This is not just money thrown down a rathole, however. Chevron boasted a solid reserve replacement ratio of 112% for 2012. What's more, while the company's guidance for 2013 production growth wasn't stellar (1 to 2%), it still looks as though production growth could accelerate to 4% to 5% a year in a few years - making Chevron one of the stronger growth stories, with a portfolio of assets more heavily weighted towards oil than most majors.

SEE: 5 Biggest Risks faced By Oil And Gas Companies

Will LNG Develop as Expected?
Not unlike Exxon, Royal Dutch Shell (NYSE:RDS.A, RDS.B) and others, Chevron has made major commitments to a variety of liquefied natural gas (LNG) projects. In addition to the large Australian projects Gorgon and Wheatstone, there is Chevron's project in Angola and the recently acquired stake in Canada's Kitimat project.

Clearly, the world's energy majors are expecting more global demand for LNG as it gets more and more difficult (and expensive) to access new, cheap sources of oil. Japan arguably has the best LNG infrastructure today and is willing to pay many multiples of U.S. Henry Hub prices for that LNG.

SEE: How To Profit From Natural Gas

The Bottom Line
While Chevron continues to invest capital to develop existing reserves, I would not be surprised to see the company look to M&A to supplement its reserves and production growth prospects. The company has a clean balance sheet and could arguably use more onshore resources in the United States and Canada. It doesn't hurt at all that Chevron would be approaching these deals from a position of relative strength - the right deal could help the company, but it doesn't have to do a deal.

Exxon Mobil is ahead of Chevron in areas like long-lived production assets and return on capital, but I think the Street undervalues/underestimates the extent to which Chevron can close that gap in the coming years. Equally to the point, I believe the Street undervalues Chevron today and that the stock's fair value lies north of $130.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Analysis
  1. These stocks have been weak, and despite rallies, investors might be better served by selling or shorting as opposed to buying.
    Chart Advisor

    Time To Take Profits On These 4 Rallying Stocks?

  2. With its huge population and booming economy, China is tops for many emerging markets investors. Here's a leveraged ETF for those who want to double down.
    Stock Analysis

    This Leveraged ETF Is For China Bulls

  3. Chart Advisor

    Is Natural Gas About to Tank?

  4. Chart Advisor

    Is It A Breakout? See The Point-And-Figure Chart

  5. Chart Advisor

    These Stocks Offer Range-Trading Opportunities

Trading Center