Recommendation: HOLD Target Price until (12/31/2016): $118.00 1. Reasons for Recommendation The driving factor behind my hold recommendation for Chevron is due to the state of the oil production industry as a whole. Oil prices have fallen from over $100 in the summer of 2014 to under $50 today. As such, the participants in the oil and gas production industry have seen decreasing margins due to decreasing revenues from the lower oil prices equating to lower returns. On July 24 th 2014 Chevron hit its 52 week high at $135 per share. The price of West Texas Intermediate (WTI) oil on July 24 th 2014 was $102.46 per barrel. As of March 30 th 2015 the price of WTI was at $48.66 per barrel and Chevron s stock was down to $106.90 per share. This represents a 53% drop in oil prices and a 25% drop in Chevron s stock price. 1 There are numerous factors that go into the global price of oil such as global supply and demand, OPEC and the costs of production. When attempting to predict the price of oil the leading indicators are crude inventories or stock levels and gross domestic product estimates. According to the Energy Information Administration (EIA) as of April 1 st crude inventory levels were at all-time highs rising 4.8 million barrels in the last week of March to a total of 471.4 million barrels. 2 Moreover the international monetary fund s GDP estimates remain low throughout the globe. With supply forecasted to remain high and demand to stay low oil prices are likely to go lower. Should these industry headwinds persist Chevron is positioned to experience a further decline in share price and due to this potential downside I would not recommend a buy at this point. Although Chevron is experiencing these industry wide headwinds the company does have a solid foundation for growth which is the reason I do not recommend a sell for Chevron at this point. Chevron has two liquefied natural gas projects (LNG) nearing completion one this year and one the next. Although Chevron does not break revenues down by LNG and Oil production the two projects are expected to contribute to Chevron s goal of increasing LNG production by 20% through 2017 from 2.6 million barrels of oil equivalent per day to 3.1 3 million. The first is the Gorgon Project. This project is slated to come online mid-2015 and is the largest single source development in Australia. The Gorgon project will add 15.6 million metric tons of LNG to Chevron s production per year. The second is the Wheatstone Project, this project will add 8.9 million metric tons per year to Chevron s LNG production and will be complete early 2016. The Gorgon and the Wheatstone Project will add a total of 24.5 million metric tons of LNG to Chevron s production per year. Although liquefied LNG is plentiful throughout the world Chevron feels it is positioned well to bring LNG to the areas it is needed most and as such plans to increase its production volume substantially in the coming years. Upon the completion of these two projects Chevron will be the largest producer of LNG in Australia. The Australia LNG market is strategically important due to its access to Asian markets where the demand for LNG has been steadily increasing. To put this in perspective Chevron looks to add 24.5 million metric tons of LNG per year with these two projects, while the current global production volume is just 240 million metric tons per year Chevron is positioned to produce over 10% of the world s liquefied natural gas. The last contributing factor to my recommendation is in relation to Chevron s financial performance and valuation multiples. Although Chevron s cash flows have fallen due to lower oil prices this will be 1 http://finance.yahoo.com/q?uhb=uh3_finance_vert&fr=&type=2button&s=cvx 2 http://www.eia.gov/
partially offset by the completion of Chevron s capital expenditure projects in Australia and the halting in its stock buyback program. This will allow Chevron to continue its industry leading dividend payouts while still being able to reinvest in its higher margin businesses. Moreover Chevron s net debt/ capital ratio is lower than most firms in its industry at 6.1% compared to 10.7% at shell and 11.8% with Schlumberger. This lower debt obligation allows Chevron to be more nimble with its cash. Moreover Chevron s P/E ratio is 10.38 compared to Exxon Mobiles 11.10, British Petroleum s 32.39 and the industry average of 22.42. After reviewing each firms earnings growth rates, profitability and risk we can see that the P/E of Chevron shows that it is still relatively cheap in comparison to its industry and peers. 2. Company Analysis Chevron Corporation is one of the world s largest oil companies. Chevron is a multinational corporation headquartered out of San Ramon California with operations in North America, South America, Europe, Africa, Asia and Australia. Chevron operates a vertically integrated business model. Meaning that Chevron owns and operates the entire supply chain for its products from start to finish. Chevron breaks business into essentially two segments, the upstream business and the downstream business. Chevron s upstream business is responsible for 88% of the company s net income and its downstream business accounts for 23% of the company s net income. Chevron describes its upstream operations as anything involved with producing and sale of crude oil and natural gas, such as exploring for, developing and producing the commodities. Moreover Chevron includes the transportation, storage, processing, and liquefaction and gas-to-liquid projects all to be involved with its upstream operations. Chevron and Chevron s subsidiaries sells these upstream services and products to other companies both owned by Chevron and by other companies with the end goal to distribute to both the business and retail consumer. 4 The second segment Chevron operates is defined as their downstream operations. Chevron s downstream operations consist of essentially their go to market operations. Anything that relates to the creation and sale of end products, such as refining of oil and natural gas, sales and marketing of gasoline, jet fuel, gas oils and other products derived from crude oil. Lastly the downstream operations also generates revenue from the manufacturing of fuel additives and lubricants. You may have heard of Chevron s most popular fuel additive Techron created for the use in consumer cars and trucks. Chevron s products are sold to retail consumers, businesses and the government. 5 Strengths One of Chevron s primary strengths are in its organizational structure. Chevron is vertically integrated which give the firm economies of scale and synergies that nonintegrated firms do not benefit from. Through Chevron s subsidiaries the firm can complete the entire cycle from production to sale for consumption of oil, natural gas and petroleum products. This gives Chevron the ability to adjust for market fluctuations better than nonintegrated firms. Also, Chevron s balance sheet has comparably low debt for the industry average. This allows Chevron to continue to invest in future growth despite the current environment of low oil prices. Chevron currently has over $266 4 5
billion dollars in assets split across the globe divided amongst business segments. The company has announced an increase to its divestiture plan to 15 billion by 2017 allowing for even more cash flow. Last, Chevron s globally diverse presence allows the company to produce oil and natural gas in regions where it is most cost effective and the most profitable. Weaknesses - Chevron s strengths are also some of its weaknesses. Due to the fact that Chevron operates globally the firm carries the risk of geopolitical unrest in unstable areas the firm does business in. Moreover, as is the same with any oil producing company Chevron s earnings are highly tied to the global price of oil and in today s low oil price environment Chevron will show a weakness in earning accordingly. 6 Opportunities Chevron s opportunities exist in the growing production volume with the nearing completions of its two LNG projects in Australia. Also Chevron s position in the United States Permian Basin and Marcellus shale offer the firm opportunities to drive down operating costs while still producing higher volumes. Threats Chevron faces the constant threat of even lower oil prices. With many leading indicators showing depressed oil prices in the future the firm will face depressed revenues. Moreover the oil industry faces the threat of replacements from competing energy sources such as solar, wind and water power. As these types of energy sources become more efficient and cost effective it will increase the competition and price pressures for oil and natural gas. Lastly the firm has the threat of limited supply. There is a limited supply of oil and natural gas on the earth and as supply dwindles the cost to produce and explore will raise putting further pressure on the firms bottom line. 3. Industry Overview Chevron s Upstream and downstream business units compete in two different industries. Chevron s upstream business is a part of the global oil and gas production drilling and exploration industry. Oil and gas production, drilling and exploration is fiercely intense due to the nature of the business. First there are many regulatory hurdles a firm must cross in order to be granted permission to drill for either commodity. Moreover, once the legal hurdles are accomplished Chevron has to compete for location. The world has only a limited area for oil and natural gas to be uncovered so Chevron has to compete with other firms for the best most profitable locations. 7 Chevron s downstream business is essentially the global petroleum refining and petroleum product production industry. Chevron operates petroleum refining facilities which are also extremely competitive and dependent on the world price of crude oil. In times of low crude oil prices competition intensifies and profit margins are cut. Economies of scale due exist in most of the industries Chevron operates in. With Chevron being vertically integrated the company is able to leverage its subsidiaries to operate extremely efficiently. 8 6 7 http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/default.aspx?entid=103 8 http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/default.aspx?entid=449
As stated previously Chevron segments their business into upstream and downstream products and services both domestically and globally. With each part of the business comes numerous competitors, for the scope of this analysis we will cover Chevron s most comparable competitors in Chevron s largest business segments. Chevron s largest businesses is its oil drilling and gas extraction industry. The suppliers in this industry are supply manufacturing companies and oil and gas field service companies. The customers are petroleum refining companies and gas distribution companies. In this industry Chevron primarily compares/competes with ConocoPhillips and British Petroleum. This industry is a very large segmented industry with total global revenues over $4.6 trillion dollars and over $407 billion in revenues within the United States. Globally Chevron makes up less than 1% of the global oil production industry. Within the United States Chevron holds only a 6.6% market share, ConocoPhillips has a slightly larger market share of 7.7% and BP holds a 6.1% market share. In this industry economies of scale are essential, larger oil and gas wells are more profitable to develop the firms that can obtain access to these wells have a clear advantage over their smaller peers. Macroeconomic factors have greatly impacted the oil drilling and gas extraction industry. Due to increase supply coming from the United States, OPEC s decision to not cut supply targets and slow global growth in terms of GDP. Oil prices per gallon have fallen over 50%. Despite these recent macroeconomic developments the industry is still expected to grow at a 2.4% clip. 9 The second industry that Chevron primarily competes in is Petroleum refining. The suppliers in this industry are the oil and gas drilling and production companies and the customers are gas stations, the airline industry and chemical companies. This industry is also a very large industry with a total revenue of $730 billion. Chevron s major competitors in this industry are Valero, Exxon, Phillips 66, Marathon Petroleum Company and Shell. These firms share the market in the following percentages respectively; 18.1%, 16.9%, 13.7%, 12.9%, 10.4%. Chevron itself has a market share of 11%. The petroleum refining industry much like the oil and gas drilling and extraction industry have very high barriers to entry. Petroleum refining equipment takes extremely large amounts of capital, to enter this industry one must meet and exceed those requirements. More over a petroleum refining firm needs to obtain contracts from crude oil suppliers which is also capital intensive and where vertically integrated firms tend to have an advantage. Profit in this industry is highly correlated to the supply and demand for oil globally. If demand is high then these firms may charge a premium to their mark up, but when supply is high and demand low these firms must then cut their markup and profit margins then decrease. Over the past 5 years profits have average 4.7% of total revenue. 10 The refining industry is extremely dependent on global oil prices. Due to increased crude oil production and decreased demand the price of oil will fall and so will the anticipated revenue for the industry as a whole. In 2015 alone revenue is expected to fall 2.7% for the industry. Petroleum refiners will continue to experience tough financial times as long as oil prices are low. 11 9 http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/industryoutlook.aspx?entid=103 10 http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/industryoutlook.aspx?entid=449 11 http://clients1.ibisworld.com.libproxy.unm.edu/reports/us/industry/industryoutlook.aspx?entid=449
Appendix: Inputs into valuation using multiples 2009 2010 2011 2012 2013 2014 Stock Price(Forward P/E) $ 76.99 $ 91.25 $ 106.40 $ 108.14 $ 124.91 $ 112.18 Stock Price(P/S) $ 76.99 $ 91.25 $ 106.40 $ 108.14 $ 124.91 $ 112.18 EPS (Basic) $ 5.24 $ 9.48 $ 13.44 $ 13.32 $ 11.09 $ 10.14 Sales $ 171,636.00 $ 204,928.00 $ 253,706.00 $ 241,909.00 $ 228,848.00 $ 211,970.00 Shares outstanding (basic mil.) 2,001.00 2,007.00 2,001.00 1,950.00 1,932.00 1,898.00 Sales per share (basic) $ 85.78 $ 102.11 $ 126.79 $ 124.06 $ 118.45 $ 111.68 P/E 14.69 9.63 7.92 8.12 11.26 11.06 P/Sales per share $ 0.90 $ 0.89 $ 0.84 $ 0.87 $ 1.05 $ 1.00 Net Income 10563 19136 27008 26336 21597 19310 2015 2016 2017 2018 2019 2020 Stock Price(Forward P/E) $ 149.95 $ 229.31 $ 235.16 $ 232.76 $ 232.10 $ 253.39 Stock Price(P/S) $ 113.30 $ 118.29 $ 126.05 $ 133.45 $ 143.26 $ 154.50 EPS (Basic) 9.284741853 14.19871225 14.56113912 14.41226789 14.37152954 15.68958135 Sales $ 210,830.00 $ 217,917.00 $ 227,558.00 $ 238,519.00 $ 253,481.76 $ 270,642.34 Shares outstanding (basic mil.) 1,898.00 1,879.02 1,841.44 1,823.03 1,804.79 1,786.75 Sales per share (basic) $ 111.08 $ 115.97 $ 123.58 $ 130.84 $ 140.45 $ 151.47 P/E 16.15 16.15 16.15 16.15 16.15 16.15 P/Sales per share $ 1.02 $ 1.02 $ 1.02 $ 1.02 $ 1.02 $ 1.02 Net Income 17622 26680 26813 26274 25938 28033 * Analyst's own calculations. Source of basic data: company's 10-K; Yahoo! Finance