Chevron Stock Analysis – Priced For Oil Perfection
Chevron Stock Price Overview
CVX stock has strongly benefited from the current rebound in oil prices and the stock is almost back to where it was before the COVID-19 crisis.
My view is that the market is pricing in the current oil price scenario into eternity, which leads to the following risk versus reward investing situation:
As the stock has shown over the past 12-months, the risk is extremely high. I haven’t seen long-term oil fundamentals change over the period, on the contrary.
Chevron’s dividend might look attractive, but my main question is what will the market be pricing in 2023 or 2028? The market’s myopic attitude often creates great opportunities like it was the case in March and October of 2020 with oil stocks, but also can lead to high long-term investing risks.
As oil prices go higher, the projections become more and more exuberant and I have heard already the first theses about oil going to $100 and above.
Perhaps the best quote to explain the oil market is the following: “The best cure for low prices are low prices, the best cure for high prices are high prices”. It is up to you to see how the risk and reward fits your portfolio.
I have made quick valuation of Chevron’s stock and a quick overview of the business that I hope will give a good perspective on the risk and reward of investing in CVX stock. Here is the video version that also expands on long-term oil fundamentals and compares CVX stock to Lukoil.
Oil fundamentals unchanged long-term
I have seen many different forecasts related to oil prices. As a conservative investor, best to focus on the negative forecasts. Lukoil’s projections about a worst-case oil scenario implies a decline in demand for oil of 15% by 2035.
Comparing the above with Wall Street’s forecast from BP and Morgan Stanley, there is an obvious discrepancy as in the worst-case scenario below, oil demand stagnates over the next decade.
As my crystal ball recently broke, I can’t tell you what will happen, but I can create scenarios so that you can see how the risks and reward of investing in oil stocks fit your portfolio.
In case demand doesn’t grow and actually declines by 2030, average oil prices will not be above $50, which is an important takeaway for valuing CVX.
Chevron’s business overview
In typical Wall Street fashion, despite the obvious headwinds in the oil sector, you must always project growth. On Wall Street, as soon as you stop growing, you are considered dead, no matter your cash flow potential. Consequently, CVX aims from growth in production over the next 10 years.
To grow production, they will have to spend approximately $10 billion per year for capital expenditures where the return on investment will totally depend on oil prices.
If oil prices average $40, CVX expects to be able to pay a dividend of around $10 billion per year. If oil prices average $60 over the next 5 years, the dividend will likely remain in that range and the company should have additional $20 billion of excess cash. In case it all goes for dividends; we could even expect an average of $14 billion for dividends per year.
The above sounds great and it can actually happen, but as a long-term investor, I am worried about what will the market be pricing in when 2025 comes? Because dividends are one part of investment returns, capital return is the other part.
Chevron stock valuation
I have created a valuation model using CVX’s forecasted dividends and assuming reality will be somewhere between $40 and $60 oil over the next 5 years for average dividend payments of $10 billion per year.
In the normal case scenario, with yearly dividends of $10 billion, growing at 3% per year and a 5% required dividend yield in 2030 (dividend terminal multiple of 20), Chevron’s intrinsic value for an expected 10% investment return is $157 billion.
In the best-case scenario where in 2030 the market requires a 4% dividend yield on a growing dividend over the next decade, only then the current market capitalization is justified for a 10% annual return.
However, if by 2025, the oil environment gets really ugly because of things that we can’t even forecast today like technological improvements, more taxes, or simply oversupply, and the company is forced to cut its dividend, while by 2030 the market expects a dividend yield of 10%, then the downside is 64% to the intrinsic value.
Chevron stock investment thesis
Of course, if oil prices go up to $100, CVX stock will follow. My message is that you have to see how the potential upside in this case, compared to the potential downside in case of longer-term stronger oil sector headwinds based on CVX’s current market capitalization fit your investing risk and reward requirements.
Attaching a 50% chance for the normal scenario, 20% for the best scenario and 30% for the worst possible scenario, my intrinsic value for Chevron for a 10% required annual investment return is $143 billion.
The current market capitalization is justified only if I use a 4.5% discount rate which still gives a positive investment return, but perhaps there are better options with less headwinds for mid-single digit long-term annual returns.
In short, I wouldn’t expect much more from CVX than the dividend, where I can only hope the company doesn’t have to cut it in the next decade.
Compared to other businesses that I have recently analyzed, CVX is among the expensive investments but still better than Tesla or the S&P 500.