Chevron Revised To $120 On Slower Production Growth, Thinner Margins
Chevron (NYSE:CVX) reported lower fourth quarter earnings on thinner refining margins and lower upstream production. The company’s 2013 full year diluted earnings of $11.09 per share declined by around 17% y-o-y. Its total oil equivalent production also declined marginally to around 2.6 million barrels per day (mbpd) due to slower than anticipated ramp up of the Angola LNG project that started last year. Chevron also announced that the Gorgon liquefied natural gas (LNG) is 76% complete and is on track for late-2015 start-up. However, rising capital expenditures remain a key worry for the company. [1]
We have updated our price estimate for Chevron to $120 per share, based on the recent earnings announcement.
See Our Complete Analysis of Chevron
Lower Production, Unfavorable Mix
More than 60% of the y-o-y decline in Chevron’s 2013 full-year earnings can be mostly attributed to its lower upstream production and unfavorable volume-mix. Incremental production volume from the company’s new capital projects fell short of offsetting normal field declines last year. This was primarily due to slower than anticipated ramp up of the $10 billion Angola LNG project, in which Chevron holds a 36.4% stake and expects incremental net production of around 0.06 mbpd at peak capacity. [2]
Although first cargo from the project was reported in June last year, it is currently operating much below its full capacity. The company officials said that it is primarily due to some technical issues with the dehydration unit at the plant. The variable feed mix at the facility, as it uses associated gas (natural gas which is found with the deposits of crude oil and is generally lost in flaring) from various oil production facilities nearby, was cited as the main reason behind these technical issues. [2]
Going forward, Chevron’s production growth is expected to remain subdued this year as well, as the company does not expect the Angola LNG project to fully ramp up until 2015. However, Beyond 2014, the company expects its annual production growth to accelerate to 3-4% as the Angola LNG and the Papa Terra projects completely ramp up and the Australian LNG projects (Gorgon: 2015, Wheatstone: 2016) come online. (See: A Closer Look At Chevron’s Biggest Bet In The Global LNG Market)
Thinner operating margins also impacted Chevron’s upstream earnings last year. This is because the company’s production skewed more towards natural gas, which has slimmer operating margins, compared to liquids. This is especially the case in the U.S., where gas prices are severely depressed compared to international markets due to a glut of supply from unconventional sources. Natural gas contributed 33.3% to Chevron’s total net production in 2013, compared to 32.4% in 2012. [1]
Thinner Downstream Margins
Chevron’s downstream earnings declined almost 50% y-o-y in 2013 due to thinner refining margins. This has been more of an industry-wide trend during 2013 as global overcapacity amid sluggish demand and higher crude oil prices squeezed operating margins for refiners. However, there have been certain bright spots as well – refineries in the Midwest U.S. that have gained from lower crude oil prices due to fast-growing supply from unconventional plays in the U.S. and a lack of midstream infrastructure. But, the sharp decline in international crack spreads more than offset this advantage for Chevron. More than 50% of the company’s refinery output comes from international markets. [1]
Going forward, we expect the global refining margins to continue to remain under pressure due to industry overcapacity, which stems from the fact that governments in different parts of the world are willing to run uncompetitive crude refineries at very low or no returns, to sustain employment and reduce their reliance on imported fuels. [3]
Soaring Capital Expenditures
Soaring capital expenditures seems to be the biggest valuation concern for Chevron right now. The company’s net capital expenditures have soared from around $17 billion in 2009 to almost $37 billion in 2013. This has been primarily due to the ongoing LNG projects in Australia, where cost structures have elevated significantly over the past few years due to rising labor costs. Gross cost estimate for the Gorgon LNG project has risen by more than 45% since 2009 to $54 billion today.
Apart from this, Chevron also exceeded its 2013 capital budget target by as much as $4 billion due to unplanned resource acquisitions in Canada, Australia and the Kurdistan region of Iraq. Due to the rising proportion of currently unproductive capital employed in ongoing projects and resource acquisitions, the company’s total return on capital employed (ROCE) has taken a major hit. At 13.5% in 2013, Chevron’s ROCE declined by more than 500 basis points year-on-year. [2]
However, the company is looking to slightly tone down capital investments this year as it plans to reverse the growing trend in favor of higher cash flows. According to the recently announced capital budget plan for this year, Chevron looks at spending around $2 billion less on leasing rigs, floating oil platforms, installing pipelines and repairing oil-refineries than it did last year. [4]
See More at Trefis | View Interactive S&P Capital IQ Analyses (Powered by Trefis)
Notes:- 2013 4Q Earnings Release, chevron.com [↩] [↩] [↩]
- 2012 4Q Earnings Conference Call Presentation, chevron.com [↩] [↩] [↩]
- Global overcapacity to squeeze oil refining margins: Campbell, reuters.com [↩]
- Chevron Announces $39.8 Billion Capital and Exploratory Budget for 2014, chevron.com [↩]