Factors That Will Drive Chevron’s Value Going Forward
Chevron (NYSE:CVX) is among the few oil and gas companies that have held their ground despite the turmoil in the commodity markets over the last two years. Though the oil giant lost almost 45% of its value in 2015 due to the plummeting commodity prices, it gradually regained that value in 2016 by mitigating its weaker upstream results with its enhanced downstream performance. Further, the rebound in commodity prices in the latter half of 2016 allowed the company to hit its 52-week high of $119 per share towards the end of the year. While the company’s stock continues to move generally in tandem with crude oil prices, we believe that Chevron’s strong project pipeline, coupled with management’s efforts to reduce its operating costs and maintain liquidity, provide a notable upside for the company in the coming years. We currently have a price estimate of $117 per share for Chevron, which is slightly ahead of its current market price.
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Strong Production Growth
With the Organization of Petroleum Exporting Countries’ (OPEC) decision to reduce their cumulative oil production by 1.2 million barrels per day, crude oil prices have been trading in the $50-55 per barrel range over the last few months. This has improved the outlook for commodity markets, encouraging large oil and gas players to expand their production in the next few years to leverage the anticipated recovery in the commodity prices and recoup their lost money.
In line with this trend, Chevron intends to grow its production (excluding asset sales) by 4-9% in 2017, and at a steady rate going forward. The company has a pipeline of over 20 projects that are likely to add roughly 2,150 thousand barrels of oil equivalent per day (MBOED) over the next 3-4 years. Of these projects, more than 80% are either operational or are expected to come on-stream in 2017-2018. Higher production, coupled with higher price realization (backed by the recovery in commodity markets), should lead to strong growth in the company’s top line through the rest of the decade.
Continued Focus On Cost Reduction
As a byproduct of the commodity downturn, many oil and gas companies have optimized their cost structures in order to sustain profitability. Chevron has made significant headway in bringing down its operational costs over the last two years, managing to reduce its operating costs from roughly $30 billion in 2014 to $25 billion in 2016, a decline of almost 16% in two years. The company will continue to restrict its costs in 2017 and beyond, which will boost its margins in an improving price environment. Accordingly, we expect the company’s profits to rebound to pre-2014 levels over the next few years, assuming that these cost reduction initiatives are successfully implemented and are accompanied by a steady recovery in the commodity markets.
Better Liquidity, Leaner Balance Sheet
Despite the optimism about a turnaround in the commodity markets, Chevron will continue to regulate its capital expenditures over the next few years. The company plans to spend $19.8 billion in capital and exploration activities in 2017, with a majority of the spend concentrated on short-cycle upstream projects. For 2018 and beyond, the company expects to keep its capital spending in the range of $17-$22 billion, subject to the trajectory of the recovery in commodity prices.
Chevron aims to utilize the proceeds of its divestment program to fund its capital spending needs. The company aims to close asset sales worth $5-$10 billion in the current year. This will allow the company to not only meet its capital expenditure requirements without raising more debt, but also enable it to return more value to its shareholders in the form of dividends and share buyback programs.
Thus, we believe that despite the volatility in the commodity markets, Chevron has significant upside potential driven by its strong portfolio of projects, disciplined cost and capital spending strategy, and strong execution by its management. However, the pace and timing of the rebound in commodity markets will play a crucial role in the company’s future value.
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