Despite a 70% rise since the March 23 lows of this year, at the current price of around $90 per share we believe Chevron’s stock (NYSE: CVX) has reached its near-term potential. The stock rallied from $54 to $90 off the recent bottom compared to the S&P which moved 37%. It has outperformed broader markets primarily due to the 100% increase in the WTI benchmark, which fell to $18 before plunging into negative territory in April. As the company has planned a 30% reduction in capital expenses and announced a 15% production curtailment in May, we expect Chevron to observe earnings erosion from low gasoline and jet fuel demand in the near term. Notably, jet fuel, gasoline, and diesel account for 20%, 40%, and 23% of the company’s total refinery sales volume, respectively.
While the broader markets have completely recovered, the low industrial and transportation demand has been a drag on the overall oil & gas industry. Interestingly, other integrated oil majors such as Exxon, BP, and Royal Dutch Shell have also planned a 30% capex reduction for the full year. More so, the U.S. crude oil inventories (excluding SPR) have surged by 13% since the beginning of this year, putting downward pressure on crude oil prices and prompting OPEC+ to continue with the 9.7 MBPD production cut, around 10% of the global supply in 2019, until July.
Consistent with stable demand and rising prices, Chevron’s revenues increased by a modest 3% since 2017. Also, the adjusted margins have improved slightly from lower corporate tax rates on excluding the impact of impairments. Thus, the adjusted net income surged by 30% from the combined effect of revenue and margin expansion.
While the company has seen revenue and earnings growth over recent years, its PE multiple has see-sawed with the WTI benchmark as it is the key driver of the company’s profitability. We believe the stock is unlikely to see a significant upside in the near-term due to a low production environment which is expected to last until there is successful containment of the coronavirus spread or a vaccine reaches the final production stage. Our dashboard What Factors Drove -20% Change in Chevron’s Stock between 2017 and now? provides the historical trends in revenues, margins, and P/E multiple. CVX’s PE multiple decreased from roughly 23.5x in 2017 to 19x in 2019. While the company’s PE is now 14.5x, we believe there isn’t much upside considering the growing crude oil inventories across the globe. While the company has suspended its share repurchase plan to preserve cash, it has not slashed dividend payouts. Thus, investors can expect a modest 4% dividend yield based on historical trends.
So what’s the likely trigger and timing for an upside?
Per recent Short-Term Energy Outlook, STEO, EIA expects the demand for crude oil to pick up in Q3 as lockdown restrictions ease across major economies. To lighten inventory pressure on benchmark prices, demand is expected to exceed supply (upstream production volume) for the rest of the year. While the trajectory of demand recovery depends on the growth in the number of new Covid-19 cases in the U.S. and other major economies, a sudden surge in demand could prompt upstream oil producers to revisit their capital expenditure plans and increase production.
As oil producers and service providers face the coronavirus storm, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.