Our dividend growth thesis on Chevron (CVX) has been rather simple at the core: For investors seeking dividend growth exposure to Big Oil, Chevron hands-down has the most financial flexibility of all the majors – irrespective of what happens to energy prices – and therefore, we think the firm is extremely well-positioned among its peer group to have the best dividend growth prospects through the course of the multi-year (and inevitably volatile) energy price cycle. A look at a breakdown among the net cash positions across the energy majors in the third quarter of last year, for example, shows Chevron with a net-neutral net cash position, while its peers BP (BP), Exxon (XOM), ConocoPhillips (COP) and Shell (RDS) all revealed material net debt positions. The firm’s pristine balance sheet is what caught our eye a few years ago when we added it to the Dividend Growth portfolio.
Though Chevron recently increased its quarterly dividend to $1.07 per share, which members are very happy about, the company’s balance sheet strength has waned since then. The company has silently levered up in recent quarters (it now holds a $7.44 billion net debt position at the end of the first quarter), and the erosion of its net cash position is shown in the image below. We find the trajectory odd as Chevron’s management has typically bragged about its net cash position in the past. Though its net balance sheet impact remains superior to its competitors’, including Total (TOT), we’d still like the executive suite to be more conservative with its balance sheet, even if it has to scale back the pace of share buybacks.
Image Source: Chevron
We acknowledge that this statement may not be straightforward for investors to understand considering that both S&P and Moody’s rate Chevron’s long-term debt investment grade (AA and Aa1, respectively), but the net balance sheet impact influences our opinion of the attractiveness of a firm’s equity in two distinct and important ways:
1) The balance sheet has a direct impact on the intrinsic value of the equity. The net balance sheet is added/subtracted to the present value of a firm’s future discounted enterprise cash flows in arriving at equity value within the context of our modeling framework. In the case of a net cash position, the net balance sheet is added. In the case of a net debt position, the net balance sheet is subtracted. All else equal, the more net cash on the balance sheet, the higher the value of the equity.
2) The net balance sheet is included in the calculation of a firm’s Valuentum Dividend Cushion score. The Valuentum Dividend Cushion score compares the firm’s future free cash flow (cash from operations less capital expenditures) to its future expected cash dividends paid. The measure also considers a firm’s net cash or net debt position on the books. In the case of a net cash position, the net balance sheet impact is added to the sum of the firm’s expected future free cash flows before that sum is then divided by future expected cash dividends paid. In the case of a net debt position, the net balance sheet impact is subtracted from the sum of the firm’s expected future free cash flows before that sum is then divided by future expected cash dividends paid. All else equal, the more net cash on the balance sheet, the stronger the dividend growth potential.
Though we have growing reservations about the trajectory of Chevron’s financial flexibility, its peers aren’t in any better shape. We maintain our view that the company’s balance sheet better positions it for sustaining and growing its dividend through the course of the multi-year commodity-price cycle relative to peers. Chevron is dedicated to growing production 20% by 2017 and hiking shareholder distributions along the way, and we expect to hold the company in the Dividend Growth portfolio as our exposure to Big Oil for the foreseeable future. Chevron boasts an annual dividend yield of 3.4% and a Valuentum Dividend Cushion score of 1.9 at the time of this writing. This is a very strong combination not easily found elsewhere.
Need background on our thesis on the outlook for crude oil and natural gas? Click here. (June 9, 2013)
Wondering what to expect next from Valuentum on Big Oil? We recently added Occidental Petroleum (OXY) to our dividend growth watch list, and the firm’s 3% annual yield is supported by a Valuentum Dividend Cushion score of 1.6. We’ll be keeping a close eye on shares, though it, too, has a net debt position.