The bottom continues to fall out of crude oil prices.
The price of West Texas crude oil hit six-year lows during the trading session Monday dipping just below $43 per barrel. The world is drowning in a crude oil, and OPEC continues to produce to drive marginal US operators to the brink. The dollar is strengthening, which is exacerbating the decline in the price of this dollar-denominated commodity.
The news is not “new.” We’ve been commenting on the fall of crude oil for months, and the lack of energy positions in the newsletter portfolios coupled with the bearish calls on the offshore drillers speak to how far ahead of the market we positioned readers. Remember Seadrill (SDRL)? It’s trading at about $9 per share at the moment, down from over $40 at the end of 2013. We can’t say we didn’t warn about the tremendous risks of this speculative entity. The cash flow statement and balance sheet tell far more about the health of a company and its dividend than the income statement, quarterly earnings or the payout ratio.
A number of members have been asking about when we’re going to remove Chevron (CVX) from the Dividend Growth portfolio, and that day is today. We’re removing the entire position in the Dividend Growth portfolio, which is housed in the monthly Dividend Growth Newsletter, at ~$102.36 per share. This transaction alert email is a follow-up to the introduction piece of the March Dividend Growth Newsletter, released to members March 1. We tend to make measured and calculated changes over time, providing as much transparency into our thoughts as possible.
We fully acknowledge Chevron’s prowess as an excellent exploration and production operator, but the decision to remove the company from the Dividend Growth portfolio has everything to do with the dislocations in the energy complex and the firm’s ballooning balance sheet to handle the shock and adversity. What was once a healthy net cash position at Chevron only a few quarters ago has surged to a $15 billion net debt position at the end of 2014.
No matter your opinion, whether you are an energy bull or energy bear or simply don’t care, it is not written in stone that crude oil prices have to go back to $100 per barrel! They don’t. Please be aware of the behavioral shortfalls associated with the concept of recency bias. It’s equally likely, in our opinion, that $40 per barrel may be the new baseline – not $150 per barrel. The game is completely different with OPEC fighting for market share, not price stability.
As it relates to Chevron, there’s nothing necessarily wrong with the company adding more leverage to the balance sheet during difficult times, especially when the price of its product has been cut in half, but this is just the beginning of its debt-raising cycle, by our estimate (the company sold an additional $6 billion just a couple weeks ago). For Chevron to sustain its massive capital spending program and its healthy dividend, the firm will have to keep coming back to the debt markets. Chevron is simply spending too much. Its $31 billion cash capital and exploratory budget for 2015 is too high. Chevron burned through $4.8 billion in cash during the most recent quarter alone.
Almost our entire dividend growth thesis on Chevron has hinged on the firm’s strong balance sheet position as a backdrop to (an insurance policy for) the inherent unpredictability of crude oil prices. The firm’s AA rating from Standard & Poor’s still speaks to its strong credit health, of course, but being able to refinance debt via an assessment of the probability of bankruptcy (which a credit rating measures) is much different than assessing the company’s ability to satisfy shareholders (which are interested in capital appreciation and income growth). Shareholders are lower on the hierarchy of the capital structure than debt holders.
Today, we are removing Chevron from the Dividend Growth portfolio. We don’t have to include a company that is navigating through a tumultuous product pricing environment and is taking on excess leverage to maintain a capital spending program that may not truly reflect the economics of $40 per-barrel oil, which could be the new reality. It is not about being right or wrong with Chevron, but sticking to companies that will work toward the goals of the Dividend Growth portfolio. We still like Chevron as a company, much like we like the other oil majors, but it no longer fits the mold of what we’re looking for. The company’s Dividend Cushion ratio has fallen materially to 0.2 as of the last update.
We haven’t had one company in the Dividend Growth portfolio cut its dividend, and we’re not starting now.
As for swapping in the Energy Select Sector SPDR ETF (XLE) in its place, we’re still waiting. It’s important, however, that as we say that we plan to add the XLE to the Dividend Growth portfolio that readers understand that there may be constituents within the XLE that will cut their dividends in the future (given the fall in crude oil prices and their need to place liquidity over dividend payments). Said differently, the underlying yield of the XLE may actually fall in coming periods, but we think diversified energy exposure is one of the best ways of capturing the potential rebound in crude oil prices without falling victim to any one operator’s capital-budget decisions.
The XLE may not fit the mold of an investor focusing purely on dividend growth, but in the context of the construct of Valuentum’s entire Dividend Growth portfolio, we think it has a place, if only a small one. Midstream operators Kinder Morgan (KMI) and Energy Transfer Partners (ETP) represent the only firm-specific exposure to the oil and gas space in the Dividend Growth portfolio, now that Chevron has been removed. As we’re wrapping up this note, it’s probably worth a quick mention that in other energy-related news, we’re hearing that Statoil (STO) may be looking to buy one of our favorite M&A targets, EOG Resources (EOG). We’re watching the situation very closely.
Here’s to a very happy St. Patrick’s Day tomorrow! I must confess – my wife made corned beef over the weekend, so we’ll likely be having leftovers on the big day, but that’s still wonderful. I love this time of year. The weather is finally starting to warm up in Chicagoland!
I can’t say it enough but it is an honor to have you as a member to our services! May you continue to have tremendous investing success!
P.S. In case you missed the March edition of the Best Ideas Newsletter, released yesterday, it can be accessed . I think it’s one of our best editions yet.
Kind regards,
Brian Nelson, CFA
President, Equity Research