We think it’s worth reviewing case studies at times to help members build a greater understanding of and an increased conviction in the products, tools, and proprietary analysis we make available to them. In the case of Chevron (CVX), the efficacy of the Dividend Cushion ratio in helping to predict a company’s future dividend policy was undeniable. The Dividend Cushion ratio is calculated for every non-financial operating company in our coverage universe and can be found in the data strip at the top of each firm’s Dividend Report. A ratio above 1.25 is generally viewed as GOOD.
For new members, Chevron had been a holding in the Dividend Growth portfolio since its inception. However, the company was removed from the newsletter portfolio March 16, 2015, following a materially lower Dividend Cushion ratio (negative 0.2) that was generated after “rolling” its valuation model to account for 1) its recently-completed fiscal year end and 2) updated forecasts that considered lower energy prices in the out-years. Barron’s recently highlighted Valuentum in January as a “Survival Guide for Oil Investors,” and we think we delivered yet again with our analysis. The Energy Select SPDR (XLE) replaced Chevron in the Dividend Growth portfolio on April 1.
Today, in its first-quarter report, Chevron said it generated cash flow from operations of $2.3 billion, a level that was completely overwhelmed by its cash capital expenditures of $7.6 billion. Though we were ahead of Chevron’s weakening free cash flow position, we continue to be surprised at the pace of deterioration and the rapid escalation of its debt load on the balance sheet. During the firm’s conference call, management indicated that it doesn’t expect free cash flow to cover its dividend until 2017, something that the Dividend Cushion ratio picked up. Here’s what else the company had to say about its dividend:
“Our financial priorities have not changed, but what has changed is our immediate financial environment, the near-term environment has changed and so the board chose not to increase the dividend this quarter.” – Chevron CFO Pat Yarrington
How did we anticipate the board’s decision? – with an intense focus on the mapping of future free cash flows relative to future expected cash dividend payments in the context of a company’s balance sheet health, specifically its net cash or net debt position; said differently, with a focus on the Dividend Cushion ratio. Interestingly, though Chevron’s board opted to not raise the dividend this quarter, we flat-out applaud the executive team for their transparency and dedication to building a sustainable franchise with a solid dividend. Though some investors may be disappointed, our views on the executive suite have actually been enhanced in light of their decision to take a pause.
We received a number of emails from members today regarding Chevron and the April edition of the Dividend Growth Newsletter, where we outlined our views on the oil giant on page 18 . Though many are still hanging on to Chevron, and we still very much like the company, too, many have told us that they were impressed with our ability to essentially anticipate its “dividend freeze.” We wanted to let those that sent the emails know that we’re reading your every word, and we appreciate that you are paying attention to our every move. Predicting the future is no easy task, but we work hard every day to put investors in the best position to do so. Your satisfaction is our only priority, and we applaud you for finding us on this vast web.
Due in part to Chevron’s quarterly report, the release of the May edition of the Dividend Growth Newsletter has been postponed to May 4, 2015.