Valuentum Exclusive Analysis for the Discerning Investor

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By Callum Turcan

Raw energy resources pricing has surged higher during the past year with room to run. The global energy complex is on the rebound as demand for crude oil and refined petroleum products is steadily recovering from the worst of the coronavirus (‘COVID-19’) pandemic. As demand for electricity and heating needs held up well during the pandemic, liquified natural gas prices (‘LNG’) put up a strong year in 2021 and remain elevated. The OPEC+ cartel is committed to slowly phasing out its crude oil supply curtailment agreement first enacted in 2020, effectively limiting growth in global oil supplies at a time when demand is rebounding at a brisk pace.

We view the near-term outlook for the global energy complex quite favorably and have been pounding the table on this issue for some time. Back on June 27, 2021, we added Chevron Corp (CVX) and Exxon Mobil Corp (XOM) as ideas to both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios and highlighted these portfolio changes (link to that article here). Shares of CVX and XOM yield a juicy ~4.3% and ~5.1% as of this writing, respectively. Recently, shares of both CVX and XOM have started shifting higher, and in our view, this is just the beginning of a strong cyclical recovery. We also recently added Chevron and Exxon Mobil as ideas to the High Yield Dividend Newsletter portfolio (more on that publication here), and highlighted two of our favorite midstream master limited partnerships (‘MLPs’) in that publication as well.

Our fair value estimate for Chevron sits at $140 per share and the high end of our fair value estimate range sits at $175 per share, while CVX is trading at ~$127 as of this writing. Our fair value estimate for Exxon Mobil sits at $92 per share and the high end of our fair value estimate range sits at $122 per share, while XOM is trading at ~$71 as of this writing. As investors continue to rotate into energy firms, we expect that the stock prices of Chevron and Exxon Mobil will continue converging towards our estimate of their respective intrinsic values.

Importantly, however, we view our energy exposure as near- to medium-term in nature and generally prefer over the long run the strong net cash rich, free-cash-flow generating profiles of moaty secular-growth powerhouses in the area of large cap growth, where many of our best ideas reside. We still think big cap tech and large cap growth remain very attractive, even near all-time highs.   

Chevron

In recent years, Chevron has placed a greater emphasis on controlling the trajectory of its capital expenditures and not chasing raw energy resources pricing higher by aggressively increasing its capital investment plans. We are huge fans of this strategy as it better enables Chevron to generate traditional free cash flows and return cash to shareholders.

For 2022, Chevron aims to spend approximately $15.0 billion on its “organic capital and exploratory spending program” which is a proxy for its capital expenditure plans. While up from its 2021 budget, please note Chevron aggressively reduced its capital investment levels in the face of the COVID-19 pandemic to conserve cash, so a moderate recovery in spending does not mean it has abandoned its fiscal discipline (for reference, Chevron spent $14.1 billion on capital expenditures in 2019).

Back during previous boom years when raw energy resources pricing was elevated, Chevron found it quite difficult to generate free cash flow as it was pouring tens of billions of dollars towards its capital investments each year. For example, Chevron spent an average of ~$34.8 billion per year on its capital expenditures during the 2012-2014 period and generated just ~$0.3 billion in free cash flow per year on average during this period as capital expenditures consumed virtually all its net operating cash flows.

Share buybacks and dividend payouts from 2012-2014 were funded by Chevron’s ability to tap capital markets for funds and by its balance sheet. This strategy created major headwinds for the company as Chevron entered the prolonged bust in oil prices (from 2015-2020) with a large net debt load on the books while contending with relatively low raw energy resources pricing.

A lot has changed since then, and Chevron’s fiscal discipline should better enable the firm to reward shareholders in the current environment. During the first nine months of 2021, Chevron generated $14.3 billion in free cash flow as the company capitalized on the recovery in global energy markets. The company spent $7.6 billion covering its dividend obligations and a modest $0.2 billion buying back its stock (on a net basis) during this period, activities that were both fully covered by its free cash flow.

During its second quarter of 2021 earnings update, Chevron announced it would resume share buybacks at a pace of ~$2.0-$3.0 billion per year (repurchases resumed in the third quarter of 2021). We view Chevron’s share repurchases as a good use of its capital in moderation given that its shares are trading below our estimate of their intrinsic value as of this writing (and have been for some time).

Chevron also used its improving financial performance to pay down debt, reducing its net debt load (inclusive of short-term debt and current marketable securities) from $38.7 billion at the end of December 2020 to $31.3 billion at the end of September 2021. Proceeds from asset sales helped here to a degree, which raised $0.6 billion in cash during the first nine months of 2021, though for the most part it was Chevron’s ability to generate sizable free cash flows that enabled the firm to clean up its balance sheet.

In October 2020, Chevron completed its all-stock acquisition of Noble Energy through a deal with an enterprise value of ~$13 billion. The combination is already generating meaningful synergies which are coming in stronger than initially expected. We covered our thoughts on Chevron’s deal to acquire Noble Energy back in August 2020 that interested members can check out here.

Most importantly, this acquisition gave Chevron a substantial position in the Eastern Mediterranean’s booming natural gas industry. Chevron acquired sizable economic interests in large producing natural gas fields off the coast of Israel (the Leviathan and Tamar gas fields) along with stakes in offshore exploration opportunities in Israel, Cyprus, and Egypt. The company’s upside in this region is quite extensive and comes from a combination of expanding the production capacity of producing fields and bringing new fields online.

Chevron’s peers have also had a lot of success discovering large offshore natural gas resources in the Eastern Mediterranean region in recent years, beyond the major discoveries Noble Energy located in Israel. For instance, the Italian energy firm Eni SpA (E) located the massive Zohr field off the coast of Egypt in 2015 and BP plc (BP) announced the Atoll discovery in 2015, another offshore gas field in Egypt.

Pivoting here, Chevron also owns a 50% stake in Tengizchevroil (‘TCO’), which operates two large oilfields in Kazakhstan (the onshore Tengiz oil field is the most important, though the onshore Korolev oil field is still sizable). TCO represents another major growth lever for Chevron as the TCO venture is actively working on expanding the production capabilities of the Tengiz oil field in a big way. We are keeping an eye on the situation in Kazakhstan as the country is currently facing a political crisis that unfortunately has turned quite deadly. Output at the TCO venture has been negatively impacted by the unrest, though Chevron and its partners are working to restore production activities to normal levels.

Exxon Mobil

We covered why we are big fans of Exxon Mobil in our December 2021 note Exxon Mobil’s Bright Growth Outlook (link here). Members that have not read that article yet are strongly encouraged to do so. Here is a key excerpt from that piece:

Exxon Mobil's stated strategy is to not chase raw energy resources pricing higher by perpetually raising its capital expenditure expectations. This strategy will better enable Exxon Mobil to generate substantial free cash flows going forward as it invests in its most promising assets while paying down debt, buying back its stock, and continuing to make good on its sizable dividend obligations going forward.

During its third-quarter 2021 earnings update, Exxon Mobil announced that starting in 2022, it would begin repurchasing sizable amounts its stock (buybacks were subdued during the 2018-2020 period). Its new stock buyback program will see the firm repurchase up to $10.0 billion of its shares over the 12-24 months starting in 2022. The company continued to make good on its dividend obligations during the pandemic which we appreciate.

Recently, Exxon Mobil has been taking advantage of its stellar free cash flows during the first three quarters of 2021 to pare back its net debt load. Inclusive of short-term debt, Exxon Mobil’s net debt load dropped by $11.4 billion from the end of December 2020 to the end of September 2021. During the first nine months of 2021, Exxon Mobil generated $23.0 billion in free cash flow and spent $11.3 billion covering its total dividend obligations. Cash raised via asset sales and its “excess” free cash flows (after paying out its total dividends) enabled the firm to improve its balance sheet strength. Exxon Mobil has a lot going for it.

In January 2022, Exxon Mobil had some positive updates to provide on its venture in Guyana, a small South American country in the northern part of the continent. The company recently announced two additional offshore discoveries in Guyana in the offshore 6.6 million acre Stabroek block, which will add to the 10 billion barrels of recoverable oil equivalent the venture has already discovered in the region. To commercialize these discoveries, the venture is currently working on developing the Liza and Payara oil fields (the Liza oil field is already producing raw energy resources). Exxon Mobil has a 45% interest in the Stabroek block and acts as the operator, Hess Corporation (HES) owns 30% of venture, and China’s state-run CNOOC energy firm owns the remaining 25% stake.

First-oil at the Stabroek block was achieved in December 2019 when the Liza Destiny floating production storage offloading (‘FPSO’) vessel commenced operations. That FPSO has the capacity to produce 120,000 barrels of crude oil per day at its peak. Going forward, the goal is to roll out numerous production facilities across the Stabroek block over the next decade to aggressively boost the region’s oil production capacity. The Liza Unity FPSO arrived in Guyana back in October 2021 and work is underway to begin production activities during the first quarter of 2022. At its peak, the Liza Unity FPSO will have the capacity to produce 220,000 barrels of crude oil per day.

By 2025, Exxon Mobil envisions having at least five FPSOs operating in the Stabroek block that combined will have the capacity to produce at least 750,000 barrels of crude oil per day. Construction of the Prosperity FPSO vessel is currently ongoing in Singapore, and by 2024, Exxon Mobil aims to have that FPSO pumping oil out of the Payara oil field.

While the Liza oil field and related developments played an outsized role in getting Guyana’s oil industry up and running, the Exxon Mobil-led venture has struck liquid gold multiple times in this region. This is about much more than just one field; it is about a wave of developments targeting economically attractive resources (due to the sheer size of these resources, which are heavily weighted towards crude oil, and the ability for the venture to leverage scale to generate meaningful synergies across this position).

Concluding Thoughts

We are huge fans of Chevron and Exxon Mobil. Please note that the success of both firms is highly dependent on the state of global oil markets, however. As the outlook for the global energy complex is promising, as witnessed through the sharp rise in raw energy resources prices over the past year, that speaks quite favorably towards the future financial performance of both Chevron and Exxon Mobil. If Chevron and Exxon Mobil stay the course and continue to practice fiscal discipline, namely by limiting their capital expenditures, both firms should generate “gobs” of free cash flow going forward that can be used to repair their balance sheets and reward shareholders.

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Oil and Gas Complex Industry - BKR, HAL, SLB, BP, CVX, COP, XOM, RDS, TOT, COG, EOG, OXY, PXD, ENB, ET, EPD, MMP, KMI, PSX

Tickerized for BNO, E, BP, HES, RDS.A, RDS.B, USO, and holdings in the XLE, XES and XOP.

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Callum Turcan does not own shares in any of the securities mentioned above. Energy Select Sector SPDR Fund ETF (XLE) is included in Valuentum’s simulated Best Ideas Newsletter portfolio. Chevron Corporation (CVX) and ExxonMobil Corporation (XOM) are both included in Valuentum’s simulated Best Ideas Newsletter portfolio, simulated Dividend Growth Newsletter portfolio, and simulated High Yield Dividend Newsletter portfolio. Enterprise Products Partners L.P. (EPD) and Magellan Midstream Partners L.P. (MMP) are both included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.