Thursday, February 26, 2009

Chevron: A Big Value in Big Oil

Chevron: A Big Value in Big Oil

Chevron (CVX) is the third-largest integrated oil company in the U.S. and the fifth-largest in the world—as well as the fifth-largest natural gas producer in North America. The company has a strong global presence in refining, marketing and transportation—with retail marketing under the Chevron, Texaco, and Caltex brands.

While the company's exploration and production earnings have been from hurt by the sharp drop in crude oil and natural gas prices, as well as reduced production rates reflecting damage from September 2008, Gulf of Mexico hurricanes, its diversification into downstream businesses has helped offset these losses, and lower crude oil feedstock costs have benefited its refining and marketing businesses.

We believe Chevron will benefit from improved industry fundamentals and higher commodity prices through its exploration and production activities. With Gulf of Mexico oil and gas production being restored, and several upstream projects slated to start up, we expect Chevron's oil and gas production will increase about 4% in 2009, and we look for annual production growth of 2% to 3% between 2007 and 2012. We believe the drop in oil prices over the past month(s) to the low $30-per-barrel range was excessive, and expect West Texas Intermediate (WTI) oil prices will average around $40 in 2009, and trend even higher in 2010 and beyond—averaging above $90 per barrel in 2014 and thereafter.

The stock recently traded at 65. A blend of our direct and relative valuation methods leads us to our 12-month target price for Chevron's shares of 95. The value represents potential appreciation of about 45% from current price levels, and an expected enterprise value of 7.5 times our 2009 earnings before interest, taxes, depreciation, and amortization (EBITDA) estimate, a discount to Chevron's U.S. supermajor oil peers. We believe that the company's high degree of earnings and dividend growth and stability (it has an A- ranking under the S&P Quality Ranking system) justifies a higher multiple than Chevron's stock currently receives in the market and that its shares are undervalued reflecting weakness in its upstream business. In addition, the shares recently had a dividend yield of about 4.0%.

The stock carries Standard & Poor's highest investment recommendation of 5 STARS (strong buy).


Our fundamental outlook for the Integrated Oil & Gas subindustry for the next 12 months is positive, as we see reduced upstream earnings being offset by increased downstream results. While we expect the profits of the U.S.-based integrated oils will drop more than 50% in 2009, we look for a rebound of over 50% in 2010 on higher projected pricing amid an improved economic outlook and continued upstream volume growth.

With the effects of the credit crisis spreading, impacts across the energy sector have intensified. Budgets are being cut, and it is difficult to expand oil and gas production. We are pessimistic about future supply trends, which we expect will put upward pressure on oil prices when demand rebounds. In the meantime, we think the slippage in supply is not enough to offset reduced global demand—focusing attention on OPEC compliance.

The current global economic slowdown has led to further reductions in global energy demand and energy prices. As of February 2009, IHS Global Insight, an economic and financial analysis firm, estimated that reduced consumption in the Organization for Economic Cooperation & Development (OECD) nations would lead global oil demand down by 0.84 million barrels per day (b/d), to 84.87 million b/d in 2009, and that OPEC cuts would lead global oil supply down by 1.67 million b/d, to 84.93 million b/d, in 2009.

As of Feb. 10, using a blend of data from the U.S. Energy Information Administration and IHS Global Insight, we estimate that WTI spot oil prices will average about $40 per barrel in 2009, $53 in 2010, and $61 in 2011. Risks to our forecasts to the downside include an extended worldwide economic downturn and limited OPEC output cuts. However, upward pressure on prices may occur if the world economy recovers sooner than anticipated, a major supply disruption occurs, or if OPEC aggressively cuts output.

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