The Dividend Mailbox

Dividend Fuel: Chevron and an Ultimately Higher Oil Market

January 17, 2024 Greg Denewiler Season 1 Episode 31
The Dividend Mailbox
Dividend Fuel: Chevron and an Ultimately Higher Oil Market
Show Notes Transcript

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Over the past decade, the oil industry has become increasingly controversial and subsequently neglected by investors. No one knows when the industry's expiration date will come due, but there are great value and dividend growth investments to be made in the meantime. Even in declining industries, there can still be big winners. 

For episode 31, Greg focuses on Chevron's resilience in a politically incorrect landscape, including its recent Hess acquisition. He explores the intersection of environmental concerns and the indispensability of oil in everyday life, with investing as the backdrop. Despite the industry's challenges, he makes a compelling case for Chevron's sustainable dividend growth and long-term potential.

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Greg Denewiler 00:11

This is Greg Denewiler and you're listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks and make each year's check larger than the last. 



Welcome to episode 31 of the Dividend Mailbox. In this episode, we’re going to talk about a company we've mentioned before. And in fact, we talked about the oil story in one of our early episodes, but then oil had a fairly significant move and Chevron had a pretty good year last year, so, we sort of dropped the topic. But the oil stocks have come back down and Chevron has come off its high by a significant amount, and I think we're back to a point where it's a great time to revisit the story and to look at Chevron specifically. 



One thing I do want to mention, this is kind of a teaser for what will most likely be at least part of episode 32, our next episode. In order to be a top performer, you don't necessarily have to be in a flashy industry and you don't have to have a flashy stock. You don't even need big growth numbers, but we will get into that in the next episode. 

And in this one, just to kind of review, oil, probably wherever you're at right now, however you're listening to this podcast, all you probably have to do is hold out your arm and you can probably touch multiple things that have oil. They either have some derivative of oil in them or are made out of oil in some way. Oil and natural gas— it's in everything in our lives. And over the last several years, it's become very easy to really look at oil and fossil fuels, natural gas, as it's doing considerable harm to the environment and if we just stopped using oil and gas then everything would get much better. But the problem is oil and natural gas are basically embedded everywhere in our everyday lives. The obvious thing is vehicles and fuel for transportation. That's probably the big one. When you look at plastics, plastic is virtually in everything. It is in clothing, synthetic fibers, polyester, and nylon. You look at carpet. You look at things like lipstick, deodorant, shampoo, soap, food additives. In the medical field, plastics are everywhere: MRI machines, pacemakers, artificial limbs, and essential oils. The list just goes on and on. And then if you really go back and look at the push towards electric vehicles, what people seem to forget is, yeah, that's great, you're not burning fossil fuels to actually drive the vehicle, but the problem is you have to mine the minerals for the batteries. There's still a lot of plastic in those vehicles. You haven't even gotten to the fact that the concrete that the cars drive on is one of the heaviest uses of energy. Asphalt production is a huge component of fossil fuel consumption. So, it's almost like, well, if we did away with fossil fuels, then you're driving your fancy new Tesla down the dirt road. And if it happens to rain, you're in really big trouble. Another obvious thing is heating and electricity. As we're moving somewhat towards renewables, one of the problems is, that renewables are well less than 50% of energy production, and probably for an extended period of time we're always going to have to have a natural gas redundancy. Nobody wants to do without electricity or heating or cooling of their house for really any period of time at all. And then, you look at the whole infrastructure of the electric grid, and a lot of it is based on copper wire. Well, those wires are wrapped in something, and lo and behold, most of it is plastic. So, the story is not that simple. The fossil fuel industry is going to be around for a long time. It will evolve, and quite likely in time, the use of fossil fuels is going to decline, but we're still going to need them. I think that's one of the things that people miss and one of the reasons why we want to look at Chevron. There's still going to be a need for them over time, and it's the well-financed and well-managed companies that will continue to exist for decades to come. And again, I'm going to queue up episode 32. You're going to see how it's quite possible even a declining industry over time can be a huge return generator. 


So now let's just get into a little bit on the overall oil market. Right now, U. S. oil production is at its highest point ever. Right now, we're producing about 410 million barrels of oil per year. To give you a little bit of perspective, back in 2000 we were at around 180 million barrels. We were up in the high 200s, back in the 70s. So, our energy production is at its highest point ever. A couple of great things about that is it gives us more national security, that's a huge issue. It helps create more stability in prices because we're less dependent on what the Middle East or other major oil producers decide to do politically, and that stabilizes the price. But, one of the things that's really kind of ironic is some of these foundations and institutions have basically banned the investing of their funds in oil. The problem is, if you take away financing, or you take away the ability to go out and look for oil, guess what, ultimately the price is going to go a lot higher. On one hand, it's almost contradictory to what outcome they're really looking for. One thing that I think will help play into the future is that, right now, we have 621 rigs in the U. S. that are drilling for oil, and that is near a historic low going all the way back into the 1970s. We got a little bit lower in 2020 but we didn't last very long down there when oil took a real dive because the economy was virtually shut down. But, at this point, if we stay at this rate of rigs that are out drilling, then it's really only a matter of time before we will probably have higher oil prices. Just kind of a back-of-the-envelope average, it's probably up around 1,200 rigs that really should be working, so the number should be probably twice as high as it is now. Another piece that would maybe be a contributor to why we have so much production when we're not doing much drilling for it in the last few years is there were a lot of wells that were drilled, but they were never completed. So, some of that may be getting run off right now, which may be another contributor. Long term, the dynamics for oil prices staying where they are, or going a little bit higher, are pretty much intact. 

But it's easy to question: “Why would I want to invest in an industry that will decline over time, even though it may continue to survive for another 50 or a hundred years, it quite likely is not a growth industry. So why put money there?” Well, the answer to that I think is pretty simple. Maybe not simple, but I think either you're going to connect the dots to this or you're not. The price of oil quite likely is going to stay high for a couple of major reasons. Number one, because oil and fossil fuels have become so politically incorrect it's hard for these companies to raise money now. Some banks don't want to lend money to them anymore. The marketplace is less willing to buy the stocks and buy their debt. That's evidenced by the stocks trading relatively cheaply and the debt trading at a higher interest rate. In some cases, they can't even issue debt. So that alone translates into the fact that it's just going to be harder to go out and explore for oil and gas. The more leveraged companies are going to have a more difficult time doing it, and if you're not looking for oil and gas but continue to use it, that sort of automatically implies that the price remains elevated. With only 662 rigs working right now, in time, that just means we're not producing enough. Demand will eventually overcome supply and it just keeps the price up until companies are willing to go out and explore again because it makes economic sense for them to drill because their profitability is higher. So, it almost is a win-win long-term. Because if it's politically unattractive from an industry standpoint, that means money doesn't go there, then it keeps the price higher. It really, in my mind, creates a long-term scenario where the prices will probably remain attractive for these guys for the foreseeable future. Whether the industry ever becomes attractive again, there is a segment of the oil and gas market, and I think Chevron is one of the companies that is still going to continue to grow regardless. Because even if demand eventually declines, you're going to have fewer companies out there that are in the industry. So the companies that are left are just going to split a smaller pie and they still have to be profitable or they're not going to stay in business. And if they don't stay in business, then we're basically going back to the 1850s, and I don't think anybody wants to drive a covered wagon down a dirt path. 

So one of the things you might ask is, “Okay, well, why Chevron? Why not one of the other oil companies?” I'm going to get into a little bit of a comparison just to give you a perspective. I always hate doing this because I don't like to overuse Warren Buffett because everybody seems to look at him as being the answer to everything. He has made mistakes like everybody else. But, Warren Buffett has a big position in Chevron and of course, if you follow Berkshire Hathaway at all or the markets very closely, you know that he's also acquired a significant position in Occidental. In fact, he owns 25% of it and he continues to buy a bigger position. From an actual dollar standpoint, his money invested in Chevron actually is larger than what the position of Oxy is right now. So, he too is committed to the long-term prospects of oil. 

If you look at Chevron, it's well diversified which takes away some of the risk. One of the problems with oil is it is a commodity and it is volatile. It's subject to politics. It's subject to the world political stage and terrorism. So one of the things that Chevron gives you that some of the independents, or most of the independents do not, is a more diversified revenue base. If you look at their crude oil production, it's about 1.4 million barrels per day. If you look at natural gas they produce 7. 6 billion cubic feet per day. Then we move to their proven reserves. They have 5 billion barrels of oil. That is down slightly, in 2020 they had 5. 3 billion. They've maintained it relatively close, but, we will talk in a minute about the Hess acquisition, which is going to greatly enhance their proved reserves. For natural gas, they have 31 trillion cubic feet of natural gas reserves. And then also their refined products, they refine about 1. 5 million barrels a day. Here's where you get into more of the downstream products, where you've got lubricants, plastics, and all the different products oil is involved with. Chevron has probably some footprint in virtually the entire oil market, so it does help give you a little bit more stability. You really saw that in 2020 and back in 2015 when there was a real tough go for the oil industry. There were a lot of bankruptcies back in 2015, and then of course in 2020, when the spot price of oil actually went negative, but Chevron continued to pay its dividend. So one of the reasons why we picked Chevron is because going out a decade or two or three, we just think that having exposure in the oil market and in a broad base makes sense. 

They did announce that they're buying Hess and they're paying 53 billion dollars for it. It looks like it's going to be an all-stock deal. So, what will they get with that? It's going to basically bring their total oil and gas production up to 3. 7 million barrels per day and that doubles what they're doing now. It takes them into shale, basically takes them up and puts them on equal footing with Exxon. Not that I think that alone is a big deal, but they seem to have some value in that. It does give them more oil production in the US in the Gulf of Mexico. It takes them into the Bakken shale area of North Dakota. And this is one of the big things I think they're after, it gives them a 30% stake in an Exxon venture that is in Guyana. That reserve alone is supposed to triple to more than 1. 2 million barrels per day in the next four years. It's considered to be a world-class asset and it greatly increases their reserves. So as far as being able to pay for it right now, Hess has $3 billion of earnings before interest and taxes. So, they have a pretty strong cash flow. You could argue whether it was a great deal, but it gives them long-term assets and it does give them more cashflow. 

Another big point of Chevron is they have $165 billion of equity, but they only have $20 billion of debt. Their debt-to-equity ratio is only 0. 12. For all intents and purposes, they're almost debt-free. In this environment, that alone could be a competitive advantage because if you follow the industry very closely, you know that some banks don't even want to loan money. It's a big ESG topic. It's more expensive for energy companies to raise capital now, and in the case of Chevron, they really don't have to go to the market to raise cash because they generate their own. That is a great advantage going out long term. 


So, let's look at some of the specifics for Chevron. We're not going to go into a lot of detail here, but this is going to give you a good sense of why Chevron is something you may want to consider from a dividend growth standpoint. If you look at the P/E ratio currently of Chevron, in the last ten years the average has been 25. Right now, Chevron's at 10. How it trades versus the market, it's basically a 50% discount. Just to give you a little perspective, I'm going to compare it to Oxy, which is more of an independent situation because they don't have the diversity that Chevron does. Oxy right now trades at 12, and that is 56% percent of the market's valuation based on the P. E. ratio. 

If you look at the price-to-sales ratio, all things equal, its probably a better one to use than the P/E ratio, at least in my book. Revenue is a lot less volatile than earnings. In the case of Chevron, their 10-year average has been 1.48, right now it's at 1.35, so it is below the average. It's about 50 percent of where the market is, and actually, Oxy is about 1. 6 times, so it is more expensive on that basis. 

And if you look at price-to-book for Chevron, it's 1.65 times and the average has been 1.5. It's actually about 40% of how the S&P 500 is valued and Oxy right now is 2.3. So they are a little bit higher on a price-to-book basis. 

One thing I will say, you have to be a little careful using these numbers because these are very asset-rich companies, there are write-offs, and there's oil and gas accounting. They do write their assets down depending on where the price of crude is, the price of energy. And, Occidental, one thing you have to remember is that here you're getting more exposure to the actual price of oil because it has a bigger impact on Oxy’s stock price. It's basically production-driven. But as a rule, the group as a whole is cheap and it's been that way for a while. Not to try to oversell this, but one of the things that you may find out is a stock that's cheap, and it stays cheap because it's politically out of favor, may be one of the best things you can hope for. But we'll leave that for the next episode. 

Now, one thing that I will throw out there, it appears that one of the reasons why Warren Buffett is taking such a big position in Oxy is because of the business they have, and the carbon capture market, they are really trying to build that business. And the lady who took over the management of Oxy, Warren Buffett has been really impressed with her and she has done a great job of really bringing down debt. Oxy was on the verge of bankruptcy not that long ago. So it has also been a good turnaround story. But Chevron has been known to be well-managed for a very long time. It's been considered to be one of the premium-run energy companies. And another thing I do want to mention, which I forgot a little bit, is in looking at technology, and with all of the— I'm not going to call it hype, because it is a real thing, and it's going to have a real impact in the world going forward— but in AI, that is one of the areas that could really benefit the oil and gas industry. These companies are really at the forefront of using technology because it dramatically impacts their balance sheet and the profitability of their company. From what I understand, they demand from their suppliers— like Schlumberger, some of the companies they use. They really demand the best technology if they use a driller contractor or any of their suppliers, they're looking to be as efficient and to get as much out of their resources as they can. 


So now moving on to, okay, is this going to be a sustainable dividend story? If you look in the 2022 annual report for Chevron, you've got their priorities for their business model. Just quoting “Execution of our strategy has enabled delivery on our financial priorities. Number one, grow the dividend consistently. Number two, invest capital efficiently. Number three, maintain a strong balance sheet and repurchase shares steadily.” It sounds like they're trying to be a dividend mailbox stock. Just looking at a few highlights as far as how they manage the business, on their pension side, one of the things companies do is they get aggressive in accounting. One of the simple ways to do it is to estimate a little bit higher return for your pension so that you don't have to put quite as much money into it every year. 

In Chevron's case, they have an expected return of 6.6%. That seems to be a very realistic goal and their compensation growth over time— they've got it estimated at 4.5%. From again, kind of a back-of-the-envelope approach, that seems to be pretty realistic. 

On to specifically what we're interested in, we'll start with shareholder yield, which consists of dividend yield and then buybacks and debt pay down. The shareholder yield in 2023 was 8.7%. In 2022, it was 7%. In 2021, it was 5. 5%. In 2020, it was 5. 8%. There's a great example, in 2020, you had a horrible oil market but they still had a yield to shareholders. 

If you look at the dividend yield specifically, right now it's slightly over 4%. Back in 2023, going all the way back to 2020 the yield has been in the mid to high threes, so the dividend yield has been fairly attractive. The payout ratio, which is a great indicator of what the sustainability is, they've run in the 30-40% area. Right now it's in the low 40%.

Going forward, earnings estimates for this year and next year are in the high 13 range. So, with a $6.04 dividend, they've got a lot of room to grow the dividend without really even growing earnings much at all. That is a big piece of the equation that we look at. If they're buying back stock, that alone, everything else stays equal, reduces the share count a little bit and allows them to grow the dividend slightly. 

Now, I hope by now, what we're kind of known for is our simple little dividend growth model. And we use this to really give us a sense of, are we going to get dividend growth, and are we going to get the returns that we want and that we need. And we're going on three years now of this podcast. The whole point of it is to help you figure out how to get sustainable dividend growth. And actually it's as much to help us stay focused and remind ourselves at least once a month, what we're doing. If you're listening for the first time, or you don't remember what our dividend growth model does, it takes the current dividend of $6.04, we grow it for 10 years, and in this case, we get to $11.10. That is what the dividend has to be in 2032 to have 7% dividend growth. So then at that point, on one level, it's just simple reverse engineering. If you have $11.10 of dividends, then what kind of earnings do you need for them to be able to pay that out? Well, the simple starting point is they already earned more than $11 since they're earning almost $14 this year— or that's what they're expected to earn this year. They actually earned more than that last year. In that case, they've already achieved part of our goal. But realistically, they're not going to pay most of their earnings out in dividends. To get 7% dividend growth, you probably have to have about $20 of earnings. Is that going to happen in 10 years? Well, we've got one big catalyst, this Hess acquisition that they just made, and they've got the cash flow to start buying back shares after they issue some for that acquisition. They've got a huge asset there that they're going to start generating a lot of cash flow on in the next five years. So, there's an indication there that it's pretty realistic that this, in fact, is going to grow at 7%. In 10 years, if it still trades at a 4% yield and they have an $11 dividend, without any compounding, you add up all those dividends and you take 4% of 11, that's a $277 stock price. It's a total return over 10 years of 150%. 

But we have one big piece left that really is a huge margin of safety here. We don't really even have to get 7% dividend growth on this one. We're starting at a 4% dividend yield and that alone is going to help our compounding and help us to be able to reinvest either in Chevron or to go out and buy something else. In three years, you've already got 12% of your investment back, everything else stays equal. 

In the last 20 years, Chevron has grown its dividend by 328%. The last 10 years, it's grown it by 83% and you may say, “Well, that's less than 7% because 7% doubles in 10 years.” Well, you have to keep in mind that in the middle of the last 10-year period was just a horrible market. So that gives me confidence that the company is fairly well managed and I'm willing to take that risk. In five years, it's grown by 32% and in the last year, it's grown by 6%. 


So that, in a nutshell, is the Chevron story. And some people may have an aversion to oil. I actually have some clients that don't want to own it. That's fine. You know, it is a personal choice. But I think all in all, everyone should have a little oil in their portfolio. Another point that some people don't want to admit— it has kind of come at the downfall of BP because they've gone fairly heavy into renewables, it's hurt their income lately— but all of these big oil companies are moving in some manner or another into renewable sources. They know at some point they've got an eventual declining revenue base. So, if a company wants to be around 50 years, they have to be cognizant of what's going on around them. These companies are diversifying. And this gets kind of counterintuitive, but probably the best thing that can happen to speed up the development of moving away from fossil fuels— again, we're never going to be totally away from them, so, having some presence there makes sense— but you actually want a higher price because that is what makes these alternatives more attractive and true alternative sources. As it is right now, with natural gas below $3.00 nothing can compete with it, so it slows down the development of new technology. A higher price of fossil fuels is actually long-term probably a positive, and then it really helps out the stock and the whole dividend story. So, I hate to say this, but on one level, it's almost a no-lose on these things. 

So, as we conclude, these shows are recorded several days before we actually publish them for multiple reasons. It just takes a while to edit them, and then they get released, so, oftentimes, one of the problems is we do try to maintain some strict buy discipline, and sometimes the stocks move on us. That's what happens with William Sonoma, and it's actually what happened originally when we first mentioned oil and Chevron. It moved almost immediately after we started to talk about it. Well, lo and behold, today, on our first recording of this episode, there was just an announcement that Berkshire Hathaway upped their stake in Oxy to 34%. So, I don't know, apparently, Warren Buffett got the advanced copy of The Dividend Mailbox. But in all seriousness, I hope you see that Oil is going to be around for decades and even though politically it's a pretty controversial topic the reality is, as we're going to find out in the next episode, some of these companies that are in declining industries can have some unbelievable returns. And I think oil is definitely in that camp. It is volatile because it's a commodity, however, I think the story just really has some long-term potential. And there's great room for dividend growth with Chevron. Really on one level, all they have to do is just grow their earnings by a slight amount, and with the 4% plus dividend and the long-term compounding, I'm sure you'll look back in a decade and it will be one of the stocks that was worth holding. 



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Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.