XOM - Chevron: Earnings Concerns Reinforced By The Hess Deal

2023-10-30 16:19:27 ET

Summary

• Chevron Corporation shares have fallen below their trading range due to soft third quarter results and concerns about near-term earnings power.
• The company's earnings power has decreased by 30% since 2022, but the earnings multiples remain non-demanding at around 10-11 times.
• Chevron's $60 billion acquisition of Hess Corporation has raised questions and may not be a great transaction for investors in Hess (in the near term).

In January , I believed that Chevron Corporation ( CVX ) saw profits coming down while it still traded at a peak price. Peak profits in 2022 were already coming down towards the end of the year, as profits were used to please investors and invest in environmental technologies. As oil prices (CL1:COM) stabilized in 2023 and mostly traded rangebound, this has caused pressure on earnings and subsequently on shares of Chevron a bit as well.

Shares have now fallen below its $150-$180 trading range for the year, as third quarter results were soft while energy prices were high. This observation and a big transaction for Hess Corporation ( HES ) raises some questions as well, perhaps resulting in additional pressure on earnings power.

Some Perspective

After the world learned about the possibilities of negative energy prices during the pandemic, Chevron flexed its financial muscles as it announced a $13 billion deal to acquire Noble Energy at the time, adding reserves and production across the globe. When the economy recovered quickly coming out of the pandemic in 2021, and the war between Russia and Ukraine broke out, this created other drivers for higher energy prices, and shares of Chevron saw a huge rally as well.

Early in 2022, shares of Chevron crossed the $120 mark again, levels at which shares traded pre-pandemic. This was driven by solid 2021 results, with revenues reported at $162 billion on which earnings of $15 billion were reported, translating into earnings around $8 per share, while the company operated with a manageable $25 billion net debt load.

Momentum was very strong in 2022, as first quarter sales rose to $52 billion, came in as high as $68 billion in the second quarter, and stabilized at $66 billion in the third quarter, only to fall to $56 billion in the final quarter of the year, resulting in a full year revenue number of $246 billion. Net debt fell to $6 billion as earnings power came in at around $18 per share, although that earnings power fell to a run rate of $13 per share in the fourth quarter.

With earnings power of $20 per share, the 9 times earnings multiple looked cheap, but clearly these kinds of profits were not sustainable in the long haul, making me cautious to get involved, even as the company was making the right moves to diversify the business and invest and acquire alternative energy businesses.

Chevron Shares Have Fallen This Year

Since the start of the year, shares of Chevron have largely fallen from levels around $180 at the start of the year to the $150 mark early in the summer. After a modest recovery in recent weeks, shares have now fallen below the $150 mark, trading at $144 per share which is the lowest level since essentially the start of the war between Russia and Ukraine.

This is noteworthy, as oil prices started the year around the $80 per barrel mark and during the first half of the year traded mostly in the seventies. Oil prices peaked in the $90s in September, now trading at $85 per barrel.

In April, Chevron posted first quarter earnings result of $3.46 per share, up thirteen cents from the fourth quarter, as the quarter was quite uneventful, if not for the fact that oil production fell below 3 million barrels of oil equivalent per day. In May, Chevron announced a $6.3 billion deal to acquire PDC Energy in an all-stock deal as net debt pushed up the valuation to $7.6 billion. While a big number in absolute terms, this was just a bolt-on deal for Chevron of course. In July, second quarter earnings were posted at $3.20 per share, due to falling realizations in the second quarter.

Towards the end of the October, Chevron posted third quarter results which of course applies to a quarter in which oil prices were moving a bit higher, and the deal for PDC closed during the quarter as well. The company posted earnings of $3.48 per share, with earnings trending at $14 per share here per annum. Net debt has ticked up to $15 billion, mostly the result of continued payouts to investors, notably buybacks on top of the generous dividends which the firm pays.

Soft Third Quarter Results

With 1.88 billion shares trading around the $150 mark Chevron commands a $282 billion equity valuation, or close to $300 billion enterprise valuation. Even after earnings power is down some 30% from 2022, the resulting earnings multiples remain non-demanding at around 10-11 times at these levels.

Besides the third quarter results, which looked a bit softer from an earnings perspective given that energy prices were high during the quarter, there was the big news about another, but this time a more substantial, deal.

Days ahead of the Q3 earnings report , Chevron announced its intention to acquire Hess Corporation in a deal valued at $53 billion based on Chevron´s share price of $171 ahead of the deal announcement. This came just after its rival Exxon Mobil Corporation ( XOM ) announced the acquisition of Pioneer Natural Resources Company ( PXD ), of course.

With an exchange ratio of 1.025 shares of Chevron for every share outstanding in Hess, we can see that the current equity value of the deal has fallen to $45 billion as shares of Chevron have fallen to $145 per share, as Hess furthermore operates with about $7 billion in net debt.

The deal rationale is driven by greater scale, a great asset in Guyana as well as shale position in the Bakken, its integrated midstream assets in that region and complementary assets in the Gulf of Mexico. These complementary assets make that both firms target a billion in annual synergies. Investors in Hess will look forward to the synergies and share recovery as they only obtain a roughly 10% premium for the shares, and with shares of Chevron down 15% since the announcement, it is far from a great transaction (yet) for investors in Hess.

What Now?

Despite the pre-announcement of an 8% increase in the quarterly dividend to $1.63 per share (still to be approved), shares of Chevron have fallen to $145 per share here, translating into a 4.5% dividend yield.

As a result of the tie-up with Hess, Chevron sees capital spending up towards $20 billion, albeit that some divestments are targeted. Net debt of about $15 billion will jump to $22 billion following the deal with Hess, not a great concern, in fact, share buybacks are now seen at $20 billion a year.

Despite the potential, investors are voting with their feet as the third quarter results were a bit soft, as investors were somewhat surprised by a relatively expensive move for Hess, and that Chevron will see some cost overruns at some projects (notably its Tengiz project in Kazakhstan). Despite some turbulence, it is the Hess deal which sets a roadmap for production to rise to 4 million barrels of oil equivalent per day by 2030.

Overall, I am a bit disappointed by the Chevron Corporation third quarter earnings numbers, as earnings are not really advancing in a generally higher commodity price environment, and an expensive deal for Hess Corporation will likely be dilutive to near-term earnings, though they should be accretive to earnings in the long haul. Nonetheless, Chevron appears to be making nice long-term moves, as I see very good reasons to hold to a long position here.

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