It's awfully hard to argue against the merits of investing in
. If you had invested in Chevron 10 years ago, you would have
more than doubled the S&P 500 on a total return basis.
Chevron's vertically integrated operations and massive global
footprint in a market that has relatively inelastic demand make
for a pretty compelling investment thesis. The old adage about
the stock market, though, is that past results do not necessarily
indicate future performance, and there are some key factors that
could send Chevron's shares down.
This isn't a prediction that Chevron's shares will fall. I'm
not here from the future and have no real way of knowing that for
certain. Instead, let's take a look at three things that could
impact the the value of Chevron's shares over the long term and
what you as an investor can look for to monitor the health of the
company before that happens.
1) Continued weak cash flow generation
Quarterly updates from a company are commonly referred to as
earnings releases, but I would argue that for a company like
Chevron knowing how much cash the company generates can be just
as important because it is such a capital intensive business. In
recent years, though, Chevron has not been very good at
converting its operations into free cash flow.
Since the beginning of January 2012, Chevron has generated
$3.28 billion in cash from operations after capital expenditures.
By itself that sounds great, but over that same time period the
company has doled out $22 billion to shareholders in the form of
dividends. To meet those cash needs, Chevon has needed to sell
assets, issue debt, and cash in some of its investments to cover
the operations shortfall.Compare that to its biggest rival --
-- which over that same time period generated $48 billion in cash
after capital expenditures to pay out $32 billion in
To be fair to Chevron, though, a large part of the reason it
has seen such weak cash generation is because it has been
spending so much on capital expenditures, and that should start
to wind down as some major projects come online. Today, more than
40% of the company's capital employed is called pre-productive,
which means that the money is spent but operations have not yet
begun and they're not producing.
Source: Chevron Investor Presentation
Over the next couple of years, management hopes to get the
percentage of pre-productive capital down to 35%, which should
help to boost returns on capital employed and free up cash for
its shareholder initiatives.
2) Future tied to the success of two projects
Source: Chevron Investor presentation
That picture right there is one of Chevron's most ambitious
projects to date. It's the company's Gorgon LNG facility in
Australia. This massive facility -- in which Chevron is the
majority operator -- not only represents part of Chevron's
future, but also one of its greatest risks.
Once online, the Gorgon facility as well as the similar
Wheatstone LNG project in Australia will represent over 300,000
barrels per day of oil equivalent production for the company.
Based on Chevron's growth plans, it will represent over
two-thirds of its production growth between now and 2017 and will
be over 10% of total production.
The one issue with having so much of its future in these
baskets is that they have been considerably more expensive than
originally anticipated. The Gorgon facility is estimated to be a
$54 billion project that has gone 47% over its original budget,
and the Wheatstone project is estimated to cost anther $29
billion. Cost overruns and delays on these projects have the
potential of eating into returns for many years, and it will mean
that just about every other project will have to be close to
perfect to offset it.
3) Likely to experience higher costs in the future compared
to its peers
One of the interesting aspects of Chevron compared to its
peers is that it isn't exposed to as much geopolitical risk.
Chevron is the only one of the big names in integrated oil and
gas that doesn't have operations in Russia, and its operations in
the Middle East only represent 3% of total production. While this
means that it is less likely to suffer production or potential
reserve losses from these slightly more contentious parts of the
world, it also means that it doesn't have as much access to some
of the few remaining "cheap" sources of oil and gas in the
Source: Chevron Investor presentation
This image covers just about every major capital project
Chevron has planned over the next couple of years. It is littered
with offshore and shale gas/tight oil projects both domestically
and internationally. These types of projects generally have much
higher marginal costs per barrel of oil equivalent produced.
Source: Chevron investor presentation
The biggest variable for Chevron here is deepwater
exploration. More than 30% of its future growth is dependent upon
deepwater development, mostly in the Gulf of Mexico but also part
of the Gorgon and Wheatstone projects. As you can see in the
graphic above, deepwater breakeven costs can be as high as $110
per barrel, and the average breakeven costs for international
shale gas/tight oil are approaching the $100 mark. This puts
Chevron at risk for higher operational costs than many of its
peers in the future, and could significantly impact profitability
What a Fool Believes
Investors that look at a company like Chevron need to keep in
mind one thing. Companies of Chevron's scale need to make their
investment decisions on a time horizon measured in decades. So if
you plan on making Chevron part of your portfolio, you should
make your investment decision based on a similar time
There are reasons to believe that Chevron can be successful in
the future, but the three things discussed here could deter that.
The best way to make sure Chevron remains on the right path for
you is to watch production costs and project budgets. As long as
Chevron can deliver projects reasonably within budget and
production costs remain modest compared to oil and gas prices
then it should be just fine, but if it starts to lose ground to
its competitors in this aspect it may be time to reconsider your
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3 Reasons Chevron's Stock Could Fall
originally appeared on Fool.com.
has no position in any stocks mentioned.
The Motley Fool recommends Chevron. Try any of our Foolish
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