Upstream Business will Lift This Energy Stock

Anindya is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Since Chevron’s (NYSE: CVX) profitability and production volumes are declining from the company's oil business, their effort in the shale gas exploration is a positive step. The recent shale gas exploration projects in China are expected to bring revenue growth for the company.

The strong position of the company in terms of its upstream business is considered an important catalyst for its long-term growth. Chevron's plan to capitalize on its excessive cash through investing in three lucrative upstream projects reaffirms my bullish stance on the stock.

2012 earnings: inline with forecast

Big Oil earned well over $100 billion in profits in 2012, while the companies benefit from continued taxpayer subsidies. Average gas prices also hit a record high last year, showing how a drilling boom may help oil companies' profit margins.

ExxonMobil (NYSE: XOM) earned $45 billion profit in 2012, a 9% jump over 2011. Chevron earned $26.2 billion for the year. In the final three months of the year, the companies earned $9.95 billion and $7.2 billion respectively. With Royal Dutch Shell (NYSE: RDS-A) and ConocoPhillips reporting $35 billion in combined profit in 2012, BP (NYSE: BP) is the last company left to announce its profits for the year.

Chevron's future growth driver: upstream business

Chevron’s capital expenditures have exceeded $100 billion over the past five years, with 90% of this going towards its Upstream Business segment. Upstream refers to the ways of finding and extracting crude oil and natural gas.

The company’s Upstream Business segment saw an increase in production in its projects involving ramp-ups in the United States, Nigeria and Thailand. However, the impact of this increase was offset by the decline experienced by its normal field projects, the operational shut down at the Gulf of Mexico due to the storm, as well as due to maintenance-related downtime. The company's management expects production to increase in the coming period, with the expected increase in energy demand.

The company's profitability is expected to increase in the coming period with the structural transformation towards natural gas. Chevron will invest around $37 billion in capex this year alone -- about the same as ExxonMobil despite having roughly half of its market cap.

Chevron's three major upstream projects

Chevron's future success lies primarily in its execution of three major projects -- the biggest of which is its massive Gorgon project.

  1. Gorgon is a $52 billion liquefied natural gas (LNG) joint venture in Australia that's one of the biggest infrastructure projects in the world. Gorgon will produce the equivalent of 450,000 barrels of oil per day (half of which goes to operator Chevron) when it comes online in 2014.
  2. Chevron’s Jack and St. Malo projects in the deepwater Gulf of Mexico were 60% complete. This project will have a capacity of 170,000 barrels of oil and 42.5 million cubic feet of natural gas per day. Chevron has working interests of 50% in the Jack field and 51% in the St. Malo field.
  3. Chevron’s Big Foot project is also in the Gulf of Mexico. The development will have production capacity of 75,000 barrels of oil and 25 million cubic feet of natural gas per day. Chevron has a 60% working interest in the Big Foot project.

Chevron's relative valuation vs peers

Chevron’s stock is trading at an EV/EBITDA of 3.590, at a slight premium when compared to Royal Dutch Shell's EV/EBITDA of 3.419 and BP’s EV/EBITDA of 2.978. However, it is trading at a discount to ExxonMobil’s EV/EBITDA of 4.239.

<img src="http://media.ycharts.com/charts/9b4bf56e6a6bf0525bd2fd9abe5a382a.png" />

EV / EBITDA & PE TTM data by YCharts

In terms of PE, the market is offering ExxonMobil a higher multiple even though its 2012 production declined 5.9%, while for Chevron it saw a slight increase.

Profit per barrel: Chevron leads the pack

<img src="/media/images/user_14403/cvx_large.png" />
 

The most compelling reason that Chevron should trade at a premium to ExxonMobil is because it is more efficient when it comes to generating profits on every barrel of oil. This is in part due to Chevron's higher weighting in oil production as compared to ExxonMobil. Moreover, Chevron CEO John Watson has recently picked up some prime Permian Basin west Texas acreage from struggling Chesapeake Energy at a very favorable price.

The verdict

Chevron's financial performance is at the top of the heap, and the stock deserves to be valued as such. 2013-14 looks to be great for the company. Chevron is a strong buy.


Anindya7 has no position in any stocks mentioned. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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