Chevron Stock: Sold Out and Undervalued, Prices Near 52-Week Low (CVX)

CVX Stock: Past Theses and New Developments

I previously wrote an article about Chevron Corporation (NYSE: CVX) shares on May 8, 2024. The article was titled “Chevron Stock’s EPS Growth Potential Could Surprise Market” and gave the stock a Buy rating. In article, I argued:

The market is significantly undervaluing CVX due to its strong EPS growth potential. My estimates show that for every $1 increase in oil prices, Chevron’s EPS could increase by about $0.33, and I see a good chance that oil prices will reach $100. Given the combination of a reasonable P/E ratio and the potential for significant EPS growth, I believe CVX offers a very attractive risk/reward profile.

Since I wrote this piece, there have been a few new events related to stocks. So I thought it would be helpful to write this follow-up article to assess my thesis. First and first and foremost, the company released its Q2 FY2024 (ER) earnings report. ER outlined several key developments in its operations, as well as some ongoing headwinds (more on that later). Second, the stock price has seen a significant correction and is currently hovering around a 52-week low, as seen in the chart below.

I will explain my re-evaluation points, as well as my buy rating, later in the article. I certainly expect the stock to face some selling pressure, judging by recent technical trading patterns (as described in the next section directly below). However, I believe the growth potential is healthy over the long term, judging by the solid ROCE (return on capital employed) and reinvestment rates. The stock is currently undervalued by a significant discount. The combination of undervaluation and growth potential creates an attractive return profile over the next few years.

CVX stock under selling pressure

I’ll start with the technical trading patterns. The top panel of the above chart shows price and trading volume information for CVX with a 20-day moving average, while the bottom panel shows its Relative Strength Index (RSI). These charts show several common indicators that suggest strong selling pressure. First, CVX price has fallen well below its 20-day moving average, as you can see, a technical indicator that often signals negative momentum. Additionally, the volume data shows a significant increase in trading during pullbacks, especially during periods of price weakness such as those in early August and over the past few trading days. Additionally, the RSI, a momentum oscillator, is currently hovering near oversold levels. An RSI below 30 is typically considered oversold, and CVX’s current RSI is around 31.8x, as you can see. Finally, many traders often view the 52-week low as a key psychological support level. CVX price is trading quite close to the 52-week low (around $136, as you can see in the above chart). If it falls below the 52-week low, it could trigger further selling.

CVX Stock: Key Catalysts and EPS Outlook

Now let me move on to the developments around the fundamentals of the business. In my opinion, ER Chevron delivered a mixed performance in the second quarter of the fiscal year. Top line increased 5% to $51.2 billion, compared to the consensus expectation of $50.5 billion, as seen in the chart below. The results were driven by a number of fundamental growth catalysts. The top driver on my list was record production in the Permian region. The increase in production brought global production up 11% year-on-year. The integration of PDC Energy (which was acquired in August 2023), as well as solid execution in the Permian and Denver-Julesburg (DJ) basins were also key drivers of the results.

On the negative side, GAAP EPS came in at $2.43. This missed the prior-year result and also missed the consensus estimate by $0.46. Normalized EPS of $2.55 also missed the consensus estimate by $0.45. In my opinion, the main reasons are lower refined product margins, the absence of favorable tax positions (which existed in the prior-year period), negative currency effects, and relatively weak raw material prices.

I believe that all of these headwinds are temporary and will therefore only impact short-term EPS growth. I see a healthy long-term growth curve for CVX, in the mid-single-digit range around 5%. My method for estimating long-term growth rates is detailed in my other articles. So I will just report the final results below:

This method involves a Return on Capital Employed (“ROCE”) and a Reinvestment Rate (“RR”). CVX’s ROCE has averaged around 19.3% in recent years, as you can see in the chart below. Its RR is averaging around 15%. With these inputs, CVX’s long-term growth rate would be ~2.9% (19.3% ROCE x 15% RR = 2.9%). Note that this number is the actual growth rate without inflation. To get the theoretical growth rate, you would need to add the inflation escalator. Assuming average inflation of 2.5%, the final growth rate would be 5.4%.

CVX stock is undervalued

In terms of valuation, as mentioned earlier, the stock is currently undervalued due to the price pullback. More specifically, the chart below compares CVX stock’s valuation multiples to its 5-year averages. As you can see, the P/E (Non-GAAP) on a TTM and FWD basis is noticeably lower than its 5-year average. Its current TTM P/E ratio of 11.57 is about 9% lower than its 5-year average of 12.67.

In addition, I believe that the P/E multiples on the books underestimate the discount. Thanks to strong cash flow, the company has been paying down its long-term debt at a rapid pace in recent years (in addition to share buybacks and dividend payments). As a result, valuation multiples based on enterprise value, such as EV/EBITDA and EV/EBIT, are trading at a larger discount (in the range of 15% to 25%) compared to historical levels, as shown in the table below.

Other risks and final thoughts

As a final upside risk, I believe my article would not be complete without mentioning CVX’s status as a dividend champion, which is a strong indication of its resilience over the long term. Furthermore, given its excellent dividend history, I believe that dividend payments are the most reliable indicator of its owner’s true earnings. With that in mind, CVX’s current above-average dividend yield serves as another strong indicator of its undervaluation. More specifically, the chart below compares CVX’s current dividend yield to its historical average. As you can see, the current dividend yield is 4.62%, noticeably above its long-term average of 4.21%.

In terms of downside risks, in addition to those listed above (exchange rates, taxes, commodity prices, etc.), there are a few other things worth mentioning. The company recently announced that it will be moving its headquarters from San Ramon, California, to Houston, Texas. This will allow for greater collaboration and engagement among management, employees, and business partners. However, the move will be a long one (the company expects all corporate functions to be moved to Houston over the next five years) and could result in higher operating costs in the process. Finally, the planned $53 billion acquisition of Hess remains uncertain. The deal is subject to review by the Federal Trade Commission and arbitration with Exxon over the company’s claim for first refusal to acquire Hess’ assets in Guyana.

In summary, all of these uncertainties are temporary in my opinion. For long-term investors who can look beyond these temporary issues and the potential price volatility they cause, I see a favorable risk/reward profile given the solid EPS growth potential as well as the discounted valuation.