justin sullivan
Turns out Russia’s foray into Ukraine has resulted in big payday for Big Oil, including upstream companies like Chevron Corporation (NYSE: CLC).
Energy company’s earnings were strong in the fourth quarter, but 4Q-22 profits fell strongly QoQ due to lower realized prices in the crude oil market.
Chevron has also pledged $75 billion for stock buybacks, which will almost certainly be done at exorbitant prices, which I object to. That said, I believe Chevron will sooner or later be forced to deal with lower crude oil prices, which will reduce the company’s earnings and cash flow outlook.
Falling fourth-quarter earnings growth is a concern
Chevron ended 2022 with $35.47 billion in profit, a 127% year-over-year increase. Chevron earned $18.28 per share, 125% more than the company a year ago.
Despite the fact results looked good on a year-over-year basis, Chevron’s earnings growth is slowing. The upstream company earned $5.49 billion in 4Q-22, down from $9.31 billion in 3Q-22, down 41% QoQ.
Earnings Reported to Adjusted Earnings (Chevron Corporation)
Chevron’s earnings were almost entirely driven by favorable price realizations throughout 2022, due to the conflict between Russia and Ukraine.
Price realizations accounted for 83% of Chevron’s earnings growth in 2022, with higher downstream margins accounting for the majority of the remaining difference.
Results 2022 vs 2021 (Chevron Corporation)
Crude oil prices are set for mean reversion
Chevron’s earnings, in my view, will continue to decline. This conclusion is based on the fact that crude oil prices have historically not held steady around 10-year highs for long periods of time.
Surges in crude oil prices have occurred regularly, often in response to geopolitical events such as terrorism, the outbreak of war, or violent local conflicts near production hotspots, but they have generally declined as quickly as they have increased.
A recession in the United States in 2023 could trigger a new bear market in crude oil, which would pose a significant challenge to Chevron’s earnings and cash flow growth.
crude oil prices (Yahoo finance)
Reimbursement of excess cash
Chevron repaid $11.3 billion in stock buybacks in 2022 ($3.8 billion in the fourth quarter) and the company repurchased $1.4 billion in stock in 2021.
The increase in buybacks is obviously the result of Chevron’s record cash flow, but I believe that this fairly large increase in buybacks that has materialized over the past year has come at a time when Chevron’s earnings are about to contract. Simply put, Chevron is reinvesting $75 billion of its cash at a time when profits have already peaked.
This implies that Chevron, in my view, is overpaying for its own actions. Chevron could do better for shareholders if it decides to pay down debt or invest in new production capacity, which would translate into future earnings growth.
Share redemption history (Chevron Corporation)
Chevron is not a bargain
Shares of Chevron surged after the $75 billion share buyback commitment was announced, but the stock is not a compelling buy-back or no-buy buy.
Chevron’s fourth quarter earnings strongly suggest that earnings have already peaked, and with investors likely facing a recession in 2023, I think the risk/reward relationship for Chevron is not attractive.
The energy company is currently trading at a multiple of 10x earnings, but the P/E ratio is so low due to a period of exceptionally strong earnings. If Chevron’s earnings continue to decline in 2023, as I expect, the company’s P/E ratio will rise.
P/E ratio (Y-Charts)
Why Chevron might see a lower/higher valuation
Chevron’s fortunes are inextricably tied to crude oil prices. A high crude oil price is fundamentally positive for Chevron’s earnings outlook, while a low crude oil price is negative for the company’s earnings and cash flow.
Going forward, I expect crude oil market prices to decline, but I could be wrong. For example, a geopolitical event (such as Russia’s expanding war in Ukraine) could occur, causing crude oil prices to rise further.
Risks to my bearish thesis
The obvious risk is that the market moves in the opposite direction to what I wrote in this article. A significant increase in crude oil prices would negate my argument for why Chevron might see weaker earnings going forward.
However, my main point remains: in the long term, crude oil is more likely to trade at $30-40 a barrel rather than $100-120 a barrel.
My conclusion
I think it would be foolish to pay top dollar for Chevron now that the company’s profits have peaked.
As the economy transitions from peak productivity, high inflation and labor shortages to a recession-like environment with weaker economic activity, declining job numbers and evaporation potential demand for crude oil and other energy sources, the market should expect a continued decline in profitability .
What troubles me is that Chevron is buying back a large amount of stock at a time when the company’s shares are at multi-year highs.
Given Chevron’s declining fourth quarter earnings, I would advise against buying Chevron stock whether or not a large buyback program was authorized.
