DGI Adventure – 12-09-2015 Investment Anti-Thesis – Chevron Corporation (CVX) – No Sale

This is the second installment in a new series where rather
than using the investment
thesis process
to explain why I want to buy a particular stock, I use it to
explain why I’m steering clear…for now anyway. Today’s edition borders on DGI
sacrilege, as I dare to question a Dividend Champion!

Dividend Cycle

Chevron should go ex-dividend sometime in
mid-early-February. I would expect the dividend to be $1.07/share which is what
it’s been since May of 2014. Chevron is a Dividend Champion, having raised its
annual payout for 28 consecutive years. They are riding the knife edge of a
technicality, however. Total payout in 2014 was $4.21/share. Total payout in
2015 will be $4.28/share (tomorrow is the last CVX pay day this year, which my
wife’s ROTH account will enjoy…woo hoo!)

So technically…they’ve raised the dividend in 2015. And
technically they could keep it at $1.07/share for the next three quarters and
then raise it to $1.08/share in the final quarter of 2016 and technically…they
would maintain their streak. That would be pretty sad dividend growth, but it
would be growth! They just might have to do something like that. I don’t think
the dividend growth picture is particularly rosy right now for CVX.

Non-Investment

I am drawn to CVX. I want to buy it. The church of Buy and
Hold tells me to buy it and then hold it. The church of DGI tells me it’s a
great company with a history of rewarding shareholders. Morningstar says the
company is run by “exemplary” management, has a “narrow moat” and earns a
4-star rating with a fair value of $107/share. I just can’t pull the trigger on
any more shares (and my wife’s position is a pretty small one…so it doesn’t
have anything to do with portfolio balance.)

I owe you a little PB (pre-blog) history. Since there aren’t
any blog posts from this time, you will have to take my word on this one. My
wife bought a small stake (~11shares) in CVX in February in her ROTH with 2014
contributions. Her cost basis is ~$108/share or something like that. As we
watched it come down through the course of the year, we were very tempted to
average down. We had cash on August 25 when CVX put in the current 52-week low
of $69.58…and we were paying attention so it’s not like we just missed the dip
completely. My wife had a limit order at $62 waiting. It never executed, and
she ended up cancelling it trying to gaff other more promising fish.

Were we too greedy? If you just look at the last 3.5 months,
apparently we were. It rallied hard after that fateful August week.

But I’ll point out that it bounced off the 200-day moving average
and is back down in the high 80’s now. Maybe $70/share was the steal of the
century…”locking in” a 6% yield on a dividend champion. What a truly rare opportunity
that might end up being.

We’ll see. It wasn’t a good enough margin of safety for me. I
like to look at share prices through the reverse DDM implied DGR lens. If
$70/share was a fair value, the implied DGR was 3.89% (assuming a 10% discount
rate on a $4.28 annual dividend). I’m thinking more like 3% DGR…

The QC (Quantitative
Case)

image

*EPS CAGR is just above the 5% threshold using 2005 – 2014 EPS.
If you were to compare 2006 – TTM the EPS CAGR is negative.

**I’m not even really sure that they can get to a 3% DGR
rate any time soon. In light of their cash flow situation right now, the
dividend staying flat for the next few years is probably the best case
scenario. But a single stage DDM analysis discounts DGR into perpetuity, and
over the long run, I’ll give Chevron the benefit of the doubt that they can
eventually at least keep up with inflation. That’s where the $62 limit came
from anyway.

LOL (Limit Order
Logic) – No sale.

I guess if I were to change my mind about all this, I would
give it a shot at $62. I think that’s enough downside, that if management did
happen to cut the dividend by 50% or something, we would still get a kinda okay
invested
yield
.

The last time shares of Chevron traded that cheaply was
February of 2009. But that was also the last time before 2014 that the company
had negative free cash flow. Negative free cash flow is no bueno if you plan to
pay $2B every quarter in dividends.

QWaF (Qualitative
Warm and Fuzzy)

It’s freaking Chevron. 28 years of dividend growth. They’re
an integrated super major in the petroleum space. They’re focusing on LNG right
now which has a better macro demand picture than oil. Revenue that exceeds the
GDP of small countries. Exemplary management. The only oil company that
actually gives a shit about the environment (this last point may be disputed by
some people, but my company actually does a lot of work as a vendor for Chevron…and
I genuinely believe they give a shit about doing things the right way. My $0.02…)

Did I mention it’s freaking Chevron?

What’s there to be afraid of? Jump on in…the water’s warm…it’s
heated by natural gas!

CPR (Cold and Prickly
Risks)

NEGATIVE FREE CASH FLOW DOES NOT MAKE FOR A VERY SAFE
DIVIDEND…

A definition of FCF
for the uninitiated.

I don’t care how allegedly “dedicated” management is to
returning value to shareholders. They’re way more dedicated to paying back bond
holders, maintaining investment grade financials, and not abandoning
multi-billion dollar capital expenditure projects before they’re completed.
Just ask shareholders of Kinder
Morgan (KMI)
how much it matters to have management’s “commitment” to a
dividend (KMI isn’t really a good comp, considering CVX isn’t leveraged up to
their eyeballs…yet…but it had a similar cult following in DGI circles up until
this week).

Now, in fairness, management announced that they are paring
down capex…like
a lot
. That’s really good news for the balance sheet. HOWEVER…they have
made ~$21B in cash from operations TTM. And that was when the average price of
crude was higher than it is now. I have no idea what the price of oil will be
in 2016, but even if it’s flat compared to this year…Chevron will probably have
negative free cash flow again even at a severely reduced capex budget of $26B.  Tighten up operations; squeeze vendors
(believe me…they can squeeze the shit out of vendors…), a little bit of
efficiency can go a long way you know. The delta is about $5B. So maybe they can
break even on the cash flow metric? Great. So, where do they get the $8B to KEEP
THE DIVIDEND FLAT? Maybe they sell some assets? Probably they’ll have to borrow
money. How long is that going to have to stretch? Short of a major rebound in
the price of oil, I just don’t see a scenario where they grow the dividend by
any significant measure, and I don’t think it would be that surprising to see a
cut. Champion or no champion…$8B is a lot of fucking money to just give away
when times are as tight as they are right now.

The Saudi’s aren’t planning to turn off the pumps any time
soon. They can play this game of chicken for at least a couple years.

Sorry. I don’t mean to defile an aristocrat…but I’m just not
interested right now.

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