Chevron (IL/A): Valuation inexpensive, but overhang from the Unocal acquisition likely to linger - Goldman Stocks - October 28, 2005
We see Chevron shares as inexpensive at 4.4X 2006E EV/DACF, but continue to prefer our Outperform rated stocks given a lack of meaningful catalysts for Chevron and an overhang from the Unocal acquisition which will likely persist near-term. We maintain an In-Line rating on Chevron relative to an Attractive coverage view. In our view, raising Street confidence in the significant strategic advantage Chevron claims Unocal assets have will take time. Although an inexpensive valuation can make a case for an investor to buy and "wait it out", we see more favorable risk/reward in higher-beta oil equities especially considering our bullish commodity outlook. A large asset sales or an expanded share buyback program could help improve investor sentiment, although given Chevron's historically disciplined, thoughtful approach we do not expect any radical changes from Chevron's current course.
A VERY INEXPENSIVE CHEVRON COULD BE APPEALING FOR LONG-TERM INVESTORS
Under our $68 per barrel WTI spot oil and commensurate assumptions for other commodity prices for 2006, we see Chevron shares trading at 4.4X 2006E EV/DACF (enterprise value to debt-adjusted cash flow), relative to the super-cap integrated oil average of 5.3X and the domestic oil/E&P average of 4.3X. In our view, given the resiliency of super-cap oils' business models and asset portfolios over the long-run, we believe reversion to the mean works for this group, and as such the current inexpensive valuation for Chevron is unlikely to persist indefinitely.
NO MEANINGFUL COMPANY-SPECIFIC CATALYSTS EXPECTED NEAR-TERM
We believe catalysts for Chevron shares are likely limited to the scope of an E&P asset sales and share buyback program. However, given Chevron management's historically disciplined, thoughtful approach we do not expect any radical changes.
(1) E&P asset sales. Given that the key strategic merit in acquiring Unocal assets is in its Asian gas assets, deepwater Gulf of Mexico portfolio, and the ACG field in Azerbaijan, we believe Chevron should consider divesting a large portion of Unocals' other US operations and take advantage of current robust E&P asset valuations to pay down acquisition capital. Although we are currently forecasting a base-case scenario of $2 billion in E&P asset sales (predominantly in the US), we believe Chevron management should consider setting the bar higher.
(2) Share buybacks. Management indicated that it may disclose a potentially revised share buyback program when it reports its regular capital budget update in December. In our view, a share buyback program that is multiples of the current $5 billion program initiated in early 2004 would be seen as positive.
(3) Merger integration. Although it is early going, management appeared positive about the progress of the merger integration. Robust commodity prices are certainly helping, but nonetheless we view positively management's comments on its 3Q earnings conference call that the acquisition thus far has been accretive to earnings and cash flow per share even before realizing any merger synergies. In its 3Q earnings press release, Chevron indicated that the former Unocal operations produced 425,000 BOE/d in 3Q 2005, which was slightly above our expectations and compares to the 412,000 BOE/d produced during 2004.
3Q 2005 RESULTS BELOW EXPECTATIONS
Chevron's reported and clean 3Q 2005 EPS of $1.64 was below the $1.91 First Call consensus and our $1.80 forecast. Given heightened storm activity in the Gulf of Mexico and noise due to the closing of the Unocal acquisition in the quarter, we believe the miss is not material to the near- and long-term outlook for Chevron shares. The negative variance between reported results and our forecast was driven primarily from lower-than-expected international R&M earnings, lower-than-expected earnings from its chemicals business, and higher-than-expected corporate charges. E&P production and realized prices were largely in-line with our expectations.
UPDATED ESTIMATES
We have updated our full-year 2005 EPS estimate for Chevron, which now stands at $6.69 ($6.86 previously). Our updated estimate reflects actual 3Q 2005 results. We have not changed our $2.00 4Q 2005 EPS forecast and our full-year 2006-2010 EPS forecasts for Chevron. See Exhibit 1 for a summary model of Chevron.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.
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Previous Goldman Sachs Research Note on Chevron:
ChevronTexaco (IL/A): Least expensive of US super-cap oils due to investor concern over Unocal deal Goldman Sachs April 29, 2005
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