Why Chevron Corporation's Disappointing Earnings Are No Cause to Panic

Chevron's (NYSE: CVX  ) earnings declined by 27% year on year in the past quarter. Time to panic? Wall Street certainly doesn't think so: Shares actually ticked higher on Monday.

Courtesy of Investor Relations 

This quarter on its own, frankly, was pretty bad. The harsh decline in earnings was led by upstream, which represents oil and gas production, but was mitigated by downstream, which represents refining and distribution. As an aside, this is exactly why the biggest oil companies integrate operations: Oftentimes upstream will counteract declines in downstream, and vice versa. 

In any case, upstream earnings led the decline this quarter. This was caused partially by extreme weather in Kazakhstan, but more so by unmitigated base decline in legacy assets. Chevron's answer to this decline is several large, multi-year projects, most of them international. The most important of these projects are yet to come online, and hence base decline was very pronounced in this quarter.

Courtesy of investor relations

The chart above adds color to the oil and gas production declines. "Major capital projects," which added to production this quarter, include Angola LNG and the Papa Terra offshore project in Brazil. Both of these had only a minor impact. Interestingly, shale projects in the Permian Basin in Texas and Vaca Muerta in Argentina added comparatively more to production than did the major capital projects, despite Chevron's obvious emphasis on the latter. 

Things will improve
Chevron's real answer to base decline will come over the next couple years. The company's biggest capital megaprojects, two offshore Gulf of Mexico rigs and two giant LNG plants in Australia, will deliver an impact much greater than that of the comparatively smaller Angola LNG and Papa Terra projects. 

One of the Gulf Of Mexico projects, Jack/St. Malo, will be completed in the fourth quarter of this year. The other Gulf project, Tubular Bells, is already 90% complete. Both of these will produce mostly oil. In Australia, the Gorgon LNG project is 80% complete. Management's target for first gas is 2015. The second Australian LNG project, Wheatstone, is only 33% complete. It will be awhile before Chevron sees any cash flow from Wheatstone. These four megaprojects represent the future of Chevron, and production declines will likely continue until the these projects come online.

Industry-leading profitability
Meanwhile Chevron's greatest competitive strength continues to be its profitability. Chevron finished 2013 with the highest return on capital employed at 17.2%, edging out its nearest competitor, ExxonMobil. Margins were even more impressive. Cash margin per barrel equivalent came in at an incredible $37, far higher than its next closest peer at only $27. 

Bottom line

Source: Google Finance

Unfortunately for those looking to add shares to their position, Chevron has run up quite a bit since its early February low. This chart shows a fairly clear pattern of jagged ups-and-downs, and so I believe we will see a better entry point for Chevron some other time.

Of all the integrated oil companies, Chevron continues to be the best 'low-risk' choice because of its high margins, leading return on capital and fortress balance sheet. The company also just recently raised its dividend payout by 7%. The stock now offers a yield of 3.4%. For all these reasons, Chevron is worth adding on a pullback.

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