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Exxon vs. Chevron - What's the Better Investment?

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By madamebutterfly1
August 17, 2009

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I don't think one can answer with certainty what would be the best investment going forward if you are looking at a 1 or 2 year horizon. Let's face it -- given today's market conditions and uncertainty as to what is going to happen to energy prices, it is difficult to assess which of the two will do better in the next couple of years and beyond.

I think both CVX and XOM are good bets, as far as stock investments are concerned. While Exxon has outperformed CVX in the past 5 and 10 years, it is not axiomatic that it will do so in the next 5 or 10, although my bet is that it may do it again -- but it all depends.

CVX has been slightly more aggressive in the way it is investing for the future relative to Exxon and it will need higher prices for these expenditures to pay handsomely. And while both companies can take a licking if Russia turns sour on foreign oil, the bite out of Chevron relative to xom will be larger. Chevron has also made some deepwater discoveries that is going to require sustainable long term prices above $70/B to make the exploitation, profitable. My point is that CVX is a slightly more risky investment than is Exxon -- but it also holds a bigger upside, for that reason. So take your pick. However, a caveat emptor -- the same was said about COP two or three years back, and look at the devastation that has taken place with COP's stock -- which may be a reason to buy if you think prices have hit bottom.

Here is the deal as I see it. If we look at the P/E ratio of both CVX and XOM today, Exxon's P/E is about 31% higher than is CVX's. So it begs the question, why?

Why are investors willing to pay a 30% premium for Exxon's future earnings over Chevron's? And this is happening at a time when Chevron is paying almost twice the rate of dividend that Exxon is -- so the strength of xom's P/E is quite amazing which also says to me they have more confidence in xom's performance that in CVX's future performance.

In other words, despite the attractiveness of a dividend yield that is almost twice that of Exxon's, the market is still willing to pay 30% more for Exxon's earnings that for CVX's.

My answer to this phenomena has to do with issues of confidence and risk.

If you look at CVX's portfolio of properties, theirs is higher cost than Exxon's. Besides there is anecdotal evidence that CVX's management had assumed a much higher crude price profile than Exxon as the acquisition of Union Oil demonstrated by the premium they were willing to pay for those barrels of reserve. Retrospectively, buying back stock would have been a better deal, which is what Exxon did.

So if prices stay low, and "low" for me implies prices less than $60 to $70/B, then Exxon will definitely do better than Chevron-- Exxon simply has a lower unit cost operation.

Secondly, I think that Exxon's management has a proven track record of squeezing more profit out of a barrel than others, and in a lower price environment this is going to make a big difference. Exxon's refining structure and integration with Chemical, while hurting at the moment, is expected to bounce back with a roar the minute the economic picks up, and here Exxon's upside, especially with Chemicals is significantly greater than Chevron's.

Thirdly, the asset mix. Exxon has a more productive asset base than does Chevron -- the numbers prove it. Just look at the average return on asset for the two companies over the last 5 years--while Chevron's returns have been good, Exxon's have been extraordinary.

Fourthly, the element of "risk". Let's face it, if prices drop under $60/B for any sustained period of time, Chevron will have to do one of two things, it will either have to cut dividends or it will have to reduce its capital expenditure. Chevron already stopped its buyback. If CVX is forced to cut dividends down the road because of weaker energy prices, the stock price is going to get clobbered-- this will not happen to Exxon. If on the other hand CVX's decides in a lower price environment not to sacrifice dividends but instead it cuts capital expenditure to avoid borrowing and adding to debt, then, future profit growth is undermined, and the market is likely to reflect this by lowering the stock price.

However, if prices remain well above $60/b, preferably above $70/B, then the dividend for CVX is secure and compatible with the current level of expenditures as well -- and thus there will be no risk of cuts, and if crude prices go even higher than they are today, then, because CVX is more leveraged than Exxon and is perceived as higher risk, it will likely experience a larger upward bump in its P/E than XOM. In other words, CVX's risk discount will take a tumble pushing the stock upward at a much higher rate than XOM stock will experience--that is my guess (and so will stocks like COP and BP).

So at the end of the day, it is the expected business environment that is going to dictate who will do better relative to the other. In a lousy environment, because Exxon's investment approach is so conservative, Exxon will do better, while in a robust price environment expect Chevron and other slightly more aggressive investment companies to probably do better than Exxon.

However, again -- caveat emptor. While the business climate does have a significant impact on companies, how management deals with long term challenges, and how it positions a company to handle a wide range of business climate outcomes, may be the dominant factor on stock performance. Exxon's investment philosophy is that if they are going to be wrong, they would rather be wrong guessing and investing as if the business climate is lousy, than the other way. If the business climate is better than management assumed, Exxon can always catch up. Whereas if a competitor is more aggressive and the business climate turns out to be worst than it was assumed, then he will be squeezed and jeopardize company performance.

In other words ---It all boils down to risk, and how comfortable you are with it.

Because of the ease with which I invest in my 401-k, I invest all my energy investments in Exxon especially because the company also gives us additional incentives and "bonus" stock when we do so. But using the principle of diversification that has been so often enunciated on this board, holding xom, cvx, bp and cop would cover the gamut of risk. I would not include RDS on this list -- while there are some that think that RDS will come out of the doldrums, I have my deepest doubt because they have some big issues than need to resolved, especially their very aggressive investment program and their acquisition of assets that will require that future prices be much higher than today. There is also a cultural and management issue -- especially dealing with honesty, that have left many investors ticked off.

Madame Butterfly