Chevron (NYSE:CVX) has been a big buyer of its stock during the last decade. Since 2006, Chevron has bought back tens of billions of dollars worth of shares that have reduced its float by 13%. In 2014 alone, Chevron bought back $5 billion dollars worth of its stock, reducing its float by 2%.
Due to low crude prices, Chevron suspended its buybacks in 2015 to save cash, and the company hasn't bought back any stock since. Although crude prices have rallied almost 100% from February, the company is unlikely to do any share purchases during the next year. Here are three reasons why:
No. 1: Chevron is free-cash-flow negative right now
Because Chevron's megaprojects like its Gorgon and Wheatstone LNG projects are not yet producing consume cash, and won't reach their full production capacity until 2017 or later, analysts believe Chevron will report a free cash flow of negative $15 billion for this year. Adding to the company's cash-flow consumption will be expansion of the Tengiz project in Kazakhstan, for which Chevron just gave the green light.
Chevron and its partners plan to invest up to $37 billion in the project beginning in 2017 to increase production to 760,000 barrels per day from the current 500,000 barrels per day. Although the Tengiz project won't initially consume as much cash flow as Wheatstone does now, it will add to the cash consumption nevertheless. The negative free cash flow makes share repurchases problematic.
No. 2: Chevron's balance sheet is strong, but the company will end up a little more leveraged than management might tolerate
Management has drawn a debt ratio of 30% as the line in the sand that the company is hesitant to cross. Given the anticipated free-cash-flow outflow of $15 billion for this year, Chevron's debt ratio might be at 30%, or slightly higher, by the time its free cash flows turn positive. Because of that, management is unlikely to do a buyback.
In addition, although crude fundamentals are improving, crude prices could still head south. Saudi Arabia could decide to turn on its spare capacity to spoil the party and hurt Iran. The various geopolitical events causing production disruptions might disappear, and more supply could come onto the market. Growth in the Chinese economy and developing world might slow noticeably, and demand for crude might grow less than the expected 1.4 million barrels per day.
No. 3: The dividend is much more of a priority
Chevron's management is more dedicated to the dividend than share repurchases. They have said time and time again that the dividend is their No. 1 priority. In 2015, they kept the dividend payout the same despite the fact that oil prices at the time didn't support the payouts. There's a reason for this.
Paying dividends is a much surer way of creating shareholder value than share repurchases. With dividends, shareholders are guaranteed to have money in their pockets no matter what happens next. With share buybacks, the value the repurchases create might be destroyed during the next market downturn, or when management decides to do something stupid.
ExxonMobil (NYSE:XOM) shareholders, for example, probably wish that the company had returned its excess capital through dividends rather than through share repurchases. Although ExxonMobil bought back $210 billion dollars worth of its stock during the last decade, ExxonMobil only trades for a market capitalization of $373 billion. The present oil crash has negated much of the value ExxonMobil generated with its stock repurchases.
Another reason is that, with Brent near $50 per barrel, Chevron is very close to having enough cash-flow coverage to cover or even raise the dividend in 2017. If Chevron spends some of its cash flow for buybacks, the company's dividend coverage will be lower.
Because Chevron is free-cash-flow negative at the moment, and dividends are a better way of creating value than buybacks, management won't likely buy back any shares during the next few quarters. Once 2017 comes around, Chevron will likely use its cash flow to lower its debt ratio, and potentially raise its dividend instead. In the long run, focusing on returning capital through dividends rather than through buybacks is a more-prudent approach.