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Chevron Stock Upgraded: What You Need to Know

By Rich Smith - Updated Apr 20, 2019 at 1:05AM

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This "conservative, through-cycle, sustaining business" will survive oil's "slow flash crash."

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

With a barrel of Brent crude selling for $62, oil prices are well off their lows of late December -- but still down a good 28% from the $86-plus that a barrel of oil cost in October -- a phenomenon that Oilprice.com has called oil's "slow flash crash." And yet, shares of one of the world's largest oil companies, Chevron ( CVX 1.50% ) have fallen just 11% from their October high.

Why is that? In the opinion of one analyst, it's because Chevron runs a "conservative, through-cycle, sustaining business" that's tailor-made to survive the topsy-turvy world of erratic oil prices.

Oil derrick against rising sun

UBS sees a bright future for Chevron. Image source: Getty Images.

Upgrading Chevron

This morning, analysts at Swiss investment bank UBS rewarded Chevron for its financial stalwartness by upgrading it to buy and assigning the $113 stock a $135 price target that implies it could gain 19% over the next 12 months. Combined with Chevron's robust 4% dividend yield (nearly twice the average on the S&P 500), this suggests that Chevron stock could reward investors with as much as a 23% profit over the course of this year.

Why does UBS love it? "[V]olatility" in oil prices, argues UBS in a note covered on StreetInsider.com (subscription required), shows the value of an oil stock with a "conservative ... financial model" that can earn good profits and maintain strong free cash flow even in times of weak oil prices.

Over the past 12 months, Chevron has racked up net income of $14.2 billion and free cash flow of $14.3 billion. That's 54% more GAAP profit and more than twice the free cash flow that Chevron generated in 2017, when oil prices averaged about what oil costs today.

How Chevron did that

How has Chevron succeeded in growing its profitability so much? Higher oil prices in the first half of 2018 certainly helped boost profits. But this company has also done a great job of containing costs to permit it to take advantage of whatever oil prices are on offer. Capital spending at Chevron hasn't grown much at all since last year, and is down more than 25% from 2016 levels (according to data from S&P Global Market Intelligence) -- and down by nearly two-thirds from the $38 billion that Chevron was spending on capital expansion in 2013.

This didn't happen by accident. In Chevron's 2019 investor presentation, management described how its strategy going forward aims specifically at getting "more out of assets" that the company already possesses, lowering the company's "cost structure," and growing "margins."

Chevron is doing all of this with a view to growing its free cash flow so the company can achieve its "#1 priority" of maintaining and growing its dividend.

What Chevron needs to do that

Despite all its efforts, Chevron does still need at least a little help from oil prices to do that. According to the company, so long as Brent oil prices remain at or above $50 a barrel, it should be able to remain at least "cash flow breakeven."

At $60 a barrel, Chevron says it can also cover its capital spending. Analysts at Citigroup recently forecast that Brent oil prices will average about $60 this year.

What it means for investors

With Brent crude selling for $62 today, Citi is right so far. But what about UBS and its prediction that Chevron will be a good stock to own in 2019?

I have to say that from my perspective, that prediction looks pretty good as well. Shares currently sell for about 15 times earnings or free cash flow. Relative to analysts' consensus forecast that Chevron will grow its profits 16.5% annually over the next five years, that looks cheap to me -- especially in light of the dividend.

And given that Chevron says maintaining and growing its dividend is its "#1 priority," I'd say you're probably pretty safe counting on that dividend remaining intact.

Check out the latest Chevron earnings call transcript.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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