Energy prices have been dealt a devastating blow by COVID-19. Every energy company has been forced to pull back, circle the wagons, and focus on basic survival, and an increasing number of companies have failed to achieve even this modest goal. Global integrated energy giant Chevron (NYSE:CVX), meanwhile, sits at the other end of the spectrum. While clearly retrenching, it is showing just how financially strong it is today.
Times are very tough
The most recent oil name to seek out bankruptcy court protections was Chesapeake Energy. It's a big event in the industry, even though it had been expected for months, because the company helped to usher in the fracking boom that turned the United States into a major energy exporter. Along the way, however, growing U.S. onshore oil production also upended the supply/demand balance in the energy sector, setting the stage for today's troubles.
Essentially, the energy sector has been attempting to adjust to the increase in U.S. production for years, with what amounted to a little bit too much supply floating around. When COVID-19 hit, however, things took a drastic turn for the worse. The global effort to slow the spread of the coronavirus via rapid economic shutdowns removed a material amount of demand, tipping the supply/demand equation deeply out of balance. In fact, at one point, oil prices actually fell below zero. There were complicated technical reasons for that, but for a brief moment in time oil drillers were effectively paying customers to take their oil.
With companies from the upstream (drilling) to the downstream (chemicals and refining) areas of the sector getting hit, energy names have been pulling back hard. The biggest moves have been to cut capital spending plans and ensure there's enough cash on hand to survive until the market recovers. Chevron has been working just as hard as any other company on those fronts, but the current environment is actually allowing it to show off its many strengths.
A balanced approach
Coming into the current downturn, Chevron had one of the most modest capital investment plans, relative to cash flow, of any of its closest peers. It was benefiting from past spending, however, so it was still expecting production to grow at a healthy 3%-to-4% annualized pace. When demand fell sharply, the company pulled back its spending plans from roughly $20 billion a year to $14 billion. This will have an impact on production -- but at today's prices, oil is probably better left in the ground than pulled out and sold cheaply. The point being that Chevron was able to take its already-conservative posturing and become even more conservative.
But the really big story here shows up on the oil giant's balance sheet. The company's long-term debt load increased a huge 20% during the first quarter of 2020. That's a massive uptick in a short period of time, and normally would be a sign that investors needed to start worrying. However, when you put that figure into the broader context of the industry, it actually makes Chevron stand out in a very good way.
For example, while Chevron's increase here was notable, it wasn't the biggest in the sector. U.S. peer ExxonMobil (NYSE:XOM) increased its long-term debt tally by 30% so it could continue to support its more aggressive counter-cyclical investment program. This is an important point of comparison, because these two U.S. companies tend to carry less debt than their European counterparts, which generally have more debt and higher cash balances. They aren't interchangeable balance sheet approaches.
When times get tough, like they are today, an already heavy debt load will make adding even more debt undesirable. And using up the cash cushion when liquidity is a key goal is also problematic. Thus, Chevron and Exxon, with more modest levels of debt, were able to tap the strength of their balance sheets during a tough period, ensuring they had the liquidity needed to survive the highly cyclical industry's headwinds. However, even after increasing its long-term debt load by 20% in a single quarter, Chevron's financial debt to equity ratio, at a very reasonable 0.25 times, is still the lowest of its closest peers. Sure, that number is roughly double the 0.12 times or so it was at the start of the year, but that just highlights how well positioned this conservative oil company was coming into the downturn.
Better prepared for the storm
When you put it all together, Chevron entered into the downturn in a fairly strong position. When the downturn hit, it was able to pull back its already relatively modest spending plans and tap its rock-solid balance sheet while still maintaining an industry-leading leverage profile. It is likely the best positioned oil major on the planet today. With a generous 5.7% yield, investors looking at the down-and-out energy sector for bargains should put Chevron on their short lists.