Shares of integrated energy giant Chevron (CVX -0.99%) are down 30% so far in 2020, pushing the dividend yield up to 6.1% -- near the highest levels in the last 30 years. Moribund oil prices are the main culprit, but this uniquely bad period presents more aggressive long-term investors with a buying opportunity. Here are three reasons why jumping into this out-of-favor sector via a purchase of Chevron's stock could be a good idea.
1. Oil is not dead yet
There are two material knocks against oil today. The first is that the price of the energy commodity is very low. In fact, at one point earlier in the year, oil prices turned negative, meaning that drillers were paying customers to take oil off their hands. There were technical reasons for that and it was a very brief event, but it was a troubling example of the fact that participants in the industry can't really control the price of what they sell. Oil prices remain relatively low, but well above their lowest levels. Supply and demand have a way of working out over time, which is why Chevron tends to focus on long-term factors and not near-term ups and downs.
Which brings up the big fear in the oil patch: Clean energy alternatives are increasingly displacing oil and natural gas. That spans from autos, where electric cars are a growing threat, to power generation, where solar and wind are expected to displace carbon-based power. This is a very real long-term issue, but one that will likely take a very long time to play out. It took the world roughly 100 years for coal to be displaced by oil, which was the last big energy transition. So even though oil may not be what it once was, it will still be a vital energy source for many years to come. Someone will have to produce it; why not Chevron?
In fact, Chevron estimates that there will be a large supply shortfall if companies don't continue to drill for the so-called black gold. With so many energy companies pulling back in the face of low oil prices (that list includes Chevron, by the way), it actually wouldn't be shocking to see oil prices spike at some point in the future.
2. Strong balance sheet
The key to surviving in a highly cyclical industry like energy is being strong enough to handle the down years so you can thrive in the up years. That has long been a focus at Chevron, which has one of the best balance sheets in the industry today. To put some numbers on that, the company's debt-to-equity ratio is a very reasonable 0.25 -- and that's after adding billions in debt to ensure it has ample liquidity to deal with the impact of the COVID-19 crisis on energy demand.
Although a debt-to-equity ratio of 0.25 is modest for any company, a few comparisons to Chevron's peers will help. ExxonMobil's ratio is roughly 0.40, Royal Dutch Shell's is 0.66, Total's is roughly 0.75, and BP sits at a worrying 1.1. To be fair, European integrated energy companies tend to have more debt and more cash. But when the industry is as deeply out of favor as it is today, that cash isn't a material help because few are willing to spend down the cushion. And adding new debt to an already leveraged balance sheet is equally undesirable. All told, Chevron's approach looks like a winner today and one that will allow it to muddle through this downturn in relative stride.
3. Dedicated to the dividend
While there's no way to know what the future holds, Chevron has been adamant about one thing: It wants to protect shareholder dividends. In fact, during its second-quarter 2020 earnings conference call, management specifically highlighted the dividend as a key financial priority. CFO Pierre Breber summed things up nicely when he explained to an analyst:
All of our actions are designed consistent with our financial priorities. The first is to sustain and grow the dividend. We showed our stress test last quarter at $30 [crude oil prices] that I think was made very clear that we have the financial capability and the flexibility in our capital program, the ability to manage our costs to sustain that dividend through what is a stress test.
There's not much more reassurance a dividend-focused investor could ask for. Sure, the dividend could get cut, but it's pretty clear Chevron is going to do everything it can to ensure that doesn't happen.
A good time to invest, if you dare
It's not easy investing when others are fearful, which is exactly what you need to do if you buy Chevron today. However, when you dig into the oil giant's story, the risks don't seem quite as great as some investors may fear. If you can stomach a little uncertainty, Chevron looks like an attractive way to play the out-of-favor energy space.