$90 Oil: Chevron and Caterpillar's 2020 Acquisitions Are Paying Off Big Time

Industry-leading companies have several advantages that make them worth owning, even if they are more expensive than smaller competitors. For Chevron (CVX -0.59%) and Caterpillar (CAT 0.91%), those advantages were put on display in 2020 when deep pockets allowed both companies to make timely acquisitions during a depressed oil and gas market.

In 2020, the average price of West Texas Intermediate (WTI) crude oil, the U.S. benchmark, was under $40 per barrel, and the average Henry Hub natural gas price was just under $2 per MMBtu. Today, WTI is over $90 per barrel. Natural gas is over $4.30 per MMBtu and got as high as $5.50 per MMBtu in October 2021. These are the highest oil and natural gas prices since 2014. 

Here's a look at how each company's acquisition plays into its broader investment thesis.

Image source: Getty Images.

Chevron's acquisition of Noble Energy

In 2020, Chevron reduced its capital expenditures to $8.9 billion as it cut costs to make ends meet. However, Chevron also played some offense by acquiring Noble Energy in an all-stock deal valued at $13 billion -- which included around $8 billion of Noble Energy's debt. Chevron announced the deal in July 2020 and closed it in October 2020. The deal gave Chevron 92,000 largely contiguous acres in the Permian Basin at the cost of less than $5 per barrel of oil equivalent (BOE) of proven reserves and less than $1.50 per BOE for 7 billion barrels of risked resource. In total, it added 18% to Chevron's total proven reserves as of year-end 2019. 

Going into the deal, Chevron was already a major player in the Permian and had expressed its interest to grow its Permian presence due to its low cost of production and faster turnaround than other shale and offshore plays. The deal reduced Chevron's cost of production, something the company has expressed as one of its core strategic goals. Today, Chevron can achieve breakeven positive free cash flow (FCF) at around $40 per BOE, allowing it to operate successfully in good times and bad.

In hindsight, the timing of the Noble deal was brilliant as it expanded Chevron's footprint in one of its core growth geographies -- not to mention that Chevron was able to buy the company at a steep discount to what it would be worth today.

Caterpillar's acquisition of Weir Oil & Gas

Caterpillar signed an agreement to acquire the oil and gas division of Weir Group in October 2020. The all-cash deal was completed in February 2021. 

Caterpillar bought Weir Oil & Gas for its well completion and drilling portfolio, which fit nicely into Caterpillar's diversified oil and gas business. Caterpillar then restructured and rebranded Weir's oil and gas division into what is today known as SPM oil and gas, an oilfield product and service division of Caterpillar currently located in Houston, Texas. 

Caterpillar's energy and transportation segment is about as large as the company's construction business. The oil and gas division sells engines and other equipment used in gas compression, offshore and land-based drilling and production, and well service. In 2021, energy and transportation sales were $20.26 billion, up 16% year over year.

Data source: Caterpillar Inc. 

Caterpillar's 2021 operating profit remained pressured due to higher costs and supply chain constraints. But given rising oil and gas demand coupled with what so far seems to be a relatively stable supply, Caterpillar is poised to have a very strong year in 2022.

Like Chevron, Caterpillar was able to buy in the middle of an industry downturn, a luxury that few companies could afford. The deal immediately showed short-term payoffs and should be accretive to Caterpillar's long-term earnings.

The value of a proven track record

Both companies have strong balance sheets and competitive advantages that allow them to perform well even during difficult times. Chevron and Caterpillar are usually able to support their dividends with free cash flow. In the case of years like 2020, both have ample liquidity to pay and raise the dividend. Although supporting a dividend with debt isn't a sustainable strategy in the long term, it does ensure that both companies can return value to shareholders even during industry downturns.

Chevron and Caterpillar's consistency is evident in both companies' status as Dividend Aristocrats. A Dividend Aristocrat is an S&P 500 component that has increased its annual dividend for at least 25 consecutive years.

When scanning the energy and industrial sector for buys, investors may find it best to keep it simple with best-in-class companies like Chevron and Caterpillar. Buying equal parts of each stock gives an investor an average dividend yield of 3.1% while exposing their portfolio to a variety of industries across the integrated oil and gas value chain.