Integrated energy giant Chevron (CVX -3.04%) announced that it earned $6 billion in the second quarter, or roughly $3.20 per share. Key bullet points from the earnings release called out record Permian production, record shareholder distributions, and an expected August closing date for a recent acquisition.
Management is clearly trying to accentuate the positives, which is fine. Only there was a negative here that shouldn't be ignored, even though it was entirely expected and predictable.
How Chevron makes its money
Before digging into the second quarter just a little, it is important to understand what Chevron does. As an integrated energy company, its operations span from the upstream (drilling) through the midstream (pipelines) into the downstream (chemical and refining). Each of these areas of the energy sector has different business dynamics. By grouping all three into one company, Chevron hopes to even out its financial performance over time.
That said, oil and natural gas prices have a huge impact on the company's upstream results. The midstream and downstream components of the business blunt the inherent swings in this commodity-driven business, but they don't eliminate them. When oil prices are high, Chevron will generally produce impressive earnings. When oil prices fall, so too will earnings.
What's notable is that Chevron has been able to increase its dividend annually for 36 consecutive years, despite the highly volatile nature of the energy sector. It managed this feat by focusing on maintaining a strong balance sheet. When oil prices are falling, it takes on debt so it can support its dividend and continue to invest in its business. When oil prices recover, the company uses strengthening earnings to pay down the debt it took on during the bad times.
CVX Debt to Equity Ratio data by YCharts
The chart shows what happened with Chevron's leverage during the last big energy market swing. That drop in Brent Crude, a key oil benchmark, came when reduced economic activity during the early days of the coronavirus pandemic led to a dramatic decline in oil demand. Chevron's leverage, looking at the debt-to-equity ratio, roughly doubled. As oil prices rebounded, management reduced leverage, which sat at about 0.15 times at the end of the first quarter -- below where it was prior to the pandemic.
The energy industry is cooling off
But look at what Brent Crude prices have done since peaking in early 2022. Now reconsider Chevron's $6 billion earnings for the second quarter. Note the company didn't point out in the bullet points it provided that earnings in the second quarter of 2021 came in at $11.6 billion, or around $5.95 per share. If it did, management would have had to say that earnings fell by nearly 50% year over year.
It's hard to blame the company for not wanting to point that out. It isn't exactly a great commentary. And yet, investors probably shouldn't get too upset by the decline, either.
As noted, Chevron's top and bottom lines are driven largely by energy commodity prices. It is just how the business works, and there's little that anyone can do about it. When times are good, they can be really good. When the good times end, financial results can drop off quickly and dramatically. That's basically what's happened, again.
In fact, $6 billion is still a pretty solid earnings number. For reference, in the second quarter of 2020, during the last big downturn, the company lost $8.3 billion. In the same stanza of 2021, that figure rose to a profit of $3.1 billion.
By those standards, $6 billion is still pretty attractive. It's just less good than the earnings the company achieved when oil prices peaked roughly a year ago. Long-term income investors looking for a reliable dividend stock in the energy patch just need to understand that this type of volatility is normal, and Chevron is built to handle the swings.
Nothing bad is happening here
All in, Chevron had a strong second quarter and is making important progress with key business initiatives, like increasing production in the Permian and growing its reserve base via acquisitions. It is also continuing to reliably reward shareholders, noting that the dividend was increased again at the start of 2023 (it also continues to buy back shares).
If you own Chevron, you need to be prepared for earnings volatility, trusting that this seasoned energy company knows how to use energy upturns to help it survive the inevitable downturns.
