This week, Fool analysts Todd Wenning and Bryan Hinmon are presenting two stock ideas for inclusion in the Fool DRIP portfolio. Energy stocks are on the docket today with Bryan presenting Lubrizol and Todd making a case for Chevron (NYSE: CVX).
Two weeks ago, Bryan and I put forth two DRIP portfolio candidates in Badger Meter and Caterpillar, and came to the same conclusion -- neither was a good buy at current prices. We realize that the lack of action is sort of a letdown, but we'd much rather you hang onto your money than pay too much for a stock!
This week, however, both of us feel that our candidates are good buys right now. Bryan will make a strong case for chemical additives company Lubrizol, but given that we're building a five- or six-stock DRIP portfolio, I prefer to maximize diversification with blue chips whose businesses are more diversified than mid- to small-cap companies.
Microsoft was a pure-technology play, for example, and now that it's officially in the DRIP portfolio (please see our position details below), I'd like to find another "pure play" -- this time in the energy sector. With oil and natural gas prices trending downward, I think now's the time to start a position in energy giant Chevron.
Four reasons to DRIP into Chevron
- Scale, scale, scale. Carnegie himself would be proud of the way Chevron has vertically integrated its operations. It makes money on the "upstream" (exploring, developing, and producing oil and natural gas) as well as the "downstream" (refining, marketing, and transporting finished product), meaning it will make money in all stages of oil and gas production.
- Smart focus. Since 2004, Chevron has invested more than $70 billion into the more-profitable upstream business. Expertise in the exploration and production of oil will be essential in the coming years as cheaper, on-shore oil sources begin running out. The remaining sources, like those found offshore and in oil sands, will be more expensive to extract and produce.
- Track record of rewarding shareholders. Chevron has increased its dividend each year for 23 consecutive years, which is an impressive feat given that oil prices have been as high as $125 and as low as $15 since the late 1970s. Managing that type of volatility sure isn't easy. When I graded Chevron's dividend a "B-" in July, it was mainly due to the high free cash flow payout ratio, but its second-quarter results gave a good boost to free cash flow. Today, it would score a "B+," which is a good grade for a stock yielding 4%.
- It's trading at a good to fair price. Just about any way you look at Chevron, it looks undervalued today. I ran a dividend discount model assuming 7% growth that trails off to 2% in perpetuity and 8% cost of equity. The result was $77-$80 per share. Also consider its current multiples relative to its five- and 10-year averages, and I think you'll agree that with shares near $73, it's at least a fair time to initiate a position.
|
Current |
5-Year Average |
10-Year Average | |
|---|---|---|---|
|
Price-to-Tangible Book Value |
1.55 times |
2.18 times |
2.37 times |
|
Enterprise Value-to-EBITDA |
3.63 times |
4.22 times |
5.09 times |
Source: Capital IQ, a division of Standard & Poor's, as of Aug. 26.
Risks to consider
- Heightened political risk. The fallout from the BP (NYSE: BP) Gulf oil spill disaster and Venezuela's recent nationalization of oil rigs owned by Helmerich & Payne (NYSE: HP) are just two examples of how much political risk there is in the oil industry.
- Double-dip risk. A slowdown in the global economy could keep oil and natural gas prices depressed, which could adversely affect Chevron's profitability.
- Alternative energy. One of the downsides to a vertically integrated business model is that when a new and better alternative technology appears, the established company needs to quickly redistribute investment into that technology to keep pace. This can be a costly endeavor and can put additional pressure on profits.
Foolish bottom line
On the whole, I agree with Motley Fool Income Investor's most recent guidance on Chevron: "Shares of oil-services behemoth Chevron have been volatile since rival BP's well explosion in the Gulf of Mexico. That movement is giving you the opportunity to buy shares of this top-of-the-class company at a great price."
Not only do Chevron shares look like a great long-term bet today, but the fees on its DRIP program are quite reasonable, as well. If you own less than 200 shares, you won't pay a dividend reinvestment fee, and though the initial commission is $10, thereafter it's just $2 per periodic electronic purchase.
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