At the end of March, I stated that the dividend of Chevron (NYSE:CVX) was safe despite the outbreak of coronavirus. While the oil giant maintained its dividend in the second quarter, there has been a record number of dividend cuts this year due to the pandemic, particularly in the energy sector, which is one of the most severely beaten sectors. In addition, the virus has become more aggressive lately, as it is propagating at a record pace in some states. It has thus led some income-oriented investors to fear that Chevron, which will declare its next dividend later this month, may cut its dividend. However, the dividend of Chevron remains safe.
The pandemic has caused an unprecedented collapse in the global demand for oil products. The demand for jet fuel, gasoline, and diesel has plunged approximately 75%, 50%, and 25%, respectively, this year. Consequently, the global oil production has slumped at a record rate this year while refiners have drastically cut their refinery utilization rates, to 60% in April and 75% in June. Both rates are daunting, particularly given that refiners normally operate at utilization rates close to 100% at the peak of the summer season.
Despite the severe impact of the coronavirus crisis on the energy market, it is unreasonable to expect the pandemic to cause a permanent collapse in the demand for oil products. There are numerous ongoing studies for a vaccine for coronavirus. The vaccine of Moderna (MRNA) has exhibited the most promising results so far, and the company will launch its Phase 3 trial on 30,000 people in July or August. Pfizer (PFE) is also expected to launch its 30,000-patient study this month while Johnson & Johnson (JNJ) recently moved the start of the Phase 1/2a of its vaccine candidate from September to July. Overall, a vaccine is likely to be identified in early 2021. Therefore, it is reasonable to expect consumers to return to their normal lifestyle the latest in late 2021.
The International Energy Agency (IEA) seems to agree on this view, as it recently issued a bullish outlook for the energy market. According to its report, the global demand for refined products is expected to surge at the fastest pace in history next year, by 5.7 million barrels per day. If this forecast materializes, the demand for oil products next year will be only 2.4 million barrels per day lower (2.4%) than it was last year, before the onset of the pandemic.
Some investors are alarmed by the high sensitivity of Chevron to the price of oil. In 2019, Chevron generated 82% of its adjusted earnings from its upstream segment. This is a much higher percent than that of the other well-known oil majors, such as Exxon Mobil (XOM), BP (BP), and Total (TOT), which are much more integrated than Chevron. In addition, while the other oil majors produce oil and natural gas at nearly equal amounts, Chevron produces them at a 61/39 ratio. Moreover, a portion of its gas output is priced based on the oil price. As a result, approximately 75% of the total output of Chevron is priced based on the oil price. Therefore, Chevron is much more overweight on the price of oil than the other oil majors.
However, Chevron learned its lesson well in the previous downturn of the energy sector, which was characterized by the collapse of the oil price from $100 in mid-2014 to $26 in 2016. The oil major drastically improved its asset portfolio by selling low-return assets and investing in low-cost, high-margin barrels. As a result, Chevron has become the most resilient oil major, along with Royal Dutch Shell (RDS.B) (NYSE:RDS.A), at the prevailing oil prices. These two oil majors have low exposure to high-cost reserves and enjoy the highest margins at $70 per barrel.
Due to the high cyclicality of the energy sector, it is extremely hard for energy companies to maintain multi-year dividend growth streaks. Chevron and Exxon Mobil are the only exceptions to this rule, with 33 and 38 consecutive years of dividend growth, respectively. The exceptional dividend record of Chevron is a testament to the long-term perspective of its management.
It is also important to note that the 33-year period of dividend growth of Chevron includes the Great Recession, which was the worst financial crisis since the Great Depression, and the fierce downturn of the energy sector between 2014 and 2016. Chevron incurred a loss of $0.27 per share in 2016 but it kept raising its dividend thanks to its conviction in its long-term growth prospects and its strong balance sheet.
In the ongoing downturn, the earnings of Chevron have slumped and hence the stock currently has a payout ratio of 250% and a dividend safety score of only 1. However, as mentioned above, the energy market is likely to enjoy a strong recovery from next year. As a result, Chevron can be reasonably expected to return to its profitability of recent years the latest by 2022.
The company posted adjusted earnings per share of $7.74 and $6.16 in 2018 and 2019, respectively. If Chevron achieves earnings per share of $6.16 by 2022, its payout ratio will drop to 84%, a much healthier level than the current level of 250%.
In the meantime, Chevron will exhaust its means to defend its multi-year dividend growth streak and, more importantly, it has the financial strength to defend its dividend despite its expected losses of $0.25 per share this year. Chevron has an AA credit rating, one of the strongest ratings in the energy sector, and its interest expense consumes only 7.5% of its operating income. As a result, the company is likely to maintain its current dividend while it waits for the pandemic to subside and the energy market to recover.
Moreover, income-oriented investors should note that Chevron is currently offering a 5.8% dividend yield. This yield is clearly at the upper range of the historical yield of the stock.
Therefore, it represents an attractive entry point for the income-oriented investors who have a long-term investing horizon and are trying to lock in an attractive yield, with significant growth potential.
The managements of most companies have become more conservative in the ongoing coronavirus crisis than in previous downturns due to the high uncertainty that results from the unknown parameters of the pandemic. The lockdown that took place in the second quarter is unprecedented.
On the bright side, such a lockdown is unlikely to occur again. However, if the virus continues to propagate at its recent pace for a considerable period, another lockdown cannot be excluded. This uncertainty is one of the factors behind the record number of dividend cuts announced this year. Chevron is highly unlikely to announce a dividend cut later this month when it is expected to announce the dividend that will be paid in September. However, if the pandemic goes completely out of control and caused another shutdown of the economy, the oil major may cut its dividend in the fourth quarter or early next year. Nevertheless, this is only a highly unlikely, worst-case scenario.
The energy sector is going through an unprecedented downturn due to the pandemic. However, the pandemic is likely to subside and the demand for oil products is likely to post a strong recovery from next year. Moreover, Chevron has greatly improved the resilience of its asset portfolio in recent years. Given also the healthy balance sheet of the oil major, its dividend can be considered safe in the absence of another lockdown.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.