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Introduction
Chevron, (NYSE:CVX) made a big splash on the upstream E&P-M&A leader board last fall with the announcement of its $53 bn plus debt takeout of Hess Corp, (HES). There was never any doubt as to their motivation for taking this good sized E&P off the table. HES’s stake in the Stabroek block, offshore Guyana proved too strong a temptation, and a deal was struck.
Wall Street reacted negatively to the news with respect to Chevron stock taking it down in a couple of days from nearly $170 per share to the low $150’s. HES shares conversely got a boost from the low $140’s to the mid-$160’s, thanks to the market perception of the deal as favoring them. Speculation about their ability to actually close the deal at some point took the shares back toward their original pre-deal levels, as investors waited for the next shoe to drop.
And drop it did with Exxon Mobil’s, (XOM) announcement that they would file for arbitration to preserve their JOA rights for first refusal of the HES stake, in early March.
In this article we will discuss what we think the current status of the deal is and what the outcome might be. We will also project a reasonable entry price for CVX stock under current conditions.
Chevron’s apparent misstep with HES
Chevron is one of my favorite upstream operators. I worked with them often in my active career around the world- California in the 80’s, Scotland in the 90’s, Brazil in the 2000’s, and Indonesia and Australia in the middle teens. South America not so much, perhaps due to Venezuela-tantalizingly poised as it is across a short expanse of ocean from the Texas/Louisiana/Mississippi coast line refining centers, being one of the few countries I’ve skipped, hopscotching the globe. I know CVX as a consummately professional organization that dots all of its “i’s” and crosses its “t’s.” And, then triple checks the final tally.
Which is why it’s a bit of a head scratcher they apparently didn’t think to touch base with Darren Woods, CEO of Exxon Mobil. A phone call or an email from Mike to Darren might have saved a lot of the current kerfuffle. One that doesn’t seem to have been made, as Darren noted at CERAweek recently.
On Monday, Exxon CEO Darren Woods told Reuters the company filed for arbitration because discussions were not happening with Chevron and Hess around the right of first refusal provision.
“Those discussions needed to happen and hadn’t been happening,” Woods said.
Well there you go. Unforced error Mike. When you stop by the side of the road to pick apples off a tree, it’s just good manners to say hi to the farmer first.
What is more relevant to an investing decision at present is the likelihood of the Hess deal going forward. Waves are being raised by the other partners in Guyana, and CVX has already said that without HES’s Stabroek stake they are not interested in consummating the deal. HES is a little desperate as they agreed to a $1.7 bn breakup fee if the deal doesn’t go through.
We all know CVX’s production in Venezuela has been curtailed in recent years and the company is always looking for heavy crude to feed its refining operations in the Houston/Mississippi area. Buying Hess for its Guyana stake seemed like an obvious move on the part of CVX. For the reserves and access to the crude, which the company churns through its Gulf Coast refineries at a nearly a half-million barrel a day clip. And, at the time of the announcement, they hadn’t made a multi-billion dollar acquisition in a few months. It was time to join the big ticket M&A party.
There may be a “Morning After”
It is a little surprising then that such a kerfuffle-which as we have noted, was entirely foreseeable, has developed over the Hess deal. Exxon Mobil feels justifiably proprietary about its Guyana operations, and has thrown a spanner in the works (joined now by CNOOC) by pressing its preemptory rights in regard to the Stabroek block, from which the company has announced 11 bn barrels of reserves thus far.
Not to block the deal, but to confirm that they reserve their right to independently value the HES stake, post-deal. That makes going forward tough for the two primary companies involved. Each have a multitude of due-diligence concerns in this regard that could lead to contentious litigation down the road, if they are not careful. In recent days both CVX and Hess have put out notices that the projected close in the second half of this year might be delayed.
Now we get the news that XOM is willing to “talk” with Chevron about a way forward. XOM CEO Darren Woods was quoted in a World Oil article as saying-
“The channels for dialog remain open,” Woods said. “This is a business issue — this is not a personal one. We’re not trying to stop the Chevron-Hess transaction. We’re trying to preserve the rights we have for the Guyana asset that we’ve developed.”
I find that language to be very conciliatory, and from it would assume back-channel negotiations are underway to smooth out the ruffles between XOM and CVX. The two companies work together frequently around the world and this sort of brouhaha helps no one. For reference using quick math, XOM projects that it will be pumping ~1,200,000 BOPD from Stabroek in 2027. On future cash flow basis that makes the HES 30% stake worth about $42.1 bn. That tracks fairly well with CVX’s overall offer of $53 bn for the entire company, which of course includes a commanding-400K+ acre position in the Bakken.
As a final thought on the valuation of this deal, it is worth noting that XOM’s incredible success rate-33 consecutive commercial finds, has confirmed that Stabroek lies in a channel referred to as the “Golden Lane.” Outside of that channel, success rates have not been nearly as rewarding. That could put a multiplier on how XOM values those reserves. XOM has already said it expects significant future discoveries in Stabroek, with 35 new exploration wells permitted for drilling through 2028. Suppose 1.2 mm BOPD becomes 2.0 mm BOPD? My suspicion is that XOM will want a premium over and above straight market value. If CVX is smart, they will pay it. Dan Pickering of Pickering Energy Partners put a fairly fine point on this notion with his comment carried in a Reuters article–
“It obviously means that 30% of Guyana is really valuable and maybe they think that Chevron is getting in too cheaply, Pickering said, adding “Right now, it feels like a food fight.”
Risks
The stock of CVX dropped about 5% on the announcement of the deal and has traded in a fairly tight range since. Would they get that 5% back were the deal to be called off? Doubtful, although there is that breakup fee coming in that scenario.
There’s also some dilution ahead for current shareholders. CVX will issue about 350 mm shares to HES holders. That’s about a 20% bump to their current float of 1.880 bn shares. They have a history of buying back shares after a deal and have the cash flow to do it. After dividend of around $11 bn and capex of $15 bn, there is plenty of money left for stock repurchases.
Your takeaway
CVX is generating $42 bn in EBITDA currently putting their EV/EBITDA multiple at 6.3X. That’s getting a little pricey, but if oil prices hold above $80 this year, EBITDA could hit $50 bn, taking the multiple down to 5.3X. That’s getting much closer to where we might consider piling in.
Analysts rank CVX as an Overweight at current prices, with targets that range from $148.00-$200 per share. The median is $179.00, about half way between current prices-$154.00 and the upper end of the range. The high end most certainly prices in the close of the deal with Hess bringing $5.6 bn in EBITDA with it. To keep the multiple at 6.3X shares would need to rerate toward $190.
With EPS of $3.45 for Q-4, 2023, CVX blew past estimates of $3.19 per share. Estimates have been lowered for Q-1,and 2 2024 at $2.99 and $3.05 respectively.
CVX is right at its upper resistance line and a hair over its 200 Day SMA. The last time it was in this position was August, 2023 where on increasing oil and gas prices it topped out at $170 per share.
As much as I would like to get into CVX, I would prefer it be nearer the support line at $142, making the current price a hold. That may be wishful thinking on my part, but there is a lot of volatility in the oil markets right now, and fluctuations of 5-10% can occur with just a whisper of peace in the Middle East.
CVX’s dividend currently yields 4.2% and boasts a payout ratio of 46%. Capturing that divvy would buttress my desire to enter the stock. The Q-1, 2024 dividend will be announced in early May with an Ex-D date o/a the 15th, so we have a little time for CVX stock to come back to us.
Come to papa, baby.
