Why Did Buffett Invest In Chevron? 

Warren Buffett, the guru of value investing best known buying and holding stock has been snapping up shares of Chevron Corporation (NYSE:CVX), one of the most prominent energy companies.

Buffett-controlled Berkshire Hathaway reduced its Chevron holding initially last year but in Q4 the company unexpectedly changed its course from selling to buying 15.8 million shares. Chevron currently ranks #5 in Berkshire Hathaway’s (NYSE:BRK.B) portfolio based on the weighting.

Berkshire was in a buying mode for Chevron during the initial stage of the Russia-Ukraine conflict, but soon thereafter unloaded some of its holdings. The rekindling of its relationship with Chevron alongside its heavy investments in Occidental Petroleum Corporation (NYSE:OXY) suggest a sort of faith in the long-term prospects for the energy sector.

Following the recent acquisition of Chevron’s shares, Berkshire now owns 6.7% of Chevron while Chevron makes up 5.8% of Berkshire’s portfolio.

Even though Buffett’s renewed interest suggests he is bullish long-term on energy, why did he in fact embark on the purchases?

The rationale behind Buffett’s recent move might be in large part due to Chevron’s substantial dividend payouts. 

Berkshire Hathaway famously adjusts its portfolios to maximize the expected returns and Chevron has earned a reputation as a stable financial performer with a steady dividend-paying history that prioritizes shareholders’ interests.

Chevron’s dividend increases have consistently shown management’s confidence in its profitability, too.Indeed, CVX has increased dividends for 36 straight years.

The cash distributed by CVX to its shareholders in 2023 reached an all-time high. The oil titan returned $26.3 billion to shareholders by disbursing dividends of $11.3 billion, a hike of 3% versus the year prior. The Board also approved the repurchase of $14.9 billion worth of shares.

Further, they announced an 8% increase in its first-quarter dividend to $1.63 a share, translating to an increase in dividend payouts by 6.3% compounded annually over the past five years. The $6.52 annual dividend yields approximately 4.10% based on the current share price.

Almost 10% of its market capitalization was returned to shareholders last year. The company is expected to continue to deliver above-average dividend growth in 2024.

Is Chevron Fairly Valued?

Warren Buffett’s legacy is closely associated with investing in value stocks so given his holding firm, Berkshire Hathaway, currently holds $20 billion worth of CVX shares, it appears clear that he believes the stock is trading at a discount to fair value at this time.

Indeed, a cursory look reveals that, in spite of all the hype around the oil and gas sector amid geopolitical issues and high prices, Chevron seems to be reasonably priced.

Chevron’s forward non-GAAP P/E ratio is 11.3x, around 8% higher than the sector average. Yet in terms of the five-year average, Chevron is trading at a substantial discount. Moreover, its forward P/S multiple at 1.45x reflects a 3.5% discount compared to industry peers.

The modest valuation points to significant upside opportunity ahead, not least given that the consensus price target among analysts is $180.37 per share. This indicates a potential share price climb of 13.5% from its last closing price.

Acquisitions Show Promise

In line with its history, Chevron has added to its traditional and new energy assets base, which have the capacity to serve the growing need of cheaper, reliable, and cleaner sources of energy.

Beyond surging oil prices, Chevron is expected to benefit from the acquisition of Hess Corporation worth $53 billion, which provides it with access to offshore oil fields in Guyana. The deal is likely to close this year. CVX also acquired PDC Energy last year, which helped it to increase U.S. production.

After a successful closing of the Hess deal, Chevron plans to go further with share repurchases by $2.5 billion, reaching the upper-tier ceiling in its yearly guidance range.

Additionally, management has committed to portfolio optimization by generating between $10 billion to $15 billion in proceeds before tax by 2028 from divestment of assets without affecting the double-digit returns on capital employed (ROCE) at mid-cycle prices. Nevertheless, the deal is pending due to some disputes.

The production growth at Chevron allows it to fulfill its promise to increase shareholder payouts with projected annual free cash flow growth over 10% at $60 Brent through 2027.

Furthermore, CEO Michael Wirth stressed the financial strength of the organization as he believed that the company will likely continue to prosper even in an environment where oil prices weaken.

Chevron has budgeted the range of about $18.5 billion-$19.5 billion for the current year’s investment in new oil and gas projects, which represents an 11% increase compared to last year. The company is increasing the level of investment and capital budget in order to increase output. The company reached production of 3.1 million oil-equivalent barrels per day in 2023, which was primarily caused by a 14% increase in its U.S. business.

Why Did Buffett Invest In Chevron?

Chevron returned about 10% to shareholders in the form of dividends and share repurchases, which is likely a primary reason why Buffett invested in it.

Although Chevron faces some weakness, as indicated by a 16.5% year-over-year drop in top line stemming from cyclicality, upcoming acquisitions are set to strengthen its financials over the long term. 

Moreover, an attractive income stream through dividends and share price trading a discount to fair value make the company attractive at this time. Notably a discounted cash flow analysis places fair value at $181 per share, suggesting material upside even from these levels.

Lastly, analyst sentiment remains favorable with 24 analysts covering the firm and largely skewing towards Buy recommendations. It’s not a surprise that they lean positively given the strong cash flows and profitability that can continue to pay dividend-seekers a generous yield for the foreseeable future.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.