Why Did Buffett Sell Chevron?

Warren Buffett’s Berkshire Hathaway investing company recently revealed that it had sold 30.6 million shares of oil giant Chevron in Q1. Chevron has been one of Berkshire’s most aggressive buys in recent years, with the stock at one time being Buffett’s fifth-largest holding. So, why did Buffett sell Chevron?

Why Buffett Owns Chevron

Buffett began buying Chevron in late 2020, acquiring an initial stake of 48.5 million shares at an average price of $80.96.

At that time, the stock was severely undervalued. Despite trading steadily in the $90-100 range for most of the preceding two years, Chevron fell as low as the $60 range in 2020 when global energy markets were hammered. Buffett, taking the longer view, recognized the value Chevron represented and began buying shares in the oil major.

Chevron has consistently displayed features that are known to attract Warren Buffett. To begin with, the company generates a large amount of cash flow from its activities. Today, Chevron produces about $28.50 worth of cash flow per share annually. Even with the higher prices the stock commands in the current market, this puts Chevron’s price-to-cash-flow ratio at an attractive 5.5x.

Chevron also returns a significant amount of cash to shareholders in the form of dividends.

The company’s current annual payout is $6.04 per share, a yield of 3.84 percent. Buffett’s remaining stake of 132 million shares, therefore, should generate about $787.3 million in income for Berkshire Hathaway this year.

Given that the payout ratio is just 32.6 percent, Chevron’s management will likely have room to continue raising the dividend in future years.

A final factor that likely attracted Buffett to Chevron is its economic moat. In the petroleum refining industry, for example, Chevron accounts for over 15 percent of total industry revenue. Chevron is also among the top three oil companies by market cap, exceeded only by Exxon and Aramco.

Why Is Buffett Selling Now?

One of the most likely explanations for Buffett’s decision to sell Chevron is the fact that the stock has already generated large returns that may slow in the near future.

Berkshire realized an average price of $167.65 on the Chevron shares it sold in Q4. Buffett’s total stake in Chevron is up about 25 percent, an impressive return given the difficulties of the stock market over the past few years.

Although Chevron remains fairly attractive, it has encountered a difficult period in the first half of 2023. The stock has lost about 12.4 percent YTD.

While analysts, on average, expect it could pop as high as $191.55, the next year could be a challenging one for oil companies. Anemic macroeconomic conditions have kept oil prices lower than expected in 2023. Even production cuts have failed to lift prices appreciably, potentially signaling that lower prices could prevail until the global economy improves.

The decision to sell Chevron may also have been related to another Buffett favorite, Occidental Petroleum. Even as Berkshire has sold off Chevron, its stake in Occidental has continued to grow. Today, Berkshire owns nearly 25 percent of Occidental Petroleum, and the firm has received regulatory clearance to purchase up to 50 percent.

Comparing the valuation metrics of the two companies, Buffett’s decision to sell Chevron while increasing his stake in Occidental begins to make sense.

Occidental’s earnings are expected to grow by nearly 20 percent this year, more than double the rate of earnings growth Chevron is projected to generate. Despite this fact, both stocks trade at roughly 11 times expected forward earnings. Occidental also generates a 45 percent return on equity, compared with 23 percent for Chevron.

Ultimately, Buffett’s decision to sell a large part of his Chevron stake was likely influenced by several factors. Selling an undervalued asset as prices normalize is a classic move for value investors.

Buffett’s position in Occidental may also have played a role, as he may have preferred more exposure in Berkshire’s oil and gas holdings to be allocated to the superior value between the two stocks.

It’s important to recognize that more than $20 billion of Berkshire Hathaway’s capital remains invested in Chevron. So far, there are no indications that Buffett is planning to pull out of Chevron altogether. Although selling nearly a fifth of the Chevron stake in a single quarter was an aggressive move for Buffett, it’s likely that the sale amounts to a portfolio rebalancing more than a fundamental rejection of Chevron as a business.

Should Other Investors Follow Buffett & Sell Chevron?

Although Buffett appears to have solid reasons for selling some of his Chevron stake, these reasons likely don’t apply to all investors. Chevron remains a dominant company within the oil and gas industry. Given its moat, excellent profitability and capacity to generate income, there is still much to like about Chevron.

While the oil market appears choppy in the short term, Chevron could still be a solid long-term investment. At 0.75, the company’s price-to-earnings-growth ratio strongly suggests that it is still undervalued. Chevron also maintains a debt-to-equity ratio of just 0.13, suggesting prudent debt management.

The picture, however, isn’t all positive for Chevron. In Q1, the company saw its revenues decline by about 1 percent. At the same time, many of Chevron’s competitors produced positive revenue growth. This is far from a critical failure, but it may be an early indication that Chevron is not performing as well as other oil majors in today’s market.

Despite the risks of the oil and gas industry and Chevron’s mildly negative performance, the stock still appears to be trading at a very attractive price today. Chevron will likely appeal most to income-focused investors for its dividend potential, though pure value investors may also find it attractive. In Chevron’s case, Warren Buffett’s decision to pare back his holdings does not appear to be a signal for other investors to sell their stakes in the company.

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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.