Why Is Warren Buffett Buying Chevron?

Legendary value investor Warren Buffett has trimmed Berkshire Hathaway’s holdings of Chevron, so should investors follow suit?

As of the end of fiscal 2023, Berkshire Hathaway Inc. (NYSE:BRK.A; NYSE:BRK.B) held 26.09 million shares of pure-play oil & gas giant Chevron Corporation (NYSE:CVX), marking a 14.4% increase to a total value of more than $18.8 billion.

The global oil and gas market is facing uncertainties with geopolitical issues affecting prices, especially the conflict in the Middle East. Chevron’s operations, too, are impacted by the conflict as it transports crude through the Red Sea region, working with the U.S. Navy’s Fifth Fleet.

The company’s shares are also under pressure somewhat, having gained just 1.1% over the past year. For some context, over the same period, the Energy Select Sector SPDR Fund (NYSEARCA:XLE) climbed higher by more than 18%.

So, what drove Buffett’s eagerness to resume buying this stock?

A Slew of Acquisitions Last Year

The U.S. oil and gas industry experienced a rapid surge in mergers and acquisition activity last year, with industry giants spending billions as they aim to secure future production at lower costs.

Amid this wave of consolidation, Chevron didn’t fall behind. For instance, the company successfully finalized the acquisition of PDC Energy, Inc. and acquired a majority stake in ACES Delta, LLC.

However, it was Chevron’s agreement to acquire Hess Corporation (NYSE:HES) in an all-equity deal worth $53 billion last year in October that captured investors’ attention.

By leveraging Hess’ stakes in Stabroek block located in Guyana, one of the most important oil-producing countries in the world, Chevron aims to diversify its portfolio and bolster its free cash flow growth.

Furthermore, management forecasts cost synergies of around $1 billion before tax within a year of closing the transaction and projects that before-tax funds generated from asset sales will surge to between $10 and $15 billion by 2028.

Some interpret this blockbuster agreement, anticipated to be completed by the first half of 2024, as a positive development. Meanwhile, others raise concerns that this acquisition might expose the company to escalating geopolitical tensions in the Guyana region. 

Apart from geopolitical uncertainties, this proposed deal also heightens Chevron’s industry rivalry with major industry players such as Exxon Mobil Corporation (NYSE:XOM) and China’s CNOOC, who are currently the only two active oil producers in the Guyana basin.

Is Chevron’s Dividend Sustainable?

The company’s fourth-quarter top-line and bottom-line figures experienced sharp 16.5% and 64.4% year-over-year plunges, reaching $47.18 billion and $2.26 billion, respectively.

Nevertheless, despite taking a substantial hit during the fourth quarter as a result of sinking oil prices and several impairment charges, the company’s profits surpassed analysts’ estimates.

Despite Chevron’s profits being hurt in 2023, the company successfully returned a considerable amount of its cash to shareholders through dividend payouts and buybacks, underscoring the company’s commitment to enhance shareholder value.

The oil giant returned an impressive $26.3 billion to its investors — $11.3 billion through dividend payouts and $14.9 billion through share repurchases. Chevron’s CEO Michael Wirth highlighted that the company returned almost a staggering 10% of its market cap to shareholders in 2023.

On March 11, the company paid its shareholders a quarterly dividend of $1.63, reflecting an 8% rise from the previous quarterly dividend. Notably, the company boasts a remarkable track record of 36 years of consecutive dividend growth. In addition, its annual dividend of $6.52 yields 4.19% at the prevailing price level.

A 46% payout ratio looks reasonable for the company to maintain its dividend payments. Moreover, the company forecasts solid cash flow growth and intends to return capital to shareholders incrementally.

Moreover, the company’s efficient capital utilization, as indicated by its confidence in maintaining a 12% return on capital employed, further solidifies its prospects for increasing dividends.

Why Did Warren Buffett Buy Chevron Stock?

Most likely, Warren Buffett bought Chevron stock because its acquisition of Hess opens up new oil production opportunities in the Guyana basin.

After dumping Chevron’s shares for three consecutive quarters of 2023, Warren Buffett’s renewed interest in the company’s shares in the fourth quarter of 2023, around the same timeline as Chevron’s announcement to acquire Hess, might indicate his confidence in the company’s acquisition endeavors.

Furthermore, Chevron’s high dividend yield and lower P/E ratio, compared to industry giants such as Exxon Mobil, align with Buffett’s value investing strategy.

For reference, Chevron’s forward non-GAAP price-to-earnings ratio (P/E) of 12.31x rivals Exxon’s 12.88x. The ratio is also significantly lower than the five-year average of 141.84x.

Moreover, another possible reason is that the “Oracle of Omaha” foresees oil prices soaring amid escalating geopolitical tensions in the Middle East. This has the realistic potential for energy stocks to yield solid profits in upcoming quarters.

Warren Buffett is Buying Chevron, Should You Too?

Warren Buffett’s huge stake in Chevron is a testament to the company’s potential to perform well in the future.

Despite decelerating revenue and profits in its last reported quarter, the company’s ability and commitment to return shareholder value through dividend distributions and share buybacks is appealing. Apart from the steady income stream it offers, the stock also appears to be reasonably priced, given its solid growth prospects.

Out of 17 covering analysts, 10 suggested buying the stock, while 7 recommended a Hold on it. The consensus price target of $177.63 per share indicates approximately a 14.2% upside potential.

While investors might have enough reason to adopt a bullish stance on the company’s shares, it is also essential to acknowledge the challenges that the company is facing related to its Hess acquisition.

In a bold attempt to stop Chevron from expanding its reach in Guyana’s lucrative offshore oil resources, Exxon filed for arbitration earlier this month, effectively challenging Chevron’s offer to buy Hess. As a result, Chevron’s acquisition of Hess might be delayed or even terminated if the court rules in Exxon’s favor.

Of course the uncertainty is precisely why Chevron shares have upside potential, and for Buffett, it’s a calculated risk worth taking.

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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.