Analyzing Chevron’s Dividend Growth Potential

Recap from March’s Picks

On a price return basis, the Dividend Growth Stocks Model Portfolio (-0.5%) underperformed the S&P 500 (+1.2%) by 1.7% from March 29, 2023 through April 25, 2023. On a total return basis, the Model Portfolio (-0.4%) underperformed the S&P 500 (+1.2%) by 1.6% over the same time. The best performing stock was up 32%. Overall, ten out of 30 Dividend Growth stocks outperformed their respective benchmarks (S&P 500 and Russell 2000) from March 29, 2023 through April 25, 2023.

The methodology for this model portfolio mimics an “All Cap Blend” style with a focus on dividend growth. Selected stocks earn an attractive or very attractive rating, generate positive free cash flow (FCF) and economic earnings, offer a current dividend yield >1%, and have a 5+ year track record of consecutive dividend growth. This model portfolio is designed for investors who are more focused on long-term capital appreciation than current income, but still appreciate the power of dividends, especially growing dividends.

Featured Stock for April: Chevron Corporation

CVX

Chevron (CVX) is the featured stock in April’s Dividend Growth Stocks Model Portfolio.

Chevron has grown revenue by 12% compounded annually and net operating profit after tax (NOPAT) by 38% compounded annually since 2017. The company’s NOPAT margin increased from 6% in 2017 to 17% in 2022, and invested capital turns rose from 0.5 to 0.9 over the same time. Higher invested capital turns and NOPAT margins drive return on invested capital (ROIC) from 3% in 2017 to 15% in 2022.

Figure 1: Chevron’s Revenue & NOPAT Since 2016

Free Cash Flow Supports Regular Dividend Payments

Chevron has increased its regular dividend from $4.32/share in 2018 to $5.68/share in 2022, or 7% compounded annually. The current quarterly dividend, when annualized, equals $6.04/share and provides a 3.9% dividend yield.

More importantly, Chevron’s free cash flow (FCF) easily exceeds its regular dividend payments. From 2018 through 2022, Chevron generated $79 billion (24% of current enterprise value) in FCF while paying $48 billion in dividends. See Figure 2.

Figure 2: Chevron’s FCF vs. Regular Dividends Since 2018

Companies with FCF well above dividend payments provide higher-quality dividend growth opportunities. On the other hand, dividends that exceed FCF cannot be trusted to grow or even be maintained.

CVX Is Undervalued

At its current price of $156/share, Chevron has a price-to-economic book value (PEBV) ratio of 0.7. This ratio means the market expects Chevron’s NOPAT to permanently fall 30% from 2022 levels. This expectation seems overly pessimistic given that Chevron has grown NOPAT by 5% compounded annually over the past decade and 11% compounded annually over the past two decades.

Even if Chevron’s NOPAT margin falls to 9% (compared to 17% in 2022) and grows revenue by just 6% compounded annually over the next decade, the stock would be worth $195/share today – a 25% upside. In this scenario, Chevron’s implied NOPAT in 2032 would be 3% below 2022 levels. Should the company’s NOPAT grow more in line with historical growth rates, the stock has even more upside.

Add in Chevron’s 3.9% dividend yield and a history of dividend growth, and it’s clear why this stock is in April’s Dividend Growth Stocks Model Portfolio.

Critical Details Found in Financial Filings by My Firm’s Robo-Analyst Technology

Below are specifics on the adjustments I make based on Robo-Analyst findings in Chevron’s 10-K:

Income Statement: I made $7.2 billion in adjustments with a net effect of removing $3.3 billion in non-operating expenses (1% of revenue).

Balance Sheet: I made $75.6 billion in adjustments to calculate invested capital with a net increase of $42.2 billion. The most notable adjustment was $24.3 billion (11% of reported net assets) in goodwill.

Valuation: I made $52.4 billion in adjustments, with a net decrease in shareholder value of $38.0 billion. Apart from total debt, one of the most notable adjustments to shareholder value was $12.6 billion in net deferred tax liabilities. This adjustment represents 4% of Chevron’s market value.

Disclosure: David Trainer, Kyle Guske II, and Italo Mendonça receive no compensation to write about any specific stock, style, or theme.