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MBA student research report

MBA student research report

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  • 1. The Stock Market Student Investment Management November 30, 2010 EQUITY RESEARCH Energy | Integrated Oil and Gas | 29 November 2010 Fund Manager: Royce West, CFA CHEVRON CORPORATION Analyst: David Clark-Joseph 614-304-1325 clark-joseph.1@osu.edu !"#$%&'$"& ()$%*%+ Recommendation: BUY 12 Month Price Target: $94.17 Despite an uncertain regulatory climate following the Current Price (Nov 27): $82.05 Macondo Prospect spill in the gulf, as fears of a Upside Potential: 14.8% double-dip recession subside, Chevron is poised to Projected Return (incl. Div.): 18.31% take advantage of the gradual global economic Stock Data recovery. Current Price $82.05 52 Week Price Range $66.83-86.19 - Chevronʼs engineering and geology expertise Market Capitalization 165.12B Diluted Shares Outstanding 2.01B has led to strong profitability, with an average Dividend $2.88 return on equity of 21% over the past five years. Dividend Yield 3.51% - Chevron has a strong record of returning cash to Historic Beta 0.71 shareholders. They pay a dividend of $2.88 12 Month Stock Performance (3.51% -- 64 bps over the 10 Year US Treasury Bond), a 5.9% increase year over year; on October 4th, they also announced that they will resume share buybacks of $500MM-1.0B quarterly. - Based on an analysis of Chevron reserves, a discounted cash flow analysis, and a valuation based on their peers, I set Chevronʼs 12 month target share price at $94.17, a 14.8% premium to their current share price, and rate it a BUY. 5 Year Total Return: 71.9% Catalysts - Litigation in Ecuador, currently creating a $4 per share drag, will reach a favorable. - Oil prices will increases due to economic expansion and lower than projected biofuels production. Sales will benefit, increasing $0.59 for each dollar increase in oil. Risks Corporate Data - Nominal global GDP growth slowing below 3.7% 2009 2010E 2011E 2012E will reduce sales growth. Sales $165.1B 188.8B 210.2 234.6B - Regulatory risk continues following gulf spill. EBIT $18.5B 32.2B 32.6B 33.3B - Acquisitions must yield additional proven Net Inc. $10.4B 18.0B 18.2B 18.6B reserves in order to add value. EPS $2.21 1.75 2.00 2.26
  • 2. Table of Contents Company Overview and Description ........................................................................... 3 Segments ...................................................................................................................................... 4 Upstream .................................................................................................................................. 4 Downstream .............................................................................................................................. 4 Chemicals ................................................................................................................................. 5 Segment Mix ................................................................................................................................. 5 Geographic Diversification Exposure ............................................................................................ 5 Strategy ........................................................................................................................................ 6 Growth Outlook ............................................................................................................................. 6 Pending Litigation ......................................................................................................................... 7 Investment Thesis .......................................................................................................... 8 Strong fundamental and competitive position and a pessimistic market ...................................... 8 Economic Analysis ........................................................................................................................ 9 Financial Analysis ........................................................................................................ 11 Profitability Analysis .................................................................................................................... 11 Peer Comparison ........................................................................................................................ 11 DuPont Analysis – Efficiency, Asset Management and Growth Prospects ................................ 12 Liquidity ....................................................................................................................................... 12 Financial Statement Projections ................................................................................................. 12 Valuation ....................................................................................................................... 13 Valuation through Comparables ................................................................................................. 13 Valuation – Discounted Cash Flow ............................................................................................. 14 Sum of Parts Valuation – Asset Value and Peer Composite ...................................................... 15 Sum of Parts Valuation – Valuation of Chevron Business Segments ..................................... 15 Sum of Parts Valuation – Peer Composite ............................................................................. 15 Valuation Composite of Scenarios .............................................................................................. 16 Conclusion .................................................................................................................... 16 Appendix ....................................................................................................................... 17 Appendix A - Selected Financials ............................................................................................... 17 Appendix B - Works Cited ........................................................................................................... 17 Appendix C - Sum of Parts – Valuation of Chevron Reserves .................................................... 18 Appendix D - Discounted Cash Flow ......................................................................................... 19 Analyst Bio .................................................................................................................................. 20 11/29/10 2
  • 3. Company Overview Company Overview and Description Chevron, an integrated oil and gas producer, - A company engaged in all aspects of the energy industry: Chevron is the third largest energy company in the world with a market cap of $165.15B, behind Exxon Mobil (XOM) and Royal Dutch Shell (RDS.A), and the eighth largest company in the S&P. Chevron has significant petroleum reserves and worldwide operations. Their upstream activities include significant oil and gas exploration and production; their downstream activities include major refining operations throughout the world. Chevronʼs 5 year average annual revenues are above $200B, though, as a cyclical play, their revenues declined 37% in 2009 to $171B. 2010 has also been a challenging year for Chevron, both because of the continued concerns about the state of the global economy, and because of one the worst environmental incidents in ever in the oil and gas industry – the oil spill in the Macondo Prospect. In addition to significant environmental damage, the spill has created a significant risk of increased regulatory burdens and even a company such as Chevron, with an industry leading safety record, will face an additional burden of proof when demonstrating that their operations and equipment are safe and technically sound. Fortunately, technology and engineering capabilities are two of Chevronʼs greatest competitive advantages. Their expertise combined with their continuing shift towards the more profitable upstream, positions Chevron to grow sales by 10.15% annually for the next decade with gradually increasing margins as oil prices gradually increase. 11/29/10 3
  • 4. Company Overview: Strategy and Growth Segments Upstream Chevronʼs upstream operations include natural gas and crude oil exploration and production. Their consolidated worldwide reserves at the end of 2009 reached 8.3B barrels, and their production operations average 2.7MM barrels per day. They have broad global diversification, and control significant production in Angola, Australia, Azerbaijan, Bangladesh, Brazil, Canada, Denmark, Indonesia, Kazakhstan, Nigeria, the Partitioned Zone between Kuwait and Saudi Arabia, Thailand, the United Kingdom, the United States, and Venezuela. Additionally, Chevronʼs exploration activities extend to the Gulf of Mexico, offshore Australia, western Africa, Thailand, Canada, the UK, Norway and Brazil. Additionally, Chevron has developed significant natural gas operations in Australia, western Africa, Bangladesh, China, Indonesia, Kazakhstan, North America, the Philippines, Figure 1 2009 CVX Annual Report South America, Thailand, the UK and Vietnam. Downstream Chevronʼs downstream activities include refining, fuels marketing, supply and trading and transportation and distribution of petroleum products at 21,750 affiliated retail stations marketed under Chevron, Texaco and Caltex brands. Downstream operations include refining, fuels and lubricants marketing, supply and trading, and transportation. In 2009, they processed 1.9MM barrels of crude oil per day into approximately 1.995MM barrels of distillates representing a 5% gain from the refinery cracking processes. Last year, Chevron sales averaged 3.3MM barrels per day of refined product sales worldwide. Chevron operates 15 refineries, recently having divested part of the Caribbean refineries in a transaction with RUBIS, a French firm. Significant downstream activities include the west coast of North America, the U.S. Gulf Coast into Latin America, SE Asia, South Korea, southern Africa and the UK. Figure 2 CVX Annual Report 11/29/10 4
  • 5. Company Overview: Strategy and Growth + Chemicals Chevronʼs chemical business consists of production of commodity compounds derived from petroleum including aromatics for the production of adhesives and plastics, and olefins, used in packaging, pipes, tires, and detergents. Chevron subsidiary Oronite produces lubricants and fuel additives; additionally, Chevron owns a 50 percent stake in Chevron Phillips Chemical Company. As a producer of commodity products, Chevronʼs chemicals business is a price taker, but revenues are strongly correlated with global demand and crude oil prices. The chemicals business made up just 0.9% of sales in 2009, but 3.9%% of revenue, indicating the segmentʼs profit potential. Segment Mix Chevron has gradually shifted their business mix towards greater upstream exposure over the past 5 years (2004-2009), increasing upstream revenue as a percentage of total revenue from 22.3% to 26%, and increasing upstream profit as a percentage of total profit significantly (79.3% to 91.5%, albeit related to Figure 3 Chevron Revenue Mix by Segment poor downstream margins related to economy). Figure 3 shows the revenue mix, heavily tilted towards downstream revenue, while Figure 4 shows that profit mix, increasingly more tilted towards the considerably more profitable upstream. Chevron capital expenditure upstream now outpaces downstream by 4:1. + Geographic+Diversification+ + Chevron has significant macroeconomic Figure 4 Chevron Net Income Mix by Segment exposure, and is exposed to foreign exchange risk and political risk from their diverse global operations. This risk is largely diversified, but their profitability is largely dependent on their ability to manage these risks, as evidenced by Q3 2010 foreign exchange losses of $400MM due to increased volatility in global currencies. Chevron hedges significant amounts of currency risk, using project finance and credit derivatives to hedge against specific market and credit risks. In 2009, Chevron reducing foreign exchange impact to 1% ($114 MM on NI of $10,563MM). 11/29/10 5
  • 6. Company Overview: Strategy and Growth Strategy Chevron primarily pursues a low-cost strategy in order to produce commodity products. In order to create shareholder value, they must continually seek to increase their operating margins, stemming from commodity prices that they cannot control and their cost structure, which they can control. This pursuit of a higher margin structure has led them to reduce their downstream assets while increasing upstream assets. By investing in upstream assets, they are able to create reserves at a fixed cost, providing extraction at a low variable cost. This strategy is executed through upstream weighted investment and acquisitions, as well as reduced downstream investment and strategic downstream divestitures. Upstream expansion has sought to increase deepwater activities and develop an extensive natural gas resource base. This strategic transformation also utilizes their extensive technical capabilities, from geology and engineering, allowing them to add value to acquisitions by reducing operating risk, and appraising possible reserves. In November, Chevron announced the $4.3B acquisition of Atlas Energy, a natural gas firm with significant Appalachian gas reserves. Chevron acquires 896.7 BCF of proven natural gas reserves, as well as 18,000 BCF of potential reserves. As 896.7 BCF of gas at spot price are worth nearly $1.18B, this suggests that Chevronʼs knowledge base examined the likelihood of potential reserves, and valued them well in excess of 3.12B. Chevron has also actively divested downstream assets, aiming to retain highly flexible refining operations in key markets. Recent divestitures include the recent sale of Caribbean fuel and refinery assets to RUBIS, a French firm. Chevronʼs upstream profits as a percentage of total profits were 86.3% Q3 2010, leading their peers whose upstream percentage in 2010 Figure 5 Long Term Historical Earnings Mix of Integrateds are approximately 80%. Growth Outlook With decreasing quantities of easily accessible petroleum resources, and increased demand from BRIC countries, traditional organic growth is becoming increasingly difficult for Chevron and their integrated peers. Chevron has embraced the changing dynamics of oil and gas exploration, and is focusing efforts on their core competencies, geological and technical expertise, pursuing deepwater exploration including recent September 2010 acquisition of deepwater interests in Liberia, Turkey and China, and entering shale-natural gas exploration through acquisitions such as Atlas Energy. Chevron conducts deep-water exploration in resource rich areas in the Gulf of Mexico, Western Africa, Australia and Thailand. Deepwater exploration carries with it considerable operational risk both in performance risk of each well drilled and in technology risk involved in engineering extraction. 11/29/10 6
  • 7. Company Overview: Strategy and Growth Management has issued capital expenditure guidance indicating their intention to spend $21.6B in 2010, and has reaffirmed its previously stated full-year net production guidance for 2010 of 2,750 MBOED based on the first nine months' 2010 average WTI price of $78. This represents a two percent increase from 2009 actual net production. I estimate that resulting sales growth will reach high single digits until 2013 based on the start-up years of Chevronʼs project backlog. From 2013-2020, I anticipate sales growth steadily increasing as Australian and Canadian projects come online, converging to 10.15%, the growth rate implied by their trailing 12 month return on equity and historic reinvestment rate. Pending Litigation Chevron is the target of high profile litigation in Ecuador alleging environmental contamination relating to Texacoʼs operations over 23 years, from 1967-1990. The 48 plaintiffs now ask for damages of $113B, a significant upward revision from the court- appointed expertʼs estimate of $27B. I estimate that the market is incorporating these damages at a 25% probability, reducing share price by $4 per share. Chevron is challenging the legitimacy of the Ecuadorian proceedings, and alleging fraud and misconduct by the Plaintiffs. Chevron has successfully petitioned the United States Southern District of New York, to provide extensive discovery from the Ecuadorian Plaintiffs Attorneys and other parties with video evidence pertaining to the Plaintiffs. These requests have been granted under 28 U.S.C 1782, which permits discovery, among other reasons, to challenge the fairness and impartiality of a foreign judgment. In a November 11, 2010 opinion, Judge Kaplan writes: The outtakes contain substantial evidence that [agents of the plaintiffs] were involved in ex parte contacts with the court to obtain appointment of the expert; met secretly with the supposedly neutral and impartial expert prior to his appointment and outlined a detailed work plan for the plaintiffsʼ own consultants; and wrote some or all of the expertʼs final report that was submitted to the Lago Agrio court and the Prosecutor Generalʼs Office, supposedly as the neutral and independent product of the expert. This evidence greatly increases the likelihood that any judgment obtained in Ecuador through this litigation, regardless of the size of the judgment, will be unenforceable against Chevron assets as enforceability of a foreign judgment under the Uniform Enforcement of Judgments Act is predicated on proof that the judgment was issued through an impartial tribunal. I have incorporated a 1% chance of an enforceable $113B judgment into the valuation. Any significant drop market cap greater than 1% upon news of a judgment represents a strong buying opportunity. 11/29/10 7
  • 8. Investment Thesis !"#$%&'$"&+()$%*%++ Strong fundamental and competitive position and a pessimistic market The market assigns a high probability of a declining future oil price, based on moderate probabilities of a slow recovery or a double dip recession, where as I predict that oil prices will rise 3-5% annually for the next decade on emerging market demand, OECD economic recovery, moderate inflation, and lower than anticipated biofuel output due to lower than projected investment. Commodity prices will be further strengthened by any Dollar weakness, and by any ongoing political uncertainty in North Korea. Additionally, the market assigns a higher value to a potential judgment in the Ecuador litigation, where as I predict that any judgment will be unenforceable under the US Uniform Enforcement of Foreign Judgments Act. My investment thesis is also shaped partially by strong signals from management. By raising the quarterly dividend in April by 5.9%, management demonstrates their conviction that the economy is in recovery, and that Chevron is in a strong cyclical position. Additionally, the announcement of share buybacks in the range of $500MM to $1B quarterly suggests that management perceives a meaningful discount to current market prices. These buybacks alone will produce modest accretion in share price of approximately 1% annually. Chevronʼs strategy of moving upstream has resulted in the greatest net profit margin of their peers. As they continue this strategy through careful acquisitions such as their purchase of Atlas Energy providing access to the Marcellus Shale play, and their divestiture of downstream assets as they pursue an efficient and flexible downstream segment. Through three valuation techniques, a sum of parts analysis of Chevron reserves at spot price, a assumption driven discounted cash flow, and a relative valuation, I have shown that Chevron sells for lower than the fair value of its assets, Chevron sells at a discount relative to conservative projections of its future cash flows, and Chevron is undervalued by the market compared to its peersʼ multiples and its past multiples. Over the next 12 months, I project that the market price will converge on my estimate of Chevronʼs fair value of $94.17 per share based on catalysts surrounding the oil prices and the resolution of litigation. + + + + 11/29/10 8
  • 9. Investment Thesis - Economic Analysis Economic Analysis The price of oil over the next 25 years will primarily be a product of global aggregate demand, energy demand, and the supply of oil alternatives. The Economist Intelligence Unit forecasts that World gross domestic product growth will double in the next 20 years, with 80% of the GDP growth coming from Non-OECD countries. Strong growth by BRIC and other Non- OECD countries will drive strong global GDP growth, and consequently energy consumption is expected to rise significantly from 495 quadrillion BTU in 2007 to 739 quadrillion BTU in 2035, a compound Figure 6 Gross Domestic Product through 2030, OECD annual growth rate of 1.4%. This will provide a strong basis for volume growth for Chevron. Sales growth will be a function of this increased demand and oil prices. The Economist Intelligence Unit also projects that oil prices will steadily decline for the next 5 years reaching, $71 per barrel by 2015. This estimate resembles the Low Oil Price case projected by the U.S. Energy Information Administration in the 2010 International Energy Outlook. The USEIAʼs Low Price Oil case relies on several assumptions: significantly greater access to non-OPEC regions Figure 7 World marketed energy consumption (quadrillion Btu), USEIA coupled with more attractive fiscal regimes in those countries, and increased production from OPEC, leaving most production in conventional reserves. In contrast, the USEIA High Oil Price case assumes greater restriction or additional financial burdens resulting in reduced access to non-OPEC reserves, as well as OPEC members reducing their production substantially below todayʼs levels, as can be seen in Figure 9. Figure 8 Three Oil Price Scenarios, USEIA 11/29/10 9
  • 10. Investment Thesis - Economic Analysis As oil prices rise, expensive unconventional oil resources such as heavy crude reserves and oil sands become increasingly attractive. Figure 9 Production: Reference v. High Oil Price, USEIA Low oil is predicated on significant growth in renewable. Both the Economist Intelligence Unit and the USEIA Low Oil Price case rely in part on significant increases in biofuels. The EIU projects significant rises in Brazil and Kazakhstan; the USEIA also projects the mix of energy production in the Low Price Oil case in 2035 would require renewables production Figure 10 World marketed energy use by fuel type, USEIA to double between 2007 and 2010. However, doubling renewables production by 2030 requires significant investment in alternative energy, an activity that, while popular until 2008 during record nominal oil prices, has been cut back Figure 11 and 12 Historical and projected investment in sustainable energy, Bloomberg New Energy Finance significantly as oil has recovered from highs and as countries embrace austerity measures. Absent a significant uptick in new investment in sustainable energy, I project renewables will increase at a slower rate of .5%-.7% annually. Accordingly, I project oil prices will most closely resemble the USEIAʼs Base Case Oil price with prices reaching $110 by 2010. 11/29/10 10
  • 11. Investment Thesis – Financial Analysis Financial Analysis Profitability Profitability Analysis 2006 2007 2008 2009 TTM Despite gross margin and operating margin steadily decreasing over the past five years Gross 31.4% 31.4% 29.2% 41.9% 42.4% Margin due to steady depletion of the most accessible petroleum, Chevronʼs profitability Operating 20.0% 19.3% 15.8% 10.8% 14.6% Margin profile is strong. Over the same five year period, their net margins have averaged in Net 8.1% 8.4% 8.7% 6.1% 8.4% Margin the high single digits, indicating a level of profitability in line with 2006-2008, and Return on 13.2% 13.2% 15.4% 6.4% 9.9% Assets achieved despite lower oil prices. Additionally, Chevron generates a high level Return on 26.0% 25.6% 29.2% 11.7% 17.4% Equity of free cash flow beyond their dividend Free Cash payments, and over the past 12 months, it 5.0% 3.7% 3.6% -0.3% 5.34% Flow / has generated $5.34 per $100 of sales, a Sales level in line with pre-recession levels. ! Peer Comparison Chevronʼs profitability profile compares strongly to their integrated peers, displaying the highest Net Margin, the second highest return on assets, and 4th highest return on equity. Their lead position in Net Margin is indicative of their success at focusing on upstream operations. While Exxon Mobile is also highly profitable, it also expensive on a relative basis, trading at 12.2 times current earnings. Chevronʼs Net Margins will likely increase as future investments are made favoring upstream activity and downstream assets are sold. In the short run, over 2010 and 2011, oil prices and stronger refining margins should contribute to higher profitability even as production costs rise from their 2009 levels. ! ! ! ! Figure 13 Profitability in peer group ! ! 11/29/10 11
  • 12. Investment Thesis – Financial Analysis DuPont Analysis – Efficiency, Asset Management and Growth Prospects + DuPont Analysis 5Y Average 2010E 2009 2008 2007 2006 Profit Margin (Net Income / Revenue) 0.08 0.08 0.06 0.09 0.09 0.08 Total Asset Turnover (Revenue/ Assets) 1.34 1.13 1.00 1.63 1.42 1.53 Return on Investment 0.11 0.10 0.06 0.15 0.13 0.13 Profit Margin * Total Asset Turnover Equity Multiplier (Avg Total assets/ Avg Total Equity) 1.87 1.75 1.81 1.89 1.92 1.96 Average Total Assets / Average Total Equity Return on Equity (ROI*Equity Multiplier) 0.210 0.17 0.12 0.28 0.24 0.25 + The DuPont analysis describes the relation between Chevronʼs profit margins, asset utilization, and leverage to describe operating management. Chevronʼs profit margins, as mentioned earlier are high single digits, an area of financial leadership among its peers. Looking to Chevronʼs asset turnover, they have been making progress since 2009, but still trail their 5 year average following a strong 2006-2009 period. When viewed in conjunction with Chevronʼs asset turnover, we can see how Chevronʼs return on investment stems from their profit margin per asset turn, to produce a 9.89% Return on Investment, a 40% increase from 2009, and only 10% off of their 5 year average. By evaluation Chevronʼs leverage, I arrived at their equity multiplier, a ratio describing the amount of assets available per equity dollar. This number has lowered over the past 5 years, and is below their 5 year average, an indication that they have reduced their overall leverage. By dividing the return per dollar of assets by the equity multiplier, I calculated the return per dollar of equity at 17.4%, a 45% increase from 2009. I project that their long term Return on Equity will converge on their 5 year average of 21.0. I also used the return on equity to derive the expected growth rate, as the amount of net income reinvested (61%), expected to earn the 2010 return on equity (16%) producing an implied growth rate of 10.15%. ,*-.*/*&0+1"/+,$#$213$+ + + Liquidity 2006 2007 2008 2009 3Q10 Chevron has adjusted their liquidity to Current Ratio 1.28 1.17 1.14 1.42 1.66 provide for greater flexibility following Quick Ratio 1.02 .9 .79 1.01 1.21 the credit crisis of 2008. Their current Debt 10,473 ratio and quick ratio both provide PV of Operating Leases 2,312 sufficient liquidity, particularly considering their low total leverage, Adjusted Debt 12,785 even after taking into account the Adjusted Debt to 7.2% Assets present value of operating lease obligations. Financial Statement Projections Appendix A presents selected financial statement data with projections for the next three years. 11/29/10 12
  • 13. Valuation Valuation Valuation through Comparables 10 Year High Low Median Current Target E/S/B/ Predicted Weight Multiple EBITDA/CF EV P/Forward E 24.1 5.6 10.6 8.6 10.6 18,860 199,919 22.5% P/S 1.5 0.4 0.8 0.8 0.8 199.577 159,662 10.0% P/B 3.2 1.4 2.4 1.6 2.4 102,243 245,383 22.5% P/EBITDA 5.34 2.37 4.42 4.26 4.26 41,955 178,728 22.5% P/CF 10.9 3.8 7 5.5 7 30,122 210,854 22.5% Weighted Target Equity Value $203,815 Shares outstanding 2080 Price per Share $97.99 Through analyzing Chevronʼs historic valuation multiples, it becomes apparent that relative to historic multiples, Chevron is trading at a significant discount, except on a Price to Sales basis. However, as Chevron moves towards higher profitability upstream earnings, and away from lower profitability downstream earnings, Price to Sales is the useful historic ratio. On each other multiple examined, Chevron trades at a discount to the 10 year median, and significant discount to 10 year highs. In considering weights, Price to Sales was reduced because of the incongruity between upstream and downstream earnings and sales. Current Multiples Chevron Industry S&P 500 Also noteworthy is that Chevron is trading Price/Earnings 9.80 14.70 15.10 at significantly lower multiples than the Price/Book 1.60 1.80 2.00 S&P 500 and industry peers, despite Price/Sales 0.80 0.80 1.30 having the 2nd highest net margins, and Price/Cash Flow 5.50 6.70 7.60 the highest return on assets over the past Dividend Yield % 3.50 3.40 1.90 12 months. This suggests that the markets are undervaluing Chevron compared to its peers, despite Chevronʼs superior financial performance. While multiples best provide historical context to overall valuation, they support my discounted cash flow and sum of parts valuations. 11/29/10 13
  • 14. Valuation Valuation – Discounted Cash Flow Appendix D presents my full discounted cash flow analysis, with which I arrive at an equity value of $203.7B, $101.47 per share, a 23% upside from current levels. To generate my discounted cash flow, I relied on the following assumptions. Assumption Description Source Market Assumptions Cost of Debt 4.97% Marginal Cost at S&P AA spread of .75 bps over 30 Year Market Factor 6.00%; β =1.21 Implied Equity Risk Premium, 11/1/10, Industry Average β Size Factor 0.41%; β = .21 Kenneth French, 11/26/10 Book to Market Factor -1.46%, β = .73 Kenneth French, 11/26/10 Risk Free Rate 4.22% 30 Year US Bond, 11/26/10 Debt to Assets 0.068 Lease Adjusted Debt Final Cost of Equity 11.26% Fama-French Three Factor Adjustments Operating Leases 1130 Treated as Debt Underfunded Pension 2496 Pension shortfall from Notes Operating Assumptions Terminal Growth Rate 3.7% Projected GDP Growth - EIU Sales Growth Rate Increasing to 10.15% after 10 Implied by reinvestment rate (0.61) * return years on equity (16.6%) Depletion, Depreciation, Amortization 0.694% of CapEx Weighted (4:1) historic 10 year average of Upstream CapEx:DDA 1.4x (80%) and Downstream CapEx:DDA 1.6x (20%). CapEx 21.6B, CAGR at 3.7% CVX Guidance, increase at terminal growth rate Operating Margin Increasing moderately to 11% Reflecting shift towards Upstream after 10 years Tax Rate Moves to 48% Reversion to company 5 year mean of 44% Shares Outstanding Reduced by $2B over 4 years Share buybacks. I also analyzed my DCFʼs sensitivity to changes in discount rate and in terminal growth rate. Note that using a higher discount rate or a slower growth rate, one could arrive very close to the current stock price under my set of assumptions. Discounted Cash Flow: Sensitivity Analysis Discount Rate $101.47 8.50% 9.00% 9.50% 10.0% 10.5% 11.0% 11.27% 12% 12.50% 1.0% 124.39 115.01 106.77 99.48 93.00 87.19 84.30 77.24 72.95 1.5% 130.29 119.96 110.96 103.06 96.07 89.85 86.76 79.26 74.72 Terminal 2.0% 137.09 125.62 115.71 107.08 99.50 92.79 89.49 81.47 76.65 Growth 2.5% 145.03 132.14 121.14 111.64 103.36 96.09 92.52 83.92 78.78 3.0% 154.41 139.76 127.40 116.85 107.74 99.80 95.92 86.64 81.13 3.7% 170.82 152.83 137.99 125.53 114.95 105.84 101.44 91.00 84.88 4.0% 179.42 159.56 143.35 129.88 118.51 108.80 104.13 93.10 86.67 4.5% 196.61 172.75 153.71 138.17 125.25 114.34 109.14 96.98 89.95 11/29/10 14
  • 15. Valuation Sum of Parts Valuation – Asset Value and Peer Composite 4.'+56+712&%+819.1&*5"+:+819.1&*5"+56+;)$#25"+<.%*"$%%+4$3'$"&%+ I performed a sum of parts valuation on Chevron reserves. The detailed valuation is provided in Appendix C. This valuation was performed using available data from the SEC, and information courtesy of JP Morgan. For upstream operations, I analyzed proven, probable and possible reserves, including the recent Atlas Energy acquisition. For the downstream valuation, I assessed refining operations by region, regional capacities and average flow; I assessed marketing by multiplying regional sites through JP Morgan estimates for valuation per site. Chemical valuation was assessed by a multiple of peak earnings weighted for Chevronʼs equity stake in Chevron Philips. I then adjusted the value of gross operating assets by lease-adjusted net debt, underfunded pension liabilities, and an expected value of Ecuadorian litigation at a probability of 1%. Through my sum of parts valuation, I assess Chevronʼs equity value at $187,640MM, or $93.45 per share. 4.'+56+712&%+819.1&*5"+:+7$$2+;5'=5%*&$+ Sum of Parts Analysis Segments Sales per P/S Competitors P/S ratios Target Segment Segment Ratio P/S VQ MWE SD NBR SUN HES FTO MUR Multiple Value Petroleum - 51328 3.0 2.6 2.4 1.7 2.43 124,727 Upstream Petroleum - 142854 0.14 0.69 0.31 0.57 0.4275 6,1070 Downstream TOTAL 194182 0.882 0.957 Target Market Cap 185,797 Date of price 11/26/10 Current Stock $82.05 Price # of diluted 2008 shares Target Price $92.53 % return to target 13% For the sum of parts peer composite, I divided Chevron sales by segment. For each segment, I identified four pure play competitors, and calculated their Price to Sales ratios. These Price to Sales ratios were averaged, and then multiplied by Chevron segment sales to estimate expected segment market capitalization. The sum of the segment market capitalizations indicates the segment-weighted expected market capitalization based on segment competitors P/S ratios. This indicates that on a sales basis, Chevron is undervalued by 13%, even when considering lower margin downstream sales. 11/29/10 15
  • 16. Valuation Valuation Composite of Scenarios Valuation Ranges 52-week Trading Range $66.83 $86.19 Multiples Analysis $76.76 $117.97 Sum of Parts Assets and $92.53 $93.45 Segment Comparables Discounted Cash Flow $72.95 Analysis 11/26/10 Trading Range $81.70 $82.60 $60.00 $70.00 $80.00 $90.00 $100.00 $110.00 $120.00 Illustrative WMT Price per Share min max 52-week Trading Range $ 66.83 19.36 $ 86.19 Multiples Analysis $ 76.76 41.21 $ 117.97 Sum of Parts Assets and Segment Comparables $ 92.53 0.92 $ 93.45 Discounted Cash Flow Analysis $ 72.95 123.66 $ 196.61 11/26/10 Trading Range $ 81.70 0.90 $ 82.60 Valuation Composite Value Weight Weighted $ DCF 203,754 40% 81502 SOP-Asset 187,640 40% 75056 SOP-Comp 185,797 8% 14864 Multiples 203,815 12% 24458 Composite $195,879 Shares 2080 $ per share $94.17 Current Price $82.05 Upside $12.12 Upside % 14.8% Conclusion Chevron is currently the inexpensive to their integrated peers, and offers a tremendous value proposition. After reviewing pending litigation in Ecuador, an item currently creating a drag of $4 per share, my analysis indicates that any judgment that may result would be unenforceable in the US under the Uniform Enforcement of Judgments Act. Combined with my oil price projections tracking the US Energy Information Administrationʼs base case, and assessing the spot value of Chevron reserves, I assign Chevron my a composite 12 month price target of $94.17. Accordingly, I recommend Chevron (CVX) as a BUY with a 14.8% upside from its close on November 26, 2010. 11/29/10 16
  • 17. Valuation >==$"/*?+ Appendix A – Selected Financials Appendix B -Works Cited 1. Economist Intelligence Unit, Global Forecasting Service, December Update 2010 2. US Energy Information Administration, 2010 Energy Outlook 3. International Energy Agency, 2010 World Energy Outlook 4. Bloomberg New Energy Finance, Global Trends in Sustainable Energy Investment 5. JP Morgan, Upstream Deepdive 2010 6. Exxon Mobil 2009 Annual Report 7. Chevron 2009 Annual Report, 2009 10K, and 2010 Q1-Q3 10-Q 8. Atlas Energy 2009 Annual Report 11/29/10 17
  • 18. Appendix Appendix C – Sum of Parts – Valuation of Chevron Reserves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`7R'2S:I867'#867)5: CDE < ?F-/:?.G* @=NB H$@&% _&/ L@== /01'56'_)a4)K1 <MM@ /*6D0*'!6^:8'/:7:805)67 @O<B 268J'G11:51 >L= B=>> /8611'G11:51 C''''''''@>LX=PO ''''201S @=X>>P ''''H:D5 @<NNL &:5'201S E@N>= !:71)67'6^:K E<M>O %J:R5:K'$0*4:'6Q'2675)7U:7R):1 E@@L= (4['6Q'J0851'%a4)5W'$0*4: C''''''''@BNXOM= 1S08:1 <==B (#!%$?(S C''''''''''''>LAMP 11/29/10 18
  • 19. Appendix Appendix D Discounted Cash Flow Chevron (CVX) Analyst: David Clark-Joseph Terminal Discount Rate = 11.27% Date: 11/30/2010 Terminal FCF Growth = 3.7% (MM) Year 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2010E Revenue 188,880 210,272 234,698 255,821 278,845 303,941 334,791 368,772 406,203 447,432 492,847 % Growth 11.3% 11.6% 9.0% 9.0% 9.0% 10.2% 10.2% 10.2% 10.2% 10.2% Operating Income 24,892 24,370 23,780 26,094 28,721 31,306 34,818 39,090 43,870 49,218 54,213 Operating Margin 13.2% 11.6% 10.1% 10.2% 10.3% 10.3% 10.4% 10.6% 10.8% 11.0% 11.0% Other Income 7,388 8,390 9,655 7,674.63 7,528.81 7,294.58 7,365.40 7,375.44 8,124.05 6,711.48 6,899.85 Other Income % of Sales 3.9% 4.0% 4.1% 3.0% 2.7% 2.4% 2.2% 2.0% 2.0% 1.5% 1.4% Interest and Other 140 147 155 256 279 304 335 369 406 447 493 Interest % of Sales 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% Taxes 14,120 14,328 14,620 11,369 12,515 13,641 15,173 17,037 19,124 21,459 23,637 Tax Rate 43.8% 43.8% 43.8% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% 44.0% Net Income 18,020 18,286 18,660 22,144 23,456 24,656 26,676 29,059 32,464 34,023 36,983 % Growth 1.5% 2.0% 18.7% 5.9% 5.1% 8.2% 8.9% 11.7% 4.8% 8.7% Add Deprc/Depl/Amort 8,258 11,565 11,970 16,583 17,247 17,937 18,654 19,400 20,176 20,983 21,823 % of Sales 4.4% 5.5% 5.1% 6.5% 6.2% 5.9% 5.6% 5.3% 5.0% 4.7% 4.4% Plus/(minus) Changes WC 1,213 (632) (722) (767) (837) (912) (1,004) (1,106) (1,219) (1,342) (1,479) % of Sales 0.6% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% Subtract Cap Ex 21,627 22,079 22,962 23,880 24,835 25,829 26,862 27,936 29,054 30,216 31,425 Capex % of sales 11.5% 10.5% 9.8% 9.3% 8.9% 8.5% 8.0% 7.6% 7.2% 6.8% 6.4% Free Cash Flow 5,864 7,140 6,946 14,080 15,031 15,852 17,464 19,417 22,368 23,448 25,903 % Growth 21.8% -2.7% 102.7% 6.8% 5.5% 10.2% 11.2% 15.2% 4.8% 10.5% NPV of Cash Flows 87,144 43% NPV of terminal value 122,026 60% Terminal Value 354,936 Value of Operating Assets 209,170 Adjustments Free Cash Yield 7.30% Litigation Contingency (113,000) Probability of Contingencies 1.0% Terminal P/E 9.6 Expected Value (1,130) Pension Shortfall (2,496) Terminal EV/EBITDA 4.7 Net Debt (1,790) Projected Equity Value 203,754 Free Cash Flow Yield 3.56% Current P/E 9.1 9.0 8.8 Projected P/E 11.3 11.1 10.9 Current EV/EBITDA 5.0 4.6 4.7 Projected EV/EBITDA 6.2 5.7 5.7 Shares Outstanding 2,008 2,003.1 1,998.2 1,993.3 1988.36 1,983.5 1,978.6 1,973.8 Current Price $ 82.05 Implied equity value/share $ 101.47 101.72 101.97 102.22 102.47 102.73 102.98 103.23 Upside/(Downside) to DCF 23.7% Operating Lease Adjusted Debt 12,785 Cash 10,995 Cash/share 5.48 11/29/10 19
  • 20. Analyst Bio Analyst Bio David Clark-Joseph is full time student pursuing a Masters of Business Administration at The Ohio State University – Fisher College of Business. At Fisher, he is an active member of the Student Investment Management program, which combines rigorous academic objectives with the practical demands of institutional portfolio managers. With his 30 classmates, he manages $20.15 Million for the Ohio State Endowment. David is actively pursuing a career in investment management and transaction advisory, and is a CFA Level I candidate. Before attending Fisher, he received a Juris Doctor from Florida State University, and performed securitization and secured transaction work with Legal Services of North Florida and served as a staff member in the Florida Senate Commerce Committee, analyzing corporate taxation and industrial bonds. 11/29/10 20