Chevron Corp (CVX) stock looks cheap based on its 4.2% dividend yield, which could rise along with an expected dividend hike next quarter. Also its forward 10x price-to-earnings (P/E) multiple is well below the historical average. One play to take advantage of this is a short-put trade.
CVX stock is down over 14% in the last two months at $142.95 as of Friday, Nov. 10, down from $166.81 on Sept. 12. That has led to investors' complacency about the stock.
Concern Over Cash Flow Overblown
Last quarter the company generated $5 billion in free cash flow (FCF), which was less than half of the $12.3 it produced last year. After deducting changes in working capital (WC) (which is variable), the $4.2 billion in adj. FCF was 39.2% of the $10.7 billion it made last year.
Moreover, this was even lower than the Q2 ex-WC figure of $5.7 billion from Q2. In other words, the company's adj. FCF seems to be weakening.
But these concerns may be a bit overblown. For one, the price of oil and gas has come down dramatically in the last quarter from historically high price levels.
Moreover, the company's adj. FCF margin is still high at 7.76% since revenue for the quarter was $54 billion. And YTD its average adj. FCF margin is 10.3% based on its $15.9 billion in adj. FCF YTD on $153.9 billion in revenue.
In addition, analysts are still projecting higher revenues going forward. If projections of $210 billion in next year's revenue come true, the company could still generate $21 billion in adj. FCF. That is a very high number and should prove valuable for the stock going forward.
CVX Stock Looks Cheap Here
For example, using a 6% FCF yield (i.e., 16.67x adj. FCF), the stock could be worth $350 billion (i..e, $21b x 16.67x). That is 30% over its present $270 billion market cap. It implies that CVX stock could rise 30% to $185.84 over the next year.
Moreover, the dividend is likely to rise next quarter. This is because it has consistently hiked the dividend for the past 35 years. Assuming it goes up 6.3% as it did last year, the annual dividend could rise from $6.04 to $6.42 per share. That gives it a prospective dividend yield of 4.49% (up from its present 4.22%).
This is well above its historical averages, which implies that the stock could rise significantly. For example, Seeking Alpha shows that over the past 5 years, its yield has averaged 2.86%. However, Morningstar says the trailing 5-year dividend yield average is 4.40%. The average between the two is 3.63%.
This implies that CVX stock could rise to $176.86 (i.e., $6.42/.0363). That implies an upside of 23.7% from here.
Lastly, based on its average forward P/E multiple of 39x (from Morningstar) over the last 5 years, the stock, which is currently trading at 10x forward earnings (using $14.32 earnings per share analysts' forecasts for 2024), is undervalued.
However, that metric is skewed by the 2020 P/E of 39.65x figure. Without it, the average is 12.6x over the remaining four years (including 2023). That implies a target price of $180.43 (i.e., $14.32 x 12.6x).
So, on average, using target prices from FCF yield ($185.84), forward dividend yield ($176.86), and forward P/E multiple ($180.43), the average valuation for CVX stock is $181.04 per share. The upside potential is therefore +26.6% from today's price of $142.95 for CVX stock.
Short OTM Puts for Income
One way for existing shareholders to play this is to short out-of-the-money (OTM) put options in near-term expiration periods. For example, the $130 strike price for the period ending Dec. 1, 2023, (3 weeks away) shows that the bid side premium is 24 cents.
That implies that any investor who short sells this put price will make an immediate yield of 0.185% (i.e., $0.24/$130). That works out to an annualized expected return of 3.145%. This is because there are 17 periods of 3 weeks in a year.
That is additional income for existing shareholders. The risk is that the stock falls to $130, or over 9% from today's price. More adventurous investors can short the $135 strike price and gain 68 cents. That works out to a 0.50% yield, for a strike price 5% below today's spot price.
The bottom line is that investors can make additional income by shorting OTM puts while they wait for CVX stock to rise substantially to the higher price targets mentioned above.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
