California-based Chevron recently announced a partial sale of its interest in Canadian oil shale holdings to Kuwait’s state-owned oil company for $1.5 billion. The divestment will allow the company to mitigate financial risks associated with the appraisal and development of tight reserves by sharing capital costs. This also falls in line with its plan to divest some $10 billion worth of assets by 2017. Chevron’s strategy is to focus on the 3 key areas of upstream growth i.e. liquefied natural gas, deepwater, and shale/tight reserves development while moderating its annual capital expenditures.
Chevron is the second largest energy company in the U.S. after Exxon Mobil. The company manages its investments in subsidiaries and affiliates, for which it provides administrative, financial, management and technological support. This extends both to its U.S. subsidiaries and to its international subsidiaries, engaged in fully integrated petroleum, chemicals and mining operations, as well as power generation and energy services. It generates annual sales revenue of around $230 billion with a consolidated adjusted EBITDA margin of ~21.8%.
We currently have a $128/share price estimate for Chevron, which is almost 12x our 2014 full-year GAAP diluted EPS estimate for the company.
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As a part of the deal, Chevron’s wholly-owned subsidiary, Chevron Canada Limited, will sell a 30% interest in its 330,000 net acres in the Duvernay shale play to Kuwait Foreign Petroleum Exploration Company’s wholly-owned subsidiary, KUFPEC Canada Inc. for $1.5 billion. The deal price also includes a portion of Chevron’s share of future capital costs for the joint venture. Chevron Canada will remain the operator of the project with a 70% interest after the deal closes later this year.
Duvernay is one of the largest shale plays in North America and Chevron’s acreage there is an important part of its long-term growth portfolio. The company acquired 86,000 total additional acres in the Duvernay shale formation last year. Since the beginning of its exploration program in the play around 3 years ago, Chevron has drilled 16 wells in the region, with initial production rates of up to 7.5 million cubic feet of natural gas and 1,300 barrels of condensate per day. However, we believe that the company decided to partially divest its interest in this lucrative play in order to mitigate the financial risks associated with sole ownership and to slightly tone down its capital expenditures.
Soaring capital expenditures has been the biggest valuation concern for Chevron over the past couple of years. The company’s net capital expenditures have soared from around $17 billion in 2009 to almost $37 billion last year. More than 92% of this $37 billion was spent on upstream projects. This has been primarily due to the ongoing development of LNG projects in Australia, where cost structures have significantly elevated over the past few years due to rising labor costs. Its gross cost estimate for the Gorgon LNG project has risen by more than 45% since 2009 to $54 billion today.
This year, Chevron plans to slightly tone down capital investments as it plans to reverse the growing trend in favor of higher cash flows. According to the capital budget plan for this year, Chevron looks at spending around $2 billion less on leasing rigs, floating oil platforms, installing pipelines and repairing oil-refineries than it did last year. We believe that this deal with Kuwait’s state-owned oil company along with the recent asset sale in Chad and Cameroon will help Chevron reduce some pressure on its operating cash flows while continuing to progress the development of its long-term growth projects.
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