Since early October, the price of oil has plunged almost 40%, from $75 to $46, while S&P has lost 17% and is thus on the brink of ending an almost decade-long bull market. This turmoil has not left Chevron (CVX) unaffected and hence the oil major has shed 18% over this period. As a result, its dividend yield has climbed to 4.3% while the company is also expected to raise its dividend next month. As Chevron is an exceptional mega cap stock and a dividend aristocrat, income-oriented investors should closely monitor the stock in order to initiate a position at an attractive dividend yield.

Business Overview

The greatest problem of Chevron was its inability to grow its production volume for a whole decade. The oil major spent enormous amounts on growth projects, particularly in the years 2012-2014, when oil was trading around $100 and the company spent more than $30 B per year. As all those capital expenses did not result in production growth until last year, most investors were disappointed.

However, it is critical to realize that many growth projects take several years from inception to materialization in the oil sector. This has proved to be the case for Chevron. After several years of stagnant output, the past projects have helped Chevron grow its production by 6% this year. In addition, management expects 2%-3% annual production growth until at least 2022. Even better, Chevron has drastically reduced its capital expenses, from $40 B in 2014 to $18 B this year, and expects to maintain these expenses around their current level in the upcoming years. To cut a long story short, the oil giant is growing its production even though it is spending about half of what it used to spend on growth projects.

Chevron has also remarkably improved the profile of its reserves since the downturn of the oil market began, in 2014. The company has divested low-margin barrels while it has invested in low-cost reserves. As a result, it has reduced its production cost from $18 per barrel in 2014 to about $10 per barrel this year and has reduced its breakeven point to $50 per barrel.

Exposure To The Price Of Oil

Chevron is the most leveraged oil major to the oil price. While the other oil majors, such as Exxon Mobil (XOM), BP (BP) and Total (TOT), produce oil and natural gas at approximately equal ratios, Chevron produces oil and natural gas at a 61/39 ratio. Moreover, it sells a portion of its natural gas based on the oil price. Overall, about 75% of its total output is related to the oil price. As a result, Chevron is by far the most dependent oil major on the oil price.

This is a two-edged sword. The recent plunge of the oil price is certainly negative for the company. On the other hand, the current oil price is not sustainable in the long term, as global demand for oil products grows by at least 1.0 M barrels/day per year and higher oil prices are required to trigger the required production growth. We view the recent plunge of the oil price as overblown and view Chevron as ideally positioned to benefit from a rebound of the oil price.

Dividend

Chevron has raised its annual dividend for 32 consecutive years and hence it is a dividend aristocrat. During the fierce downturn of the oil sector, which lasted from 2014 to 2017, the company saw its earnings plunge and thus froze its dividend for 10 consecutive quarters. However, it froze its dividend in such a way that it maintained its multi-decade dividend growth streak. Moreover, the oil major raised its quarterly dividend by 4% in the beginning of the year, from $1.08 to $1.12.

As the company is poised to more than double its earnings per share this year, from $3.7 to $8.19, it has reduced its dividend payout ratio to 55%. This is a safe level, which provides the company ample room to continue to raise its dividend for years. Therefore, we expect a quarterly dividend hike of at least $0.04 next month, from $1.12 to $1.16. Such a dividend hike will result in a 4.5% dividend yield.

Investors can thus lock in an attractive yield by purchasing this dividend aristocrat at its current stock price and rest assured that the dividend will not be cut for the next several years, particularly given the strong balance sheet of the oil major and the resilience of the dividend even in the recent fierce downturn of the oil sector.

Final Thoughts

The oil price and the broad stock market have been in a strong downtrend lately. Such periods are ideal for initiating a position in dividend aristocrats and thus locking in attractive yields. Chevron will be offering at least a 4.5% dividend yield from next month, when it announces its next dividend hike. Moreover, the current oil price is unsustainable from a long-term point of view and the oil major will greatly benefit from a recovery of the oil price. Nevertheless, given the remarkably negative market sentiment right now, investors may want to wait for a further correction of Chevron, in the high $90s, for an almost 5.0% dividend yield.