Chevron’s “Safe” Dividend Safety Score Reaffirmed Following Acquisition of Noble Energy

On July 20, Chevron agreed to acquire independent oil and gas producer Noble Energy for $5 billion in an all-stock deal. Chevron will also assume Noble's debt of about $8 billion.

We don't expect this deal to materially affect Chevron's dividend profile and are maintaining the firm's Safe Dividend Safety Score.

The downturn in energy markets seemed likely to lead to consolidation as many smaller shale companies lacked affordable access to capital and needed higher oil and gas prices to service their debt loads.

Chevron's acquisition of Noble marks the first major deal since the pandemic began earlier this year.

Noble adds low-cost reserves and resources to Chevron's portfolio, including assets in the Permian basin which are adjacent to Chevron's existing footprint.

Noble also has a complementary presence in the DJ basin and helps diversify Chevron's business by adding substantial natural gas assets in the Eastern Mediterranean.

Overall, we estimate Noble would have increased Chevron's 2019 production by about 12% while boosting its proved reserves by 18%.

Acquiring these assets during a downturn adds to Chevron's resource base cost efficiently and without requiring exploration risk.

For example, Noble had total proved reserves of about 2 billion barrels of oil equivalent at the end of 2019. These are economically viable resources that the company reasonably expected to extract in the future.

Based on the transaction's $13 billion value, Chevron is acquiring each of these barrels for only around $6, well below the current price of oil (near $40).

Given the complementary nature of many of Noble's key assets and various business redundancies, Chevron expects to generate annual cost synergies of $300 million before tax.

That alone would be more than enough to offset the estimated $250 million of incremental dividends Chevron will need to pay after issuing shares to close the deal.

Management also expects the deal to increase Chevron's free cash flow per share and earnings per share one year after close (likely in the fourth quarter of 2020), even at a Brent oil price of $40 per barrel.

Noble was already achieving high-margin production growth at oil prices near $45 per barrel and was expected to have a neutral free cash flow profile in 2020-21, per ratings firm Fitch.

Most importantly, acquiring Noble does not impair Chevron's balance sheet strength.

After taking on Noble's $8 billion debt load, we estimate Chevron's net debt to capital ratio will increase from 14% to about 18%.

For perspective, Chevron's peers have ratios closer to 20% to 30%.

Chevron earlier this year also estimated that its gearing would remain below 25% even if Brent oil averaged $30 per barrel in 2020 and 2021 and money was borrowed to maintain the current dividend.

Buying Noble will push that figure a little higher, but management has said previously that Chevron planned to move its gearing into the 20% to 25% range over time, which "is not an uncomfortable level to be at."

Simply put, Chevron continues to have the ability to endure a couple years of tough pricing without threatening its dividend, even after acquiring Noble.

Ultimately, the concluding comments we made in our June note remain true:

Like the other oil majors, Chevron eventually needs higher oil prices to sustain its capital spending program and dividend. No business can increase leverage forever, especially for the sake of maintaining a dividend.

Oil prices above $60 per barrel are required by most major oil-producing nations to balance their budgets, but how long it takes for fundamentals to normalize is anyone's guess.

Supply side dynamics are extremely complex thanks to disruption caused by U.S. shale players, and demand recovery is still in the early days as the pandemic's impact lingers.

For the dividend's sake, it's important that conditions in the oil market improve meaningfully by the end of next year. 

Should a price recovery fail to occur or Chevron's balance sheet runway materially shorten for any reason, we would consider downgrading its Dividend Safety Score.

For now, income investors can rest a little easier knowing that Chevron is arguably the best positioned oil major to protect its dividend and has made that its first priority.

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