What happened
Shares of U.S. integrated energy giant Chevron Corp (CVX 2.21%) were down by about 5% by noon or so on Wall Street.
The drop started shortly after the market opened, as the company held a conference call to discuss its pre-market earnings release. On the surface, the quarter wasn't so bad, but dig in a little and there was some troubling news. Worse, the next few quarters could get ugly. Investors didn't take the news well even though the dour outlook wasn't really much of a surprise.
So what
Chevron earned $3.6 billion (roughly $1.93 per share) in the first quarter of 2020, up from $2.6 billion ($1.39 per share) in the same period of the previous year. That was the good news. The bad news is that the first quarter benefited from roughly $680 million in one-time items (an asset sale and a tax gain) and currency effects increased earnings by another $500 million or so. Thus, the first-quarter results weren't exactly representative of the company's real earning power in the current environment.
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For example, earnings in the U.S. energy business fell by 68% year over year because of lower oil and natural gas prices. The international energy business saw earnings increase nearly 13%. However, that's the division that benefited most from the one-time items. Pull out the asset sale and tax gain and earnings fell 15%, again largely because of falling energy prices (removing the currency impact would make the numbers even worse). Strong margin performance on the downstream side of the business helped offset some of the hit on the upstream side, showing the benefit of diversification. However the big takeaway from the quarter is that low commodity prices are materially crimping earnings even if the top-line numbers don't quite show it.
And it's going to get worse, since weak oil and gas prices continued into the early portion of the second quarter. In fact, the company specifically noted in the press release that "[f]inancial results in future periods are expected to be depressed as long as current market conditions persist." A huge portion of the problem is related to the worldwide economic shutdowns meant to slow the spread of COVID-19, which led to a steep drop-off in demand. Thus, the "current market conditions" are likely to linger for a while, with the world only just starting the process of opening up again a month or so into the second quarter. It's expected to be a slow-moving effort.
Although Chevron cut its capital spending plans once already, it announced another 13% reduction to help shore up its balance sheet and protect its dividend. Low energy prices clearly aren't expected to be a one- or two-month issue.
Now what
Chevron came into 2020 with a relatively modest capital spending plan compared to its peers and one of the strongest balance sheets. As the industry pulls back because of low energy prices driven by a massive supply/demand imbalance, Chevron continues to look like one of the best-positioned integrated energy companies. The problem is that getting supply and demand back into balance is going to take time, and while the rebalancing is taking shape, Chevron and its peers are going to post some ugly financial results. Chevron and its peers are trying to adjust to the unfolding situation, but you'll need a strong stomach to invest here because this industry downturn, as the company pointed out, is far from over.
