Chevron (CVX) is one of the busier price volume leaders Tuesday midday with 605,746, the 18th-busiest.
Investors have had a day to contemplate the oil giant’s $6.3 billion ($7.6 billion including net debt) all-stock offer for PDC Energy (PDCE), the Colorado-based independent oil and gas E&P company with operations in Wattenberg Field in Colorado and the Delaware Basin in West Texas.
Chevron is paying $72 a share for PDC, a reasonable 14% premium to PDC’s 10-day average closing price through May 19.
In return, it adds as much as $1 billion in annual free cash flow and significant proved reserves. So it seems like a winning transaction.
However, it could be a very dilutive transaction if the economy falters and oil prices drop significantly.
Based on the positives and negatives of the deal, I’ll consider whether CVX stock is a buy at current prices.
An All-Stock Deal Makes Sense
At the top of Chevron’s list of benefits for the acquisition is that It will be accretive to all key financial measures by the end of the first year post-closing. In addition, as long as a barrel of Brent crude stays at $70 or higher, as mentioned earlier, PDC will add $1 billion in free cash flow to Chevron’s cash flow statement.
Based on its trailing 12-month free cash flow of $35.7 billion through Q1 2023, the company’s boosting its free cash flow by nearly 3%.
More important than the additional free cash flow is the fact it is adding over 1 billion barrels of oil equivalent (BOE) to its position in the Denver-Julesburg (DJ) Basin. That’s a 10% bump to Chevron’s proved reserves at an acquisition cost of less than $7 a barrel. It also adds to its position in the Permian Basin in West Texas.
“PDC’s attractive and complementary assets strengthen Chevron’s position in key U.S. production basins,” stated Chevron CEO Mike Wirth in its press release announcing its acquisition.
Between cost synergies and capex efficiencies, it expects to realize about $500 million in annual savings, which will help offset about 30% of its $1.4 billion in increased capex due to the acquisition.
Chevron will issue 41 million shares to pay for the acquisition, increasing its diluted shares outstanding by 2.2%, or 1.94 billion. The transaction’s expected to close by the end of the year.
Analysts are questioning why PDC would accept such a small premium. Barron’s reported several comments from analysts after the deal’s announcement.
“Without commenting on whether the deal will go through or not, PDC shareholders might want to ask the question: why now, why sell at 2 times its 2024 Ebitda?” Barron’s reported Mizuho Group analyst Nitin Kumar’s comments about the deal.
If Chevron’s able to push this deal past the Federal Trade Commission -- three companies would control most of the acreage in Colorado -- it appears to be getting an excellent deal for PDC.
Does It Really Need More Oil?
As I said in the intro, if oil falls significantly below $70 per barrel of Brent crude -- it hasn’t traded below $70 in two years -- it won’t matter that Chevron got an excellent deal on PDC. It will be sitting on a lot of oil that’s not generating revenue.
However, in a phone interview, Wirth said the company isn’t averse to making further acquisitions if the price is right.
“The PDC tie-up ‘doesn’t preclude our ability to do further transactions,’ Wirth said in a phone interview. ‘But we don’t have gaps to fill. We’re always looking, but we’ll stay very disciplined as we have been on a number of transactions as we have done over recent years,’” Yahoo Finance contributor Kevin Crowley reported.
According to Crowley, Chevron has faced criticism from Wall Street for its lack of growth relative to Exxon Mobil (XOM). Perhaps that’s why CVX stock is down nearly 9% over the past year compared to Exxon’s 14.8% gain over the same period.
Wirth will open the wallet when a deal strengthens its position in a top production region like the Wattenberg Field. For example, the addition of PDC nearly triples its production in Colorado to 400,000 barrels per day.
A year ago, oil prices were over $100 a barrel. Today, they’re below $80, with a possible recession knocking them further lower in the year's second half.
Chevron has been very focused on its acquisitions in recent years. For example, it wouldn’t have bought PDC if it didn’t think it would significantly improve its position in Colorado. At the same time, it’s been allocating most of its free cash flow for share repurchases and a higher dividend.
However, analysts believe that companies like Chevron will continue to drive consolidation in the industry while solidifying inventories.
So far, Chevron is willing to nibble around the edges with bolt-on acquisitions such as PDC.
CVX is the better value to XOM. It remains an energy sector buy.
On the date of publication, Will Ashworth 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.
