Chevron’s Q2 Free Cash Flow Rises

Chevron Corp (CVX) reported a 15% increase in free cash flow (FCF) quarter-over-quarter (Q/Q), and following the closing of the Hess acquisition, its FCF outlook is now stronger. Assuming Chevron ups its dividend by 4%, CVX could be at least 10% undervalued.

CVX closed at $151.40 on Friday, Aug. 1, after releasing its Q2 results in the morning. This is well off its high of $168.51 on April 1.

Moreover, as I discussed in a July 6 Barchart article, shorting out-of-the-money (OTM) put options is a great income play here. More on this below. First, let’s look at Chevron’s results and an updated price target.

Chevron reported that its adjusted free cash flow (FCF) was $4.9 billion in Q2, up over +16% over last quarter’s $4.2 billion adj. FCF, despite a 10% decline in crude oil prices, according to the company.

The FCF  adjustment adds back to FCF the net changes in working capital and certain acquisition costs, as seen in the table below from pages 2 and 10 of its earnings release:

The fundamental point is that Chevron is squeezing out higher amounts of cash from its operations. Now that the Hess acquisition closed on July 18 (i.e., in Q3), management says its FCF outlook has been extended.

The net effect is that Chevron is finally covering its huge dividend and share buyback costs. This can be seen in the company’s deck presentation table (page 9):

It shows that in Q2 adj. FCF of $4.9 billion was $0.6 lower than the $5.5 billion cost of shareholder payments (i.e., $2.9 billion in dividends plus $2.6 billion in share buybacks).

Moreover, this could be covered if revenue and FCF margins play out as expected. For example, the Q2 adj. FCF was 10.3% of its $47.6 billion in quarterly revenue. If this improves by 12% to 11.65%, it could cover annual shareholder returns.

Here is why. Let’s use analysts’ $194.5 billion (according to Seeking Alpha’s revenue estimates for 2026):

11.65% x $194.5 billion = $22.65 billion adj. FCF

 $5.5b div and buybacks x 4 = $22 billion shareholder payments

Even if it stays flat at 10.3% adj. FCF margins, the figure would be $20 billion, or less than 10% below shareholder payments.

The bottom line is that investors can expect CVC stock’s high dividend yield of 4.52% (i.e., $6.84 dividend per share / $151.40) could fall, pushing CVC stock higher.

For example, Chevron has already announced or paid out 3 of 4 quarterly payments at a $1.71 dividend per share (DPS) rate.

Since it has consistently raised its dividend over the last 37 years, let’s assume the quarterly DPS rises by 4.1% to $1.78 (i.e., $7.11 annual run rate):

$1.71 + ($1.78 x 3) = $7.05 next 12 months (NTM) DPS

Morningstar reports that the average yield over the last 5 years has been 4.16% and Yahoo! Finance says it’s been 4.33%. Therefore, using an average yield of 4.25%, here is a price target:

$7.05 / 0.0425 = $165.88 target price = +9.6% upside

That is almost 10% higher than Friday’s close of $151.40. Moreover, using an expected $7.11 DPS next year, the price target is 10.5% higher:

$7.11/0.0425 = $167.29, and

$167.29 / $151.40 = 1.105 = +10.5% upside

So, on average, we can reasonably expect at least a 10% higher target price or $166.54.  Analysts tend to agree.

Yahoo! Finance’s survey of 24 analysts has an average of $165.64, and Barchart’s survey is $164.35. However, other surveys show higher prices.

For example, Stock Analysis says the average of 14 analysts is $168.14, and AnaChart.com, which tracks recent analyst recommendations, says that 19 analysts have an average of $184.25 per share.

The average of these surveys is $170.60. That is an upside of +12.7%, slightly higher than the +10% upside using historical yield metrics.

Nevertheless, there is no guarantee this will happen over the next 12 months. For one, the market needs to see if Chevron’s free cash flow improves.

As a result, one way to play this is to set a lower buy-in price and get paid. This also allows existing investors to make extra income.

In my Barchart article 3 weeks ago, I suggested selling short (i.e., entering a trade to “Sell to Open” a put contract at any strike price), the $144.00 strike price expiring Aug. 8. This strike price was just less than 3% below the trading price (i.e., out-of-the-money). How did that perform?

At the time, the premium received was $2.41 per put contract shorted, which was a 1.67% yield (i.e., $2.41/$144.00 = 0.0167). As of Friday, that premium had decayed to 21 cents in the midpoint. In other words, the investor has made 91% of that 1.67% yield, and the short-play has been successful.

It makes sense to roll this over to a new period. For example, look at the Sept. 5 expiry period. It shows that the $167.00 put option, 2.91% out-of-the-money (OTM), has a $2.65 midpoint premium.

That gives a short-seller of the $167.00 put strike an immediate yield of 1.80% (i.e., $2.65/$147.00 = 0.0180) over the next month.

This gives the short-seller a lower potential buy-in breakeven of $144.35, or 4.6% below Friday’s close. For existing investors, this provides additional income.

For example, even after rolling the prior trade over to this new expiry period, the net yield is $2.44 (i.e., $2.65-$0.21), or 1.66% (i.e., $2.44/$147.00).

So, over the two periods of 7 weeks, the total income earned would be $485 for an average investment of $14,550. That works out to a 3.33% yield for 7 weeks, or an annualized expected return (ER) of over 23.3% (assuming the same yields can be made 7 times a year).

The bottom line here is that this is an additional way to play CVX stock for both existing and new investors.

On the date of publication, Mark R. Hake, CFA 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. This article was originally published on Barchart.com