Buy, Sell or Hold: Chevron Corp.

Chevron Corp. (CVX), the second-largest U.S. oil company, has recently experienced a decimation of its share price: The stock has dropped nearly 20% from its 52-week high of nearly $105 to Friday's close of $86.05.

But here's the thing: At some point down here, Chevron's stock becomes quite a compelling buy.

Let me explain.

The San Ramon, Calif.-based Chevron is a broadly based energy-sector company that engages primarily in petroleum exploration and production. It's also involved in natural gas, chemical production (including commodity petrochemicals), and even plastics. In its current form, Chevron resulted from the $36 billion merger with longtime nemesis Texaco Inc. back in 2001.

The company is very solid financially. Last year's sales of nearly $221 billion represented a 5% increase from the $210 billion in sales reported for 2006. And Chevron's 2007 profits of $18.69 billion represented a 9% jump from its 2006 profits of $17.14 billion.

At Friday's closing price, Chevron's shares are trading 13% above their 52-week low, but 18% below their 12-month high. The shares are trading at about 9.5 times current earnings and 10.5 times projected profits, and feature a dividend yield of slightly more than 3%.
Chevron's current market value is nearly $178 billion.

Let me start my analysis by first noting that Chevron reports its earnings on Aug. 1st.  As we all know, banks and other institutional investors have been forced to liquidate huge amounts of assets of all varieties in recent months - in order to reduce their leverage and raise cash. This is why, many times of late, that the market seems not to make sense.

This vast liquidation continues to hit the losing sectors - such as the so-called "structured products" that contain subprime mortgages. But recently this forced selling has even affected the formerly high-flying sectors: Positions in oil and gas, recently hot stocks in the steel sector, and even integrated oil companies such as Chevron and Exxon Mobil Corp. (XOM). Many of these stocks have been liquidated regardless of merit, bringing some down to almost "fire-sale" levels.

Should we look to capitalize on some of these fallen stars? You bet.

The question, however, is twofold: When do we buy in and at what price.

In general, I don't like to trade in or out of a stock just ahead of earnings. The market sentiment prior to an earnings release is very important.  In the case of Chevron, we have seen oil and gas prices plummet from record highs in just the last few days. And I am writing this ahead of the U.S.-Iran nuclear proliferation talks that were scheduled for the just-concluded weekend - a great example of an event that can cause investor sentiment to shift both quickly and drastically, especially in a sector that's as volatile as energy. Hurricanes in the Gulf of Mexico also could cause prices to change very fast, as well.

Chevron is the kind of company that is capable of continuing to post large profits - propelling its share higher from current levels - even if oil-and-gas prices were to drop from current levels over the next three years. That's because Chevron's business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market "spot" prices were to decline. Also, the company's production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.

Chevron was recently forced to reduce second-quarter earnings guidance because of losses in the refining and marketing segments, where it underwent major maintenance, and because it suffered some hedging losses.

And yet, despite all these "problems," the second quarter will be a record quarter.

We can also expect upbeat progress updates on their key new exploration projects, one of which - the Abgami Project in Nigeria - will be kicking into production very shortly.  While conceding the near-term results may come in below my expectations, let me say that I still prefer Chevron to the other integrated U.S. oil-and-gas producers because of its higher potential reserves, and because of an intermediate boost in benefits from production increases from Kazakhstan, the North Sea and West Africa, due to more aggressive exploration.

One problem we have to face is that this quarter's disappointment in refining and marketing will linger in the memory of Wall Street's analyst community, which could hold down the price of Chevron's shares, or even depress them further in the near term. But look at that as a positive: It could even provide investors who don't already have a position in Chevron shares the chance to do just that.

And if Congress does what's needed and opens up exploration and production opportunities in U.S. offshore waters, this company will be well ahead of the pack.

So buy CVX shares in progressive stages - starting small before and after the Aug. 1 earnings report - and you could see shares some 50% from current prices within a year if the scenario we've sketched out for you here unfolds as we expect.

Action to Take: BUY Chevron. Investors can generate some powerful potential profits from this U.S. energy heavyweight.

[Editor's Note: Horacio Marquez was working as a vice president of the Merrill Lynch Emerging Markets Fixed Income Group in 1994 when he correctly predicted that both Argentina and Mexico were headed for currency crises - cementing his reputation as an expert on both the emerging markets and on the nuances of global finance. Now Marquez brings that expertise to you with his newly created "Shadow Stock Trader" service. To find out how to subscribe, please click here. "Buy, Sell or Hold" is a brand-new Money Morning feature that so far has covered Cisco Systems Inc. (CS), ABB Ltd (ADR: ABB) and Cummins Inc. (CMI). We continue to appreciate all the readers that are writing to us, suggesting stocks they'd like to see analyzed.]

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