The previous year was a challenging one for the energy producers as commodity prices remained weak. The decline in oil and natural gas prices was brought about by an increase in aggregate energy production and a decline in demand due to the slow recovery of the global economy. Another reason for a fall in commodity prices in North America was the Shale Revolution. As the market adjusts to the dynamics of demand and supply, a ray of hope is emerging for the businesses operating in the natural gas and oil industry. ConocoPhillips (COP) also faced several challenges as profit margins declined in response to the industry climate. However, the future does not look as grim as the past.
ConocoPhillips' earnings were in line with the market expectations; however, the production figures fell by 3% year-over-year, which was a worrying sign. The financials fared well with the quarterly earnings of up to $2.1 billion with an EPS of $1.73. The reported results were above analysts' expectations even though the reported results showed a fall of up to 27% as compared to the previous quarter. However given the economic climate the company was able to deliver lucrative returns.
The leverage ratio remains stagnant at 31%. Despite the dormancy in the ratio, it does expose the company to a certain degree of interest rate risk. The liquidity of the company was generated mainly from cash from operating activities, which amounted to $4.6 billion. Proceeds generated from disposal of its international reserves and downstream operations were used to finance dividend payments and capital expenditure. Thus, the company commits to its dual goal of dividends with consistent growth.
The management expects that it will be able to achieve its target of 3-5% growth. At the moment, most of the energy giants are facing a problem in replacing the depleting reserves, which has hampered their production capacity. The company plans on achieving these goals through changing the composition of its asset portfolio. The idea is to concentrate investment in operations yielding higher returns.
The North American Shale boom brought about a significant change in the operating structure of the energy players. The focus was on extensive drilling, efficiency and cost reductions as the industry enters into an era of resource abundance and flexibility. ConocoPhillips reacted to these changes by expanding its domestic line of production while deciding to dispose of its reserves in Kashagan, Algeria and some other global operations. The proceeds generated from the sales amounted to $8.5 billion, which shall be used to finance expansion projects with higher value and lower effective tax rates.
Overall production in both conventional and unconventional segments showed a net increase. New discoveries of reserves such as the resource base in the Gulf of Mexico and more sophisticated production techniques are expected to generate higher earnings in the coming quarters.
The nature of the industry in which ConocoPhillips operates is that of high risks associated with commodity price volatility and shifts in demand. The shale development comes along with certain associated risks such as the tax regime and other government regulations. Future environmental regulations further limit the growth prospects of the company as stringent regulations would mean higher compliance costs. Another significant risk faced by the company is its limited ability to manage risks due to its joint nature of operations. The company however has invested in financial and commodity derivative securities to mitigate risks, i.e. falling commodity prices and unfavorable interest rate changes. Nonetheless, exposure to risk still puts the company in a vulnerable position as is evident from the last year's events.
Keeping in mind all the strengths and weaknesses of COP, I believe the stock is attractively priced at current levels. It is suitable for both growth and income investors as the stock has a stable stream of dividends. The company has managed to safeguard ROI and ROE ratios of 6% and 13%, respectively for three consecutive years; above the industry average of 8%. The company has one of the highest dividend yields of about 4.26%, almost double the rate offered by some of the other players in the sector. The decline in asset base does pose some risks, but as the industry trend takes a recovery route, ConocoPhillips is expected to reap higher cash flows from its operations.