These days, the trend of spinning off operations and becoming focused on a few specific parts of the business is perceived to offer more value for all stakeholders involved. It all started with the Marathon Group spinning off into Marathon Oil (MRO) and Marathon Petroleum (MPC). ConocoPhillips (COP) followed suit soon afterwards by splitting its company into Phillips66 (PSX), which handles downstream operations, while exploration and production continue to be operated by ConocoPhillips itself. I will be providing my input on the two oil and gas integrated spin-offs and their performances from an interested shareholder's perspective. Occidental Petroleum (OXY) had also been thinking of a spin-off as well, and I have added it into the assessment in order to provide readers with a clearer picture of how the spin-offs for MRO and COP have been beneficial.
After spinning off Phillips66, ConocoPhillips is engaged in a major capital reshuffle in geographic and administrative terms. 2013 will be considered a year when COP put things in order for years to come. It would be unwise to expect that COP will be operating at a loss throughout 2013. The #3 American oil company reported slightly lower oil and natural gas production in the first quarter compared to a year ago, with a profit of $2.1 billion. This is down from $2.9 billion in the same quarter in 2012. Due to unfavorable prices of gas, the company has made it clear that its production mix in the Americas will shift from natural gas to liquids, from 45% to 51%. COP expects to generate $8.2 billion as it sells off assets in Algeria, Nigeria and Kazakhstan. Furthermore, it has announced two big discoveries in the Gulf of Mexico, along with its intention to start drilling in a shale field in Colombia in the second quarter. Good news continues for the people looking to invest in this oil giant as it has $5.4 billion in cash reserves. Last year, the company spent 61% of its profits buying back its own stock.
Marathon Oil reported a profit of $383 million in the last quarter, compared with $417 a year earlier. The 8% fall in profits comes at a time when production went up 19%. Due to the weaker prices of crude oil, the increase in production could not be translated into revenue. The company's increase in production was backed by strong growth in the Eagle Ford and Bakken shale plays. Occidental Petroleum had been rumored to be following a similar path, but its CEO broke the news that while the company did assess the option of spinning off, it is not currently the best solution for its shareholders. For Marathon and ConocoPhillips however, this was undoubtedly a beneficial idea.
The graph below shows the obvious shareholder value untapped by MRO and COP as they spun off downstream businesses. So why shouldn't OXY follow suit and spin off some of its business to allow better returns for its shareholders? Simply put, in order to benefit from a spinoff, the two companies need to focus on their core business, as PSX has invested large sums to deliver crude oil to its refineries. For OXY, the company's midstream and pipeline assets are too concentrated in the Permian Basin in West Texas to make a difference for investors. MRO and COP have drawn a wedge between their pipeline assets and midstream operations because of their geographically diverse portfolios. OXY cannot do this as it does not have the advantage of having its assets being separate. The majority of the company's processing facilities are located in the Permian Basin, and it does not make sense to spin off a business when it does not even fall close to being a potential source of revenue. OXY earns most of its revenue from exploration, not refining.
ConocoPhillips is the largest company by market capitalization among the three and still has the highest dividend yield, making it a clear cut favorite for investors at first sight. It is also the most undervalued of the three, while being consistent with its income. The company's revenue stream has shown a negative trend over the past 3 years, but weak commodity prices and the recent spinoff of PSX have had much to do with that. Occidental Petroleum is undoubtedly a strong oil and gas producer, but COP is impressive with its ROE and depressed P/E rating. In my opinion, ConocoPhillips wins this comparison of companies with its financial performance and dividend offer. The company's payout ratio is a respectable 44.7% and the dividend paid is $2.64 per share annually. While being relatively pricey, COP shares are still eclipsed by OXY prices while being unable to provide similar performance.
Net Income Growth (3 Yr Avg.)
Revenue Growth (3 Yr Avg.)
Dividend Yield, %
Return on Equity
Upside Potential to Reach Fair Value
Data taken from Morningstar and Financial Visualizations on May 13, 2013
Make or Break for Investors?
COP's Phillips66 and MRO's MPC - what do they mean for Occidental Petroleum? Simply put, OXY is stuck in a catch-22 situation - if they spinoff, they're worse off. If they don't, they're worse off still, since PSX and MPC have been two of the best performing stocks on the market due to their renewed focus on core capabilities. All of this draws investors away from OXY and towards its competitors. The company's power struggles at the top also discourage investors from buying into a company whose board is one of the highest paid in corporate America. Furthermore, reasons against splitting go further into the Middle East, where doing business is becoming increasingly less attractive. Perhaps a logical alternative would be to gradually step out of Middle East and focus on North America, capitalizing on the company's size and the considerable areas of land, resources and operations it currently owns.
COP has come out on top because of its financial performance and also due to the success of its spinoff. What about the future? Moving forward, MRO and COP have the unique opportunity to focus only on their core capabilities of production, etc. Based on international commodity prices, the two companies stand to make considerable profits from their broad bases. MRO's stock price has appreciated approximately 50% since its low in June, but based on its weak financials (compared to COP), I believe investors will be better off investing in COP.
ConocoPhillips' strong dividend and consistent earnings also beats Occidental Petroleum's because OXY is currently going through both a power struggle and anemic growth period which has only been exacerbated by the emergence of PSX and MRO.
ConocoPhillips' profits fell 27% in the last quarter due to the transition of splitting and also the weak international commodity price picture. However, all of this was expected and the eventual results were better than the expectations. I strongly believe ConocoPhillips' share price will grow considerably over the next two years as new projects come online causing a price appreciation.
Buy ConocoPhillips for long run!