ConocoPhillips (NYSE:COP) is an independent E&P oil and gas company with operations around the globe, particularly focusing on Conventional & Unconventional resources, Deepwater, and Canadian oil sands:
Latest news informs investors that the company has increased its quarterly dividend by 4.5% to $0.69, up from $0.66. ConocoPhillips is an attractive equity among its peers:
The company ranks 5th on list by market cap (just behind the $100B+ Integrateds) and absolute EBITDA. Eni Spa (OTCQB:EIPAF), an Italian O&G, which is not on the list here, has a market cap of comparable size, ~$58B. Other than that, ConocoPhillips feels quite lonely, being one of the very few companies in the range of $10B - $100B in market capitalization. In fact, Exxon Mobil (NYSE:XOM) did not even consider ConocoPhillips as one of its major competitors in its 2013Q1 Analyst Presentation.
Nevertheless, ConocoPhillips offers a compelling 4.25% annual dividend yield (I have annualized the recent dividend figure, which is higher than the LTM dividend of $0.66 and gives a slightly higher yield). The E&P earned $23.5B in LTM EBITDAX on $43.5B of last twelve-month revenues. ConocoPhillips has an Enterprise Value of $97.5B as of July 16, 2013, total interest bearing debt of $21.6B and total cash (excluding restricted) of $3.6B. In its latest analyst presentation, the company's management stated that ConocoPhillips currently has a daily production of 1.555 MMBOED (millions of barrels of oil equivalent per day). This translates into a Price per Flowing Barrel of $62.7K, much lower than, for example, Exxon's $98.8K.
I will present the key factors, which, as the company's management outlined, are going to drive ConocoPhillips's value in the next 5 years:
1) Increase in production by around 20% to 1.9MMBOED from current 1.55MMBOED
2) Increase in margins (particularly, Cash per BOE) by 3%-5% CAGR
3) Continuous increase in dividends
4) Share buy-backs
The first three points can be found in the Spring 2013 fact sheet, while the last factor I added myself, having screened the financials for the last 5 years.
I would like to attempt to quantify these raw figures and estimates into a fair value per share.
Calculating Discount Rate, WACC
All details for calculations are available in the downloadable workbook. Hence, simply an output will be posted here:
For practical purposes the figure of 5.97% is rounded to 6%. I tend to use Valuation App a lot when calculating Unlevered Beta and the end result, WACC. Inputs are gathered from Reuters, Bloomberg, and the company's financials.
Impact of Production Increase
Using the current Price per Flowing Barrel figure, I arrived at the following sensitivity table:
The numbers presented here are lower than the current price of about $65 per share, reflecting the fact that the market does not solely value ConocoPhillips on its production estimates. I will use the average price of ~$56 (intersection of a higher WACC of 7.0% and a lower Daily Production estimate of 1.8MMBOED) as the foundation for further valuation.
The management describes the increase in daily production in 2013Q1 as the company being "On Track" and gives guidance for the full year.
Increase in Margins
Increase in the Cash Margin per Barrel, calculated as adjusted CFO (cash from operations) divided by most current Daily Production figure, is a key driver in ConocoPhillips's value. The management plans to achieve this by spinning off lower-margin projects and concentrating on worldwide production, focusing mainly on oil:
Given below is a snapshot of current and historical Cash Margin per Barrel calculations:
The latest figure, $26.63 per BOE will be used as the input for the following sensitivity table:
The results are very similar to those obtained from the Production Increase table. Again, we see that the market has already factored that in ConocoPhillips's share price. A table picturing a combination of margin increase and production increase would definitely show a higher figure but I would like to be more conservative on this side.
Continuous Increase in Dividends
The company plans to grow dividends by 3%-5% annually in the long term. This guidance is a little lower than the 10-year average of almost 6%:
I used an average figure of 4% CAGR to arrive at the following estimates:
As we can see, dividends play a significant role in ConocoPhillips's valuation, adding an extra ~$11 per share on top of market valuation of the company's production capabilities and forecasts.
In the past three annual fiscal periods ConocoPhillips spent a little over $20B in share buy-backs, decreasing the total number of shares outstanding by about 17%. That figure is even higher, at 20%, if the numbers from 2009 are used:
Given that E&Ps spend significant amounts of money on CAPEX and exploration, this value-adding activity can mean only one thing: ConocoPhillips's management strongly believes that the stock is undervalued at current levels. I made projections for future buy-backs, dating up to 2017:
For the "High" estimates I used the 4-year average rate of -7.1%, for the "Medium" I decreased the rate by 50%, and for the "Low" I applied a rate 75% lower than the "High" figure. I will be using the "Low" estimates for the end result. At this point in time, the difference between valuation with and without share buy-back looks the following way:
The variation in estimated share prices is phenomenal: for the average price of $55.8 this activity offers another $20.5 per share, an increase of 37%. This means that share buy-backs should not be overlooked when making investment decisions.
The question is whether ConocoPhillips can sustain its aggressive share repurchasing policy in the long run. To answer it, I ran calculations using cash flow figures from the past 3 years:
Dividends and share buy-backs pushed FCF into a negative territory. Net income has been sufficient to cover these activities and interest-bearing debt has actually decreased from 2010 to 2012 by about 10%. However, it is clear that the company cannot sustain the ~7% rate in the long term. This brings me to a conclusion that the more conservative "Low" estimate is the best option to be used for projecting value creation from equity repurchasing.
Bringing It All Together
In conclusion, let us bring together the four drivers and draw a picture of ConocoPhillips's fair value per share:
The ~$88 per share estimate gives a compelling 35% upside from current market levels. This means that the stock is considerably undervalued (by about a quarter). Here is a distribution chart of the value drivers:
About two-thirds of the fair value is attributable to valuation of production and exploration, while more than a third is dependent on the management's collaboration with shareholders. Again, this proves the point that dividends and share buy-backs play a vital role in total returns on investment.
This conservative measure of a stock's attractiveness was developed long ago by famed Benjamin Graham. For ConocoPhillips, this number equates to ~$72.5, significantly above the current price of $65 per share.
While it is important to arrive at a fair price per share, it is also vital to not overpay for the stock in the short term. An article from Investorplace.com argues that a good entry point is somewhere around $62 per share. This figure seems fair because of the fact that the stock jumped around 10% in the past two weeks:
Hence, I suggest that interested investors wait for a modest sell-off and/or buy in chunks, if brokerage fees permit.
ConocoPhillips's book value per share is about $39 and mainly consists of PP&E, cash, inventory, and other good tangible assets. The company's P/E ratio is average among its peers and floats around 11X compared to S&P 500's figure of 18X. The stock never went below $35 in the darkest times of 2008 - 2009 and has never fallen below $50 since then. In fact, it is pushing its 52wk high and has appreciated by about 18% over the last twelve months.
At current valuation ConocoPhillips is undeniably a buy. The company revamped its operations and has exclusively focused on high-margin E&P activities, having a strong balance sheet with little debt. Investors should load on prices around $62 per share. The ex-dividend date is July 22, 2013, while the actual payment will be made on September 3, 2013.