Click to enlargeConocoPhillips (NYSE:COP) released Q2 2013 earnings that beat consensus estimates by $0.12/share. While the company has been performing flawlessly on its strategic multi-year transformation plan by disposing of non-core assets, organically growing production, and providing a compelling dividend, the story this quarter was early signs of the 3-5% growth in cash margins the company has promised. As a result, COP's Q2 earnings beat was in stark contrast to slightly disappointing results from Chevron (NYSE:CVX) and a disastrous earnings report from ExxonMobil (NYSE:XOM).
Strategic Multi-year Transformation Plan Update
- Asset Dispositions: Since the beginning of the year, COP has received approximately $1.7 billion in proceeds from asset sales (Cedar Creek Anticline) and expects to close Algeria, Nigeria and Kashagan dispositions by year-end. These sales will add ~$9 billion of additional proceeds in 2013. The company also said it is still looking to rebalance its interest in Canadian oil sands holdings where it is a bit over weighted.
- Production Growth: Adjusted for dispositions and planned downtime, COP had 4% organic production growth in Q2 compared to a year ago. Last quarter COP grew 2% on the same basis.
- Compelling Dividend: COP recently announced a 4.5% dividend increase to a quarterly payout of $0.69/share and now yields 4.2%. Conoco's yield continues to be significantly higher than Exxon Mobil's 2.7% and Chevron's 3.1%.
Cash Margin Expansion
As I mentioned, the big story in COP's Q2 earnings was early signs of the 3-5% margin growth the company predicted when it first unveiled its strategic plan. CFO Jeffrey Sheets commented on the margin growth during the conference call:
The year-over-year increase in adjusted earnings was primarily driven by higher margins.
COP has accomplished growth in cash margins by shifting production growth to higher margin liquids and by growing production in the lower-48, Canada, and Asia -- all regions that have more attractive fiscal returns that the company's current average:
High margin production growth was led by the company's Eagle Ford operations, arguably the most economical shale play in the U.S. Eagle Ford production exceeded COP's expectations in Q2. Production averaged 121,000 boe/day, almost double the same period last year and up 20% sequentially. Production also increased 20% year-over-year in Asia. Bohai Bay resumed full production, the Panyu project in China showed impressive growth, and early production from the Gumusut project in Malaysia came online. While Canadian oil sands production was relatively flat, liquids production was up 12% and the pricing environment was stronger.
As a result, overall cash margins improved. Cash margins per boe were $27.10 in the quarter -- up 12% over the prior year quarter and up 2% sequentially:
While ConocoPhillips is no longer a fully integrated company since its spin-off of Phillips 66 (NYSE:PSX), it is hard not to compare the company's performance with its former peers Exxon and Chevron. Exxon posted a 57% decrease in Q2 earnings on lower production and a host of other issues. Chevron also missed by $0.19 in Q2 on lower oil prices, maintenance issues, and lower refining earnings. So the bullish report by COP, which also raised 2013 full year production guidance, was in stark contrast to its old friends. Also, it could be argued that PSX's Q2 refining, midstream, and chemicals performance was better than similar operations at Exxon and Chevron. But that is a more complicated and lengthy analysis and will be saved for another day. That said, in my opinion, the COP+PSX combination is outperforming both Exxon and Chevron.
The outperformance of COP is due to its early embrace of unconventional oil assets in the lower-48 and oil sands in Canada. The company was an early mover in the Eagle Ford and acquired arguably the best position in the play at prices averaging only $300/acre. As I pointed out some time ago, this would be the crown jewel in enabling COP to execute its ambitious strategic plan. On the other hand, while Exxon and Chevron are very profitable and great companies, both have focused more on unconventional natural gas plays in the lower-48. As a result, COP is growing liquids production and margins. XOM and CVX are not.
Summary and Conclusions
While I still believe Chevron is the best integrated oil company in the world, it's hard not to consider COP as the better investment today. Exxon Mobil is no longer even in the conversation. COP will reap ~10.7 billion in asset sales in 2013. It's clear the company knows how to plow this capital into low-risk, high margin production growth projects in countries having overall lower tax rates than the company's current average. So the last unproven goal of the company's strategic plan, 3-5% growth in cash margins, is coming to fruition. COP is a STRONG BUY at its current valuation. The company will continue to thrive as management executes flawlessly on its strategic plan. Management should be congratulated on its vision, which sets it apart from the company's former peers, Exxon and Chevron. In addition, the company's stock chart has broken through previous resistance at the $60 level and appears to be poised for a nice run higher.
P/E (ttm) = 10.7
EPS (ttm) = $6.16
Div *(Yield) = $2.76 (4.2%)
Disclosure: I am long COP, CVX, PSX, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article was obtained from company documents and/or sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for investment decisions you make. Thanks for reading and good luck!