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Executive Summary:

  • Temporary pressure on the oil and gas sector has created a buying opportunity.
  • Increased production levels will support revenue and cash flow growth.
  • Free cash flows are positive again and growing.

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The oil and gas sector has not had an impressive start to the year and most of the stocks in the sector are down. ConocoPhillips (COP) is also showing a decline of about 9% year-to-date, which may just be a result of profit taking from some investors as the stock gained about 20% during the last year. However, ConocoPhillips has lost less than most of its peers in the industry - Exxon Mobil (XOM), Chevron (CVX) and Chesapeake (CHK) have lost 11.5%, 10.6% and 9.06%, respectively, since the start of the year. So, compared to peers, ConocoPhillips stock has still done slightly better. All of these stocks had a very good year and recorded substantial gains. The winner of the pick was Chesapeake which gained more than 63% - the trend is consistent with all the stocks. Going forward, I expect these stocks to again post substantial gains over the next twelve months. However, in this article, I will only be focusing on ConocoPhillips.

Growth in Earnings is Apparent

ConocoPhillips reported its earnings for 2013 recently - its earnings for the year were $9.2 billion. In 2012, the company had annual earnings of $8.4 billion. Basically, this shows a 9.5% growth in profits. But the important thing to note over here is that $8.4 billion in 2012 also included $1.2 billion of proceeds from the downstream segment, which is now under Phillips 66 (PSX). So, if we were to evaluate the company on the basis of businesses which it currently holds, we would subtract the $1.2 billion from $8.4 billion earnings of 2012 i.e. $7.2 billion. This will give the earnings that accounted for ConocoPhillips' current business back in 2012. Comparing $9.2 billion of 2013 and $7.2 billion of 2012 shows a 27% growth. This is the growth which the company has really achieved after letting go of its downstream segment.

Growth in Production

In the fourth quarter of 2013, production in Latin America increased by 4.6% year-over-year i.e. 22,000 Barrels of oil equivalent per day (BOE/D). The liquid rich Permian, Bakken and Eagle Ford gave the company a production growth of 31% as compared to the same period last year. Aside from this growth, the company faced some setbacks in Alaska where the production went down by 7.6%. Now that the Alaska Production Act has been passed, the company has expanded its activities in the region by adding another rig. The company has let go of its plans of drilling in the Chukchi Sea. This takes out the uncertainty from the picture as the region is posing a huge regulatory threat to the company.

Production in Canada decreased by 1% in the fourth quarter of 2013 as compared to 2012 but it was more than made up for by the increased production in Christina Lake Phase D and E. The year-over-year increase in the region was 12% easily covering the loss in Canada. Important thing to notice is that the company is shifting its focus from natural gas to liquids. In the lower 48 and Canada, the quarterly increase in the production of natural gas liquids is 10%.

Increased Free Cash flow: A Good sign for Dividend Hunters

ConocoPhillips is one of the companies that give good and stable dividends. During 2013, the free cash flow of the company increased significantly. As of the end of second quarter of 2013, the free cash flow of the company was around negative $250 million when the company was separating its Phillips 66 wing. As the company is getting back in the flow, this figure has now increased to $550 million, showing growth of over 300%. Even with the negative free cash flow in the past, the company paid its dividends timely and even increased the dividends. With robust growth in free cash flow, dividend hunters can expect the company to increase the dividend further this year. Currently the stock holds a dividend yield of 4.2%.

Conclusion

The growth in earnings is solid which would allow the company to keep expanding in the coming quarters. Also, production for the company is also increasing with a handsome growth rate. With the projects already in progress, we will see increased production in the coming quarters leading to higher revenues. Also, as we move forward, the overall cost of the company will go down after it finishes expanding in these regions. In my opinion, the stock is undervalued and the market would soon realize the true potential of the company's growth.

Source: ConocoPhillips: A Good Time To Buy?