ConocoPhillips - Continues To Be My Favorite Energy Play With A Solid 4-Year Growth Plan

May. 2.14 | About: ConocoPhillips (COP)

Summary

Conoco is on track with its ambitious 2017 targets.

The company offers potential for growth, margin expansion and increased reserves.

Combined with operations in stable geographic areas, Conoco deserves a premium valuation.

Investors in ConocoPhillips (NYSE:COP) continue to be pleased by the company's impressive growth strategy towards 2017. Conoco is aiming to grow production and increase its margins while keeping capital investments equal.

The resulting free cash flow generation should benefit investors in the coming years combined with growing earnings.

April Investor Presentation

Investors were already pleased with Conoco's update on the 10th of April. Holding an investor presentation, the company stated that its objective is to aim for double digit returns to shareholders with regards to dividends and cash flow growth.

Specifically, Conoco aims to show 3-5% production growth accompanied by higher margins, a compelling dividend, a focus on financial returns and continued focus towards execution and safety.

Focused Strategy Yields Growth...

Like many oil majors Conoco has embarked on a more focused strategy resulting in $12.4 billion in proceeds of the sale of non-core assets over the past two years. The spin-off of its downstream assets in a company called Phillips 66 (NYSE:PSX) comes on top of that.

The focus on running efficient operations tailored towards future growth has already been a big driver for the stock. Over the 2012-2013 period the company has achieved a 167% organic reserve replacement ratio, only adding to the reserves which currently stand at 8.9 billion of oil-equivalent. Important to notice, 83% of these reserves are located in OECD countries.

These efforts are already resulting in production growth. From a base of 1.47 million barrels of oil-equivalent last year, Conoco now sees 1.51-1.55 million barrels of production for this year, ending the year with a production rate above 1.6 million. Unconventionals, APLNG and Surmont could boost production further in 2015. By 2017, Conoco now sees production at 1.8-1.9 million barrels of oil equivalent per day.

...At Relatively Little Costs

The good news for shareholders is that Conoco is managing to grow while planning to keep its capital expenditure budget between 2013 and 2017 stable at roughly $16 billion. Important to notice is that Conoco make a clear strategy shift by focusing more on development programs instead of major projects investments. The latter group are typically plagued by big cost overruns, making them less worthwhile.

Of course a steady capital expenditure budget combined with rising production is a very good sign. Even better, Conoco expects margin expansion targeting as it targets 95% of its investments to projects which carry margins exceeding $30 per barrel. The focus for the coming years is on LNG projects, US shale, international operations and North American conventional projects.

The majority of these investments is targeted towards North America. This includes a roughly $3 billion capex budget for the Eagle Ford area to boost production to 250,000 barrels per day by 2017. The Bakken area sees annual capital investments of a billion while other major investments are targeted to LNG projects, the APLNG project and oil sands.

The strong replacement ratios means that total reserves have risen to 15 years of current production as the company expects to continue to add to proven reserves for the foreseeable future. The vast majority of reserves being located in stable political areas.

First Quarter Headlines

Investors were pleased with Conoco's performance in the first quarter, indicating that the company is on track with its trajectory towards 2017.

GAAP earnings were down by a percent to $2.12 billion as last year's earnings were aided by gains on asset sales. Adjusted earnings rose from $1.75 billion to $2.25 billion with adjusted earnings per share advancing to $1.84 per share.

Production excluding the operations in Libya totaled 1.53 million which was up by 24,000 barrels of oil equivalent per day compared to last year. Production was up by 41,000 barrels after adjusting for adverse weather and downtime effects.

While production is seen at 1.49-1.54 million barrels in the second quarter of this year, the company maintains its full-year outlook of 1.51-1.55 million barrels.

Implications For Investors

The combination of expected production growth, margin expansion and stable capital expenditures bodes extremely well for investors. The company reported normalized revenues of $56 billion in 2013 and earnings of $8 billion. As such, the company should be able to grow to reporting revenues of $75 billion by 2017 on which it could earn about $11 billion.

Additional earnings and higher depreciation charges as a result of recent higher investments will provide a boost to cash flows. This is needed to some extent as Conoco has incurred a bit of leverage in recent years trying to grow and please investors through cash returns at the same time. Having access to $7.7 billion in cash and equivalents, the company still holds a net debt position of nearly $15 billion at the moment.

To limit the run up in debt for the moment, Conoco has effectively suspended share repurchases over the past year. Yet its quarterly dividend of $0.69 per share provides investors with a very interesting 3.7% dividend yield.

Trading at $75 per share the company commences a $92 billion valuation, or roughly 10 times earnings of $9 billion which should be attainable this year. The prospects for production growth, margin growth, increasing reserves and very stable political operations should be very comfortable to investors.

I continue to be a buyer on dips after shares have already risen some 15% over the past quarter.

Disclosure: I am long COP. 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.