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Summary

  • Volatility in gas prices forced exploration and production companies to shift their focus to liquid plays.
  • Occidental Petroleum and ConocoPhillips are investing heavily in a move toward liquid plays in order to generate growth in margins and volume.
  • The stock of both ConocoPhillips and Occidental Petroleum are at attractive entry points, but Occidental looks to be in a better cash position.

Because of supply and demand dynamics, natural gas prices continue to be volatile. Speaking of natural gas prices, companies in the E&P industry expect that in 2014, natural gas prices will remain relatively flat compared to 2013. However, crude oil prices were fairly stable throughout 2013. The production of oil continues to be more profitable than natural gas. Consequently, companies operating in this industry have been shifting their focus to oil production. To make a change toward liquid plays, companies are investing billions to acquire oil producing assets while disposing of non-core assets. The change in strategy has worked for companies in 2013 as liquid plays offer much better volume and margins.

In this article, I picked ConocoPhillips (NYSE:COP) to see where it stands during changing circumstances when compared to Occidental Petroleum (NYSE:OXY). Also, I will determine which company offers better returns for investors in this rapidly-changing business environment. This article will focus on their ability to sustain returns by looking at their business plans, financial situations and future prospects. That way, I can point out whether either of these stocks is a buy or hold.

Where Does ConocoPhillips Stand?

ConocoPhillips is the globe's largest E&P Company. It has a long history of providing sustainable returns for investors, with its diversified portfolio of assets in North American oil sands and shale assets and oil assets in Europe, Asia, Australia and other international locations. Its goal is to generate 3% to 5% growth in production and margins. To achieve that goal, the company is investing significant amounts of capital to acquire high-growth assets throughout the world.

In 2013, the company invested nearly $15 billion and in this current year it plans to make capital investments of around $16.7 billion. The company's business plan is simple and straightforward. Along with concentrating on organic growth, it is investing heavily in liquid plays and LNG projects while making limited investment toward the production of natural gas. Recently, it brought three projects online. Therefore, with the shift toward liquid-rich resources, at the end of 2013, liquid accounted for roughly 56% of its total production. Recent investments in liquid plays, especially in the oil sands in Canada and the Lower 48, contributed to higher production levels and reserves.

This year Conoco intends to make investments in its legacy assets and ramp up its unconventional plays with additional projects like the recent startup at Siakap North-Petai, and the startups in Canada, the United Kingdom and Malaysia. Its shift in focus to liquid plays is bearing fruit for the company. As a result of the shift, the company's production and margins have expanded over the past few quarters. In the first quarter, its productions increased by 3% to 1,530 MBOED. With the successful execution of its strategy, the company's cash situation is improving. Its cash flows from operating activities expanded by 32% to $6.2 billion in the first quarter. It invested $4 billion and paid dividends of $0.9 billion.

Where Does Occidental Petroleum Stand?

Occidental Petroleum's business strategy is similar to Conoco's. The company's main focus is toward growing domestic liquid production due to higher growth and volumes in liquid plays. In the past year, it grew its domestic oil production by 11,000 barrels per day. It achieved its growth by aggressively working to add new reserves while disposing of non-core assets. Its reserve replacement ratio for liquids was at 195%, reflecting its focus on oil drilling instead of gas. Its reserve replacement ratio in the United States was high at 190%. All this led to the company having an all-time high 3.5 billion barrels of reserves. In addition, in the first quarter of this year, the company improved domestic oil production by 10,000 barrels per day.

The California, Permian basin and international regions like Qatar and Oman are key places for Occidental's investments and growth opportunities. Its investment in projects like the BridgeTex Pipeline, the New Johnsonville Chlor-alkali plant and the Al Hosn Gas Project are expected to boost cash flow. Financially, the company is in a very strong position, which I believe is due to well-timed strategic investments. Occidental consistently achieves strong top and bottom line growth, in most quarters the company's top line growth was led by liquid plays. Its bottom line growth also benefited because liquid plays are providing better margins. All of these positives led to strong cash flows which will be used to support investments and returns. Occidental is also improving its cash flow by disposing of low performing assets. For example the sale of a portion of its stake in the General Partner of Plains All-American Pipeline brought in about $1.4 billion.

Which Is a Better Buy Investment?

COP

OXY

Industry Average

Price/Earnings TTM

12.0

12.9

28.3

Price/Book

1.8

1.8

1.9

Price/Sales TTM

1.6

3.0

2.7

Rev Growth (3 Yr Avg)

-33.6

10.3

-12.1

Net Income Growth (3 Yr Avg)

-6.9

9.2

-15.9

Debt/Equity

0.4

0.2

0.5

ROE

18.3

14.2

7.1

Source: Morningstar.com

COP Chart

COP data by YCharts

Conoco and Occidental are both making large capital investments to adjust to the changing business environment. These companies have moved their focus to higher-volume and higher-margin liquid assets and both have been successful in doing that. However, I must give marginal edge to Occidental as it has been generating strong growth in revenues and earnings with the shift in business focus. Further, it has been very efficient in investing its capital. It is improving its capital efficiency by lowering development and operational costs, which further enhances its potential to expand investments. In the past year alone, it improved its capital efficiency by 24% domestically, primarily from the Permian Basin, with a 25% gain from California and a 25% gain from other domestic assets. With strong operational efficiencies and strong top and bottom line growth it improved its cash flow. In the past quarter, its operating cash flow was at $2.7 billion and its capital expenditures were $2.2 billion, thus free cash flows were positive at $0.5 billion, which equaled its dividend payments. It has cash on hand of $2.3 billion. Further, it has a bank credit facility of $2 billion expiring in 2016, but no amounts have been drawn yet under this credit facility, and up to $1 billion of the credit facility is available as letters of credit. Consequently, Occidental has been able to grow its dividend by 118% in the past five years and 12.5% in the last year.

On the other hand, Conoco needs to make massive acquisitions and dispositions in order to chase industry trends. That is why; its capital investments surpassed its operating cash flows, which hindered its dividend growth, as the company's free cash flow did not cover dividend payments. Thus, its dividend growth remains slower than Occidental's. Nevertheless, Conoco has now gained momentum as a result of its shift to liquid plays. It is now generating better growth in its top and bottom line. In the past quarter, it generated $6.2 billion in operating cash flow with capital expenditures of $4 billion. Conoco's cash flows are also receiving support from the sale of noncore assets.

If I were to recommend one of these two companies stocks, I would recommend Occidental Petroleum even though it is marginally overvalued when compared to ConocoPhillips. Further, its strong cash-generating potential, its good business strategy, its strong asset portfolio and its ability to generate double-digit growth in earnings and dividends make it a better stock for defensive investors. In addition, it is now working on a stock buyback, which I believe will have a positive impact on its earnings per share and dividend.

Source: Is ConocoPhillips A Better Buy Than Occidental Petroleum?