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Summary

  • ConocoPhillips is well positioned to deliver strong liquid-based production growth and is on track to meeting its production target of 3 – 5 percent growth per annum.
  • The company enjoys acreage positions in the most lucrative resources in the U.S.
  • In addition to higher volumes, ConocoPhillips has been putting efforts into curtailing operating costs, which are primarily driven by multi-pad well drilling efficiency coupled with lower completion efficiency.
  • The liquid based production growth coupled with higher operating margins means that the company will be able to generate ample cash flows to support increasing dividends.

After a recent board approval for a 5.8% increase in the quarterly dividends to 73 cents per share, ConocoPhillips (NYSE:COP) has been currently trading at a dividend yield of 3.22%. In addition to the increased dividends the company's stock price also increased to 85.84 from less than 70 cents per share in December, reflecting an increase of approximately 23%. The fact that the company is trying to deliver value to shareholders is appreciated by investors. It has been delivering returns to shareholders by regularly increasing dividends. However, whether ConocoPhillips will be able to sustain its standards of returning value to shareholders is a concern that needs to be addressed. Let's discuss what the future holds for ConocoPhillips.

Ample Production Growth

The company's future growth is usually measured by its ability to generate cash. In the case of ConocoPhillips the future growth in cash flows is expected to be driven from the lower 48 region as the company is aggressively ramping up the development of its onshore assets. The company particularly focuses on areas with higher liquids production. Going forward, with the continued efforts to develop the existing and emerging assets, the company is expected to boost not only the average daily production of hydrocarbons but also its operating margins in the long run. The company is targeting an overall production growth of 3 - 5 percent per annum.

Source: Investor Presentation

The company plans to invest approximately $3 billion annually in one of its most lucrative assets, the Eagle Ford Shale. It is worth mentioning here that Eagle Ford is being considered the largest tight oil play as per EIA estimates. The capital expenditure is directed toward developing acreage in the shale which will increase production to approximately 250,000 BOE per day by the end of 2017.

Similarly, to develop acreage in the Bakken shale play, ConocoPhillips is expected to spend nearly $1 billion. Going forward, the company expects to increase the production rate from around 33,000 BOE per day in 2013 to over 68,000 barrels of oil equivalent per day by 2017, creating more than 100 percent production growth.

Lower Operating Costs to Expand Margins

While the company is poised to deliver production growth it is also making deliberate efforts to cut costs. The increased use of multi-pad well drilling has created drilling and completion cost efficiency improvements in the Eagle Ford Shale. Going forward, the company is determined to use the multi-pad well drilling technique in 75% of the wells drilled in the Eagle Ford Shale, which will result in further reductions in the average cost per well.

Similarly, in the Bakken Shale the company managed to reduce drilling days by 30 percent and reduce completion cost per unit by 50 percent. The company is all set to drill 90% of 2014 wells by using multi-pad well drilling and I believe that it will further lower the average well cost.

Investment Thesis

During 2012 and 2013, ConocoPhillips divested nearly $12.4 billion of non-core assets, achieved a reserve replacement ratio of approximately 167 percent, and recently increased dividends by 5.8%. The company is on track to deliver stronger production growth. ConocoPhillips enjoys one of the best asset bases in the sector and the recent developments will result in considerable growth for the company. The acreage position in all three of the fastest growing liquid shale plays signifies that the company will produce more than many of its peers. Moreover, the company has been efficiently using its resources and the planned capital expenditure will further strengthen its position.

Conclusion

The management is determined to secure double digit annual returns for investors in the next few years. The stronger growth prospects coupled with a leading position in some of the best oil plays means that the company will be able to achieve its target. In addition to production growth, ConocoPhillips is all set to deliver margin expansion driven by lower operating expenditures.

Currently, the company has been trading at an earnings multiple of 13.19. Given the company's growth plans it seems that the stock is undervalued. Despite the fact that the stock is trading at higher levels I do not believe the company's upside potential has been exhausted and there is ample room to improve.

Source: ConocoPhillips: Upside Potential Has Not Been Exhausted