ConocoPhillips (COP) is one of the largest integrated oil and gas companies in the world.The Houston, Texas-based company is primarily engaged in operations in the U.S., Norway and the United Kingdom. ConocoPhillips recently reported its 3rd quarter earnings. Last quarter EPS of $2.52 was significantly higher than the consensus estimate of $2.17.
As of the time of writing, ConocoPhillips stock was trading at $71, with a 52-week range of $58.37 - $81.80. It has a market cap of $96.9 billion. Trailing twelve month (ttm) P/E ratio is 9.1, and forward P/E ratio is 8.6. P/B, P/S, and P/CF ratios stand at 1.4, 0.4, and 5.5, respectively. The 3-year annualized revenue and EPS growth stand at 0.7% and 1.8%, respectively. Operating margin is 9.5%, and net profit margin is 5.1%. The company has some debt issues. Debt-to-equity ratio is 0.3. ConocoPhillips pays nifty dividends. The projected yield is 3.7%.
ConocoPhillips has a 4-star rating from Morningstar. It is categorized as a large-value company. While its trailing P/E ratio is 9.1, it has a 5-year average P/E ratio of 7.9. Thus, ConocoPhillips is trading slightly above its historical P/E ratio. Out of 20 analysts covering the company, 5 have buy, 1 has outperform, 11 have hold, and 3 have sell ratings. Wall Street has diverse opinions on ConocoPhillips’s future. The bottom line is -16.4% growth, whereas the top-line growth estimate is 20.8% for the next year. Average five-year annualized growth forecast estimate is 8%. Major U.S.-based competitors in the integrated oil and gas field include Exxon Mobil (XOM), Chevron (CVX) and Occidental Petroleum (OXY).
What is the fair value of ConocoPhillips, given the forecast estimates? We can estimate ConocoPhillips’s fair value using discounted earnings plus equity model as follows.
Discounted Earnings plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E_{0} + E_{1 }/(1+r) + E_{2 }/(1+r)^{2} + E_{3}/(1+r)^{3} + E_{4}/(1+r)^{4} + E_{5}/(1+r)^{5 } + Disposal Value
V = E_{0} + E_{0 }(1+g)/(1+r) + E_{0}(1+g)^{2}/(1+r)^{2} + … + E_{0}(1+g)^{5}/(1+r)^{5} + E_{0}(1+g)^{5}/[r(1+r)^{5}]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E_{0}(1+g)^{5}/[r(1+r)^{5}] = E_{5} / r
While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.
Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $2.27 along with the mean estimate of $3.34 for the next year.
E_{0 }= EPS = ($7.81 + $8.24) / 2 = $8.025
Wall Street holds diversified opinions on ConocoPhillips’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 26.9%. Book value per share is $17.1.
The rest is as follows:
Fair Value Estimator | ||
V0 | E_{0} | $8.03 |
V1 | E_{0 }(1+g)/(1+r) | $7.81 |
V2 | E_{0}((1+g)/(1+r))^{2} | $7.60 |
V3 | E_{0}((1+g)/(1+r))^{3} | $7.39 |
V4 | E_{0}((1+g)/(1+r))^{4} | $7.19 |
V5 | E_{0}((1+g)/(1+r))^{5} | $7.00 |
D | E_{0}(1+g)^{5}/[r(1+r)^{5}] | $63.61 |
BV | Equals | $51.03 |
Fair Value Range | Lower Boundary | $108.63 |
Upper Boundary | $159.66 | |
Minimum Potential | 51.34% | |
Maximum Potential | 122.44% |
(You can download FED+ Fair Value Estimator here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for ConocoPhillips is between $108 and $160 per share. As of Aug 22, ConocoPhillips was trading at a price of $71. The current price indicates that the stock is deeply undervalued. Based on my FED+ fair value estimate, ConocoPhillips has minimum 50% upside potential to reach its fair-value range.
Peer Comparison
Company | Yield | O-Metrix | Fair-Value Range | YTD Return |
ConocoPhillips | 3.68% | 6.53 | $108 - $160 | 9.26% |
Chevron | 2.96% | 4.75 | $158 - $216 | 22.97% |
ExxonMobil | 2.31% | 4.26 | $105 - $137 | 13.40% |
Occidental | 1.88% | 6.48 | $134 - $177 | 1.13% |
With a nifty yield of 3.68%, COP has the highest yield among its peers. COP’s bigger brother, Chevron, comes second with a yield of 2.96%. In terms of O-Metrix scores Chevron also has the highest score of 6.53, followed by Occidental Petroleum (6.48). The fair-value analysis suggests that all of these companies have significant upside potential to reach their fair-value range. However, ConocoPhillips has the highest upside potential, followed by Chevron, Occidental, and ExxonMobil.
Summary
Due to their high exposure to commodity prices, large-cap integrated oil and gas companies are deeply undervalued with single digit P/E ratios. ConocoPhillips is no exception. The stock is trading with a low trailing P/E ratio of 9.19, and forward P/E ratio of 8.71. Chevron has a slightly lower trailing P/E ratio of 8.13, but its EPS growth expectation is only 5%.
As of October 21, ConocoPhillips was trading at $71, significantly lower than my fair-value range of $108 - $160. Its price to book ratio of 1.41 is also well-below the market average. However, its O-Metrix score of 6.53 is the highest among its peers. As companies with higher O-Metrix scores tend to outperform, I expect COP to be an outperformer.
COP’s ytd return of 9.26% is below the 22.97% return of Chevron. Occidental also lacked its peers with a return of only 1.13%, since January. While I think ConocoPhillips is the best of its breed based on fundamentals, Occidental can also be a good contrarian play.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.