ConocoPhillips: Should You Buy Before Or After The Split?

| About: ConocoPhillips (COP)

With 2011 ending effectively flat, investors are looking forward to hopeful gains in 2012. The protective nature of sustainable dividend yields has led many to strong blue-chip paying behemoths like Coca-Cola (KO), Procter & Gamble (PG) and Johnson & Johnson (JNJ). Assuredly, many of you have already read your fair share of “5 Dividend Stocks You Must Buy in 2012” type articles. As a dividend growth investor I too am interested in these types of companies, but I don’t really care what their price does in the next year or even in the next five years. If the company remains fundamental, with a strong competitive advantage that allows it to grow both earnings and payouts, we’re good. The price will eventually follow.

This article looks to neither sway nor dissuade you from an upcoming purchase. However, I am interested in your opinion about the time-sensitive nature of the upcoming ConocoPhillips (NYSE:COP) split. In reviewing my ending 2011 portfolio, I found a gap in the oil/energy sector. Luckily the available options for such companies with sustainable growing dividends are immense. So much so that you need not look further than the top four on the Fortune 500 list to find three well qualified candidates: Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and ConocoPhillips.

Irving, Texas,-based Exxon Mobil comes in at number two on the Fortune 500 list, trailing only Wal-Mart (NYSE:WMT), with 2010 revenues over $350 billion. XOM has proven to be more than consistent on the dividend front having not only paid but also increased its dividend for the last 29 years. With a current yield around 2.2%, some income investors might take a pass, but the payout ratio near 23% suggests great sustainability. Dividends have been growing in the mid to high single digits as of late.

California-based Chevron (CVX) doesn’t even make two-thirds of the revenue or profit that Exxon does, but it still comes in at number three on the Fortune 500 list. CVX has proven to be both rewarding and sustainable, having increased payouts for the last 24 years while keeping a payout ratio near 24%. Additionally, the current yield is a bit friendlier, hovering around 3%, while dividends have been growing in the high single digits.

To be sure, both XOM and CVX have provided lasting shareholder value and look to continue this trend in the future. But here’s why I liked ConocoPhillips best before the split announcement. On a pure dividend comparison, the 3.6% current yield and much higher dividend growth rates are compelling. Last year the dividend grew by 23% while the average 10-year rate is around 14%. True, COP has only been increasing payouts for 11 years and has a slightly higher payout ratio at around 34%. But the fact that COP is smaller than CVX and XOM is appealing, as it becomes much more difficult to grow as a company becomes very large.

Given that I liked COP before the split announcement, there’s plenty of reason to love COP afterwards. After-all it creates two distinct companies that are both smaller and more focused. Additionally, the dividend looks to increase substantially in the near term.

Let’s walk through some positives and potential reservations of the split to see if we can come to a conclusion. A more complete analysis can be found on the COP website here.


1. Dividends – As a dividend growth investor you’re looking for a reasonable yet sustainable payout that will increase at a rate that far outpaces inflation. Before the split COP looked to do just that with a more than acceptable dividend growth rate, current yield and payout ratio. After the split, COP and a new downstream company - “Phillips 66" - appear to continue this trend. If you buy before the ex-split date (second quarter of 2012), you will receive one share of Phillips 66 for every two shares of COP you own.

Management has indicated that COP will maintain its current $2.64 a share in dividends, while the new Phillips 66 will likely pay an annual $0.80 dividend. This means that if COP is bought today at a 3.6% current yield, one would receive $3.04 for every COP share after the split, or a yield on cost close to 4.2%. Note, the additional dividend amount of $0.40 reflects the one share for every two COP shares owned. Comparatively, this is like buying COP at $63 given the current payout and if no split was announced. Moreover, COP might increase its payout before the split announcement in February as it has done in three of the last five years. Effectively, assuming the two companies provide similar profitability as the singular COP, this answers the call for those clamoring for an increase in the payout ratio.

2. Shareholder Value – But if COP wanted to increase the payout ratio, they could simply do just that. For shareholders let’s hope that the two separate companies don’t have the same profitability as the stand-alone COP. After all, splits are used to “unlock shareholder value” and would not be pursued if management did not see a tangible benefit. COP appears to have a strong vision going forward as the company believes that “repositioning provides opportunity to capture ~$20 billion in shareholder value." Additionally, the new spin-off company would be large enough to be included in S&P 500 indexes, which could create even more value.

3. Sell the Company You Don’t Like – Once COP splits into two companies you have the original $2.64 (perhaps more) dividend plus a competitive $0.40 (per COP share) to boot. Unlike the Abbott Laboratories split in which the dividends of the two companies combined will equal the current payout, COP creates two competitive dividend yields. You could simply hold on to the company you feel has better prospects and sell the other.


1. Just Wait – Of course if you don’t like one of the companies, why not just wait until after the split and buy the one you do like? For example, if you like the original COP and its large, diversified exploration base but are not sold on the growth prospects of Phillips 66 you could simply wait to buy the new COP. It would provide a likely current yield over 5% with room to grow through anticipated dividend increases and share repurchases. However, there is an additional area of concern in that dividend growth is projected at 5%-plus in the near future. To be sure, this outpaces inflation and works well with a high current yield. But for dividend growth investors, a 5% payout growth can become problematic when searching for double digit yield on costs. After all investors buy companies like Consolidated Edison (NYSE:ED) for safe, current income and not necessarily for its half a cent yearly dividend increase.

2. Limited Time Offer – Something doesn’t strike me quite right about a time sensitive purchase. When pressed for time, investors often disregard due diligence and continue on raw emotion, likely to regret it later. While there is still plenty of time to evaluate the transaction, analysts are surely ahead of the game. In just the last three months COP has climbed over 16%, coming from an October low around $61. And while it can be hard to pull the trigger against positive momentum, it should be noted that COP is still selling for less than it did directly prior to the split announcement.

3. Energy in General – Just like Phillip Morris (NYSE:PM) or Altria (NYSE:MO) with cigarettes, you should question the super long term demand of oil. I don’t see it happening in the next couple of decades, but eventually oil plays the scarcity card and alternatives become paramount. The real question is whether or not COP has the wherewithal to become a lead in energy in general. Much like Coca-Cola (NYSE:KO) and PepsiCo (NYSE:PEP) combating the issue of declining sugary beverage sales by offering healthy alternatives, COP must prove to be well positioned to offer alternative energies. To this point COP appears to be in the conversation as it recognizes the need for ethanol, bio-fuels, solar, wind and geothermal along with other options. A more short-term concern would be the volatile fluctuations in oil prices.

Overall COP appears to be a sustainable dividend growth company with the ability to increase payouts over time. I liked COP before the split announcement and I must say that I like the COP payouts even more after the announcement. Management has a clear path laid out and they have proven to be able to both reach and exceed objectives in the past. The uncertainty of COP appears to be short-term, as the long-term prospects for both energy and ConocoPhillips look reasonable. To borrow from Warren Buffett : “In the business world, the rear view mirror is always clearer than the windshield." Then again Buffett also gave us the wisdom that "you can’t strike out looking."

I like ConocoPhillips before the split. How about you? Are you going to take a swing before the second quarter, or wait for another pitch?

Disclosure: I am long KO, PG, JNJ, PEP.