Rose Colored Glasses For Sale

| About: ConocoPhillips (COP)

Summary

Up To $8 billion assets are targeted for sale, but that number could easily grow unless operations provide sufficient cash flow.

The new long-term debt level target is $20 billion but that may be too much debt for the capital budget, stock repurchases and other uses of operational cash flow.

Double-digit annual returns could be at least two years away without a commodity price rally.

Dividends should be a function of cash flow and capital investments. Too much distributions send Mr. Market a negative message about the future prospects of the company.

The breakeven price is down significantly. It needs to go lower. This company needs to be able to thrive if oil prices drop into the $30 per barrel range.

For a long time, probably too long, management talked about a break-even point when oil was $60 per barrel. Now, finally, management is putting a significant amount of properties up for sale and ConocoPhillips' (NYSE:COP) management is talking about properties that make money below oil prices of $40 per barrel. For whatever reasons, management may be having that realistic cost discussion of the company in a low commodity price future that really never existed in past shareholder communications.

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Source: ConocoPhillips November, 2016, Analyst and Investor Meeting Slide Presentation

Obviously, the single largest significant strategic change is the decision to sell up to $8 billion in assets. This is a big company with some very large challenges. Turning the company around "as is" can be a Herculean task made far more difficult by all the projects demanding capital. Focusing on the company's strengths was indicated long before now and shareholders should not be surprised if more property sales are indicated in the future. But at least now management is beginning to focus on the "focus," whereas before the property sales seemed to be more "ad hoc."

This impression is supported by the decision to pay down debt to $20 billion. Before the asset sales were relatively small and appeared to support operations until the commodity price downturn "blew over." Now management appears to recognize that lower prices are here to stay and it is time to compete for a long time in this environment. But cash flow has been insufficient for a while, so enough sales to drive debt lower, probably to $10 billion, are indicated unless management demonstrates cash flow to support the current company assets with the $20 billion debt.

The third-quarter conference call featured a brief answer to a question where management was patting itself on the back for meeting the cash flow goals, if oil was priced at $60 per barrel. But that accomplishment, though significant does not appear realistic. It should have been more of a "celebrate the moment but keep going" kind of answer. This has really been the first presentation with a realistic future vision or at least a "what if it is worse than we thought" vision. But many commodity company managements have been used to planning for such scenarios for a long time. This management appears to be new to this contingency planning.

Really the company needs to be able to thrive in an environment where oil prices are in the $30 per barrel price range. That should assure profitability in about the most conservative or extremely industry hostile environments. That would be a change from "breakeven at the current trading level." But management needs costs to be lower than the current price so that this company makes money even if the rest of the industry loses money. This company is not diversified, so it has no other choice. It has to be the lowest cost producer.

There are still some inconsistent strategies and assumptions that need to be worked out. First, the company wants to grow dividends as a very high priority. Since dividends are a function of profits, then maybe, just maybe, management should be focused on cash flow and profitability before even discussing the dividend. A dividend needs support from somewhere and a company that is selling properties plus paying down long-term debt does not need to waste cash on a dividend to shareholders. Basically, the company is issuing a liquidating dividend in this situation which sends a very bearish signal about the company's future to shareholders.

Next the company wants to maintain an "A" credit rating. This is a very responsible and well-noted goal. However, management needs to do a lot more than state this goal. They need to break apart all the requirements for that "A" credit rating and how they intend to meet each individual requirement. Property sales and increasing dividends will not completely reassure bankers. Far more emphasis needs to be stated on cost cutting and production growth. Holding production flat while all the industry reports significant operational improvements, may not be much of an accomplishment even for a very large company such as ConocoPhillips. ConocoPhillips needs to demonstrate how this company offers investors superior investment opportunities to other comparable investments. Right now that message is not very clear.

Selling (hopefully) high cost properties and paying down debt are responsible. But a demonstration of the potential of the remaining properties by showing production growth is probably a mandatory requirement as well. Otherwise it will be hard for Mr. Market to see much future in a company such as this. There has to be a benefit that ConocoPhillips has from the remaining properties that will result in superior prospects. Otherwise this company needs to split into smaller pieces with each part demonstrating its value.

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Source: ConocoPhillips November, 2016, Analyst and Investor Meeting Slide Presentation

Large companies often take a long time to turn around. These slides are a good of example of some of the reasons why. The first slide shows the accomplishment of increasing lower cost reserves as well as total reserves. But the second slide really does not emphasize future growth enough. For shareholders that have suffered through a dividend cut, there needs to be far more emphasis on restoring cash flow and future growth. That is the only way for shareholders to get back to breakeven. So while the company is touting the future prospects of different projects, the overall message is flat production and downsizing sales. The message to shareholders is still inconsistent.

The company has a generous credit line, and the debt markets are open to reasonable propositions. Management needs to determine the steps necessary to put this company back on the growth track (besides stating the goal is important). In addition to property sales a key acquisition or two along the lines of Marathon Oil (NYSE:MRO) maybe a sensible guideline. Marathon management has adroitly repositioned the company for future profits in about a year. ConocoPhillips may be a larger company, but management could still learn a thing or two by watching the competition.

Even with large companies, at some point Mr. Market will lose patience with the pace of progress made. For now, that does not appear to be a concern, but the longer this company progresses without significant growth or without sufficient cash flow, the higher the risk of a downward stock price adjustment. Increasing cash flow from operations usually precedes share price appreciation. Until then shareholders need to beware, as the stock may become a short target. Right now the stock is best left to traders to take advantage of price swings and momentum changes.

Disclaimer: I am not an investment advisor and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.