ConocoPhillips (COP) is one of the most popular energy stocks among hedge funds. At the end of last year, there were 39 hedge funds reported to own ConocoPhillips in their 13F portfolios. These 39 hedge funds invested about $3.4 billion in total in this $98 billion market cap stock. Among them, billionaire Warren Buffett was the most bullish money manager about ConocoPhillips. As of December 31, 2011, Buffett's Berkshire Hathaway had $2.12 billion invested in this stock. Many other well-known fund managers, including Bill Miller, Jim Simons, Louis Navellier and David Dreman, were also bullish about ConocoPhillips. Why do hedge funds love ConocoPhillips and should ordinary investors follow them into ConocoPhillips?
ConocoPhillips is currently trading at a P/E ratio of 8.8, a significant discount to the industry average of 17. The reason for the relatively low P/E ratio is probably because the slightly lower earnings expectations for the upcoming years compared with its earnings in 2011. Analysts expect ConocoPhillips to earn $8.35 per share in 2012 and $8.55 per share in 2013, versus $8.77 per share in 2011. The stock is currently trading at about $77.26 per share. So its P/E ratio for 2012 is about 9.3 and its P/E ratio for 2013 is around 9.0, still below the average of its peers. Over the long term ConocoPhillips' earnings are expected to grow at around 3% per year. As conservative investors, we like the stability of ConocoPhillips' earnings.
ConocoPhillips has a dividend yield of 3.45%, which is good for dividend investors. Though the dividend yield is not very high to attract the attention of income investors, we see great potential for future dividend growth. ConocoPhillips' payout ratio is only about 30%, which means that the company has the ability to further increase its future payouts. In fact, ConocoPhillips has an impressive record of increasing dividends. It has been raising its dividend payments for 11 consecutive years. It recently increased its quarter dividend by 20% to $0.66 per share, which was paid to its shareholders at the beginning of March.
ConocoPhillips' earnings yield is more than 11%, versus 3.45% for its dividend yield. What does the company do with the rest of the money it makes? It buys back shares, which is also good for shareholders. The company suspended its share repurchase program in 2009 when the oil prices dropped to about $40 per barrel. But when oil prices rebounded to above $80 per barrel in early 2010, ConocoPhillips announced a share repurchase program of $5 billion and resumed the program in the second quarter of 2010. In 2011, it bought back over $11 billion of its stock. It also plans to purchase $10 billion worth of more shares in 2012.
ConocoPhillips also plans to spin-off its refining and marketing business. In July 2011, the company announced that it would split its upstream and downstream businesses via a tax-free spinoff of the refining and marketing business to its shareholders. The spin-off is expected to be done in the second quarter of this year. This may unlock some value as the spin-off will enable each entity to pursue its own strategy.
Spin-offs always attract event-driven hedge funds. This explains the large hedge fund interest in the stock (see the list of hedge funds with COP positions). ConocoPhillips also has an asset disposition program. In 2010, the company said it plans to divest about $10 billion of its assets in the next two years and use some of the proceeds to pay down its debt. As of February 2011, the company has sold its 20% stake in Lukoil and received about $9.6 billion in proceeds. In 2012, it plans to sell about $5-10 billion worth of assets. We believe the asset sales will increase the company's net income and cash flow on a per barrel basis in the near term.
Competitors of ConocoPhillips include Chevron Corp (CVX) and Exxon Mobil Corp (XOM). All these energy stocks are trading at attractive valuation levels. Their current P/E ratios are 8.19 and 10.22, respectively. They also have decent dividend yields of 2.94% and 2.18%, respectively. Chevron is expected to earn $12.93 per share in 2012 and $13.34 per share in 2013, so its forward P/E ratio is 8.5 and its P/E ratio for 2013 is 8.3. Exxon Mobil is expected to make $8.23 per share and $8.84 per share respectively in 2012 and 2013, so its forward P/E ratio is 10.5 and its P/E ratio for 2013 is 9.8.
ConocoPhillips' 2013 P/E ratio of 9.0 is lower than Exxon Mobil's but slightly higher than Chevron's. But we actually love both stocks. They make more than 10% per year with stable growth and distribute about 20-30% of their earnings as dividends. They also have strong dividend growth history. Chevron has been increasing its dividend payouts for 24 consecutive years. We picked COP over CVX because its management is more shareholder friendly. They implemented higher dividends, share buybacks, asset divestitures and spin-offs. That's why we are long-term investors of the stock.
Note: This article is written by Guan Wang and edited by Meena Krishnamsetty. Meena has a long position in COP, whereas Guan doesn't own any shares in the companies mentioned in the article.
Disclosure: I am long COP.