ConocoPhillips: Break-Up Of The Company Should Unleash Significant Value

| About: ConocoPhillips (COP)

Shares of oil giant ConocoPhillips (NYSE:COP) lost 0.8% after publishing its first quarter earnings report, moving largely in line with the wider equity markets.

First Quarter Earnings

ConocoPhillips reported first quarter earnings of $2.9 billion vs. a profit of $3.0 billion last year. This year's earnings included a $330 million gain on asset disposals. Earnings per share of $2.02 missed analyst estimates who expected the company to report $2.08 in earnings. Revenues remained flat at $58.4 billion.

"We operated according to plan during the first quarter of 2012, achieving production and refinery utilization targets," according to CEO Jim Mulva. "We continued to progress our asset divestment program and execution of our major projects and growth plans.

Exploration and production

Earnings came in at $2.55 billion vs. $2.35 billion last year. Excluding one-off items earnings came in at $2.13 billion, down 3% on the year on lower volumes, higher taxes and lower natural gas prices. Production fell by 65,000 barrels to 1.64 million barrels per day and is expected to fall further in the second and third quarter on higher maintenance levels and asset disposals.

For the full year of 2012 the company expects production to come in at 1.55-1.60 million barrels. Furthermore the exploration division has an investment budget of $15 billion for the entire year of 2012 after investing $4.2 billion in the first quarter.

Refining and Marketing, Chemicals and Midstream

The refining and marketing earnings fell 6% to $452 million on lower refining margins. The capacity utilization rate increased to 91% on minimal downtime. Improved market crack spreads could not offset the impact of less favorable crude differentials.

Chemical earnings increased to $218 million as industry margins for ethylene were the highest in over two decades. Midstream earnings increased to $93 million on higher volumes from less downtime.

Strategic Repositioning

The company has decided to split up in two companies. ConocoPhillips will focus on production and exploration while Phillips 66 will focus on refining, marketing and distribution activities.

After a favorable tax ruling and a final decision of the board of directors the break up of the company is expected to be effective as of the 1st of May.


ConocoPhillips ended the first quarter with $4.2 billion in cash and short-term investments. The company operated with $28.4 billion in long term debt for a net debt position of $24.2 billion. The market value of the oil major is about $92 billion which values the company at 0.4 times annual revenues and 7.4 times 2011's annual earnings.

The valuation multiple of 0.4 times annual revenues compares to a 0.8 times revenue multiple for competitors Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM). The break up of the company in an upstream and downstream business is the first step in closing the valuation gap compared to its major two competitors.

The company is on track to repurchase $5 billion in its own shares during the first half year of 2012 and it pays a $0.66 quarterly dividend for a 3.6% annual dividend yield.

Investment Thesis

ConocoPhillips published a decent first quarter earnings report. Despite rising oil prices, which have seen a little correction in recent weeks, shares are unchanged on the year as natural gas prices have fallen to record lows. Furthermore volumes are depressed on higher maintenance levels.

The break up of the company into ConocoPhillips and Phillips 66 will reduce the corporate overhead and result in two separate companies which are entirely focused on their "core" activities which should result in a strong margin expansion. This break up will be the main driver behind an increase in the valuation of the firm.

An investment in ConocoPhillips is a decent addition in any long term diversified portfolio.

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