ConocoPhillips
ConocoPhillips (COP) has had a high legacy asset drive for more than five years of low risk growth, and proven resources, which reduce the downside risk of the stock.
COP has positioned the company as a high-yielding E&P offering a dividend yield of 4.8%. The company shared its plan to achieve growth going forward by shifting to high margin production, and reinvestment of cash flows to achieve organic reserves replacement of more than 100%.
A key risk to the profitability of COP and the E&P Industry is the further decline in oil prices internationally and a reversal in the oil prices will be a positive trigger.
Industry
Oil and gas are among the most widely used commodities for energy consumption in the world today. The demand for oil and its price is linked to the economic conditions prevailing in the global markets. Demand has in the past been affected by economic slowdowns and recessions.
The Oil Industry is distributed in two major segments: Upstream (Exploration and Production), Downstream (Refining and Marketing). The Upstream segment is primarily involved in the exploration of new oil and reservoirs and production of oil and gas from existing and new reservoirs. The Downstream segment is involved in the refining of oil, and marketing and distributing of oil and natural gas to different consumers.
Company Overview
ConocoPhillips was an integrated energy company with a presence in the U.S and International markets. COP was the third-largest integrated energy company in the United States, based on market capitalization. However, as per the approval of the Board of Directors and in line with the reposition plan of the company, it completed the spin-off of its downstream businesses to its shareholders. After the spin-off, COP has become the largest independent exploration and production (E&P) company, based on proved reserves and production of oil and natural gas as announced by the company.
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Source: Company Presentation (pdf)
Annual CAPEX of $15 billion
COP has announced plans to undergo a disciplined CAPEX of approximately $15 billion per annum, which is expected to support the company's reserve replacement target of more than 100 percent. The company expects that 2013 onwards it will generate 3-5 percent annual production and margin growth from important development projects under way in the onshore United States (unconventional), United Kingdom, Norwegian North Sea, Canadian heavy oil sands, Malaysia and Australia.
Investment in Unconventional oil and gas
COP currently has a relatively lower dependence on unconventional production of oil and gas. However, as per the company's plan, it intends to achieve growth and is expected to increase its production of unconventional oil and gas.
As per a report by analysts at JP Morgan & Chase, contrary to conventional production, the first-year production of unconventional fuels is very high, but it drops drastically after the first year. To maintain growth, the cash flows generated must be reinvested continuously in other development wells, which increase the capital intensity of the company.
Due to the continuous reinvestment of cash flows to develop new wells, the dependency on cash flows shifts from longer duration to shorter duration, and is more severely affected by price swings, since not only does the cash earned decrease, but production and growth are also impacted.
Cash Generation to be of interest
It will be of interest to see how COP manages its cash flow going forward as an independent E&P company. COP plans to reinvest 75-80% of its cash flows, which will be dependent on commodity prices going forward, and may be difficult since the company does not enjoy the benefit of downstream cash flows providing support to the upstream investment program in times of weak commodity prices.
Bid for Canadian Oil sands assets
According to market rumors and the management's policy of divesting its assets, the Oil & Natural Gas Corporation Limited is in consultation as to whether to bid $5 billion ConocoPhillips Oil Sands Assets in Canada. Any development on this front may be positive for the company.
Share repurchases
As announced by the company, it will continue with its share repurchase program through the open market in 2012, and this is expected to provide additional support to the stock price.
Turn around and scheduled maintenance
The production and earnings for the second and third quarter of 2012 are expected to be affected by major turnarounds, scheduled maintenance, dispositions and seasonality. Consistent with the previous earning guidance provided by the company and depending on the timing of the disposition, the production for FY2012 is expected to be 1.55-1.60 million of BOE per day
Oil and Natural gas prices and its impact
Oil prices have taken a dip of approximately 20% since the beginning of 2Q2012 to date. Since COP is now only an independent producer, its revenue and earnings will severely be impacted by the prevalent oil prices.
The following graph shows the relation between oil prices and the stock price
Natural gas prices have taken a dip in the U.S., and are trading at $2.40/MMBTU, a decline of 49% compared with $4.10/MMBTU average price for 1Q2011.
COP a dividend play
COP has positioned the company as a high-yielding E&P, in a sector where investors have historically rewarded portfolio and production growth over cash returns to shareholders (dividend and share repurchase) and free cash generation. The share price performance of COP will depend on whether dividend-seeking investors view COP as a low volatility stock.
Stock Price Performance
The stock price performance has shown a decline of 4% in the previous three months, underperforming the NYSE composite, a decline of 2% YTD underperforming the NYSE composite and a decline of 1% in the last one year, outperforming the NYSE composite.
Financial performance
The EPS of $2.02/share for 1Q2012 increased 11% compared with EPS of $1.82/share reported in 1Q2011.
Following is the E&P net Income attributable to ConocoPhillips
$ Millions | 1Q2012 | 1Q2011 | % change |
Alaska | 616 | 549 | 12% |
Lower 48 | 254 | 314 | -19% |
United States | 870 | 863 | 1% |
International | 1,678 | 1,489 | 13% |
Total | 2,548 | 2,352 | 8% |
Following is a comparison of the cash flow from operations and CAPEX
$ Millions | 1Q2012 | 1Q2011 | % change |
Cash flow from operations | 4,182 | 1,947 | 115% |
CAPEX | (4,260) | (2,884) | 48% |
Competitors
The major competitors of COP include Exxon Mobil Corp (XOM) and Chevron Corp (CVX).
Exxon Mobil Corp is trading at a P/E and P/B ratio of 10.4x and 2.5x, and offers a dividend yield of 2.7%. Its EPS has witnessed a decline of 6.5% in 1Q2012.
Chevron Corp. is trading at a P/E and P/B ratio of 8x and 1.6x, and offers a dividend yield of 3.5%, which is on the high end for the E&P Industry. Its EPS has witnessed a growth of 3.5% in 1Q2012 and its bottom line is expected to decline by 2% for the year.
Recommendation
With high legacy asset drive for more than five years of low-risk growth and proved resources, COP has positioned the company as a high-yielding E&P, and has shared its plan to achieve growth going forward by shifting to high-margin production.
COP is trading at a P/E and P/B ratio of 8x and 1.1x, and is offering the highest dividend yield in the industry. We have a buy recommendation for investors looking for a high-dividend yield and seeking exposure in the E&P Sector.
Investors can short the Oil ETF (USO) to hedge against the long position in COP.
COP | XOM | CVX | |
P/E | 8.1 | 10.4 | 8.0 |
P/B | 1.1 | 2.5 | 1.6 |
P/S | 0.3 | 0.9 | 0.9 |
Dividend Yield | 4.8% | 2.7% | 3.5% |
Total Debt/Equity | 42.6 | 10.0 | 7.4 |
EPS growth 1Q2012 | 11.0% | -6.5% | 3.5% |
EPS growth expected 2012 | -30.0% | -1.9% | -2.0% |
3 month performance | -4% | -1% | -1% |
YTD performance | -2% | -2% | -6% |
52 Week Performance | -1% | 5% | 2% |
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
