Buy the Dip on Big Oil

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Includes: COP, CVX, XOM
by: Tony Kau

As ConocoPhillips (NYSE:COP), Chevron (NYSE:CVX) , and ExxonMobil (NYSE:XOM) lick their wounds after the recent 12% draw-down, let's take a peek at the outlook, fundamentals, and correlation of these U.S. Supermajors.

With almost boringly consistent margins and steady dividend increases, these stocks appear to be great for the long-term, dividend growth investor. When looking at a multi-year price chart, what we see is a very tight correlation between their price movements, and also with the price movements of crude oil, as you might expect.

As crude plunged recently, we saw that correlation play out, so part of your own valuation should factor in your outlook on crude prices. Another way to look at this relationship could be that these companies are diversified oil ETF's that also pay dividends.

I believe all 3 stocks have upside worth buying, especially after that drop. Using conservative expectations, I modeled all three companies, and was met with three very similar pictures, like this model of XOM, below.


(Click to enlarge)

In this chart, Valuation is based on a DCF model, using approximately consensus numbers. I decreased expected growth rate and margins to be on the conservative side, but even with modest inputs, the valuation is much higher than the current trading price. The buy/sell bands are a function of the price volatility, where significant deviation is seen as a buy/sell signal. My price targets with consensus estimates for all three:

My price targets for XOM and COP were substantially higher than their consensus target, while CVX came in just under consensus. Let's take a look at the key reasons why.

Looking at just the price-to-book, price-to-sales, and free cash flow per share, it's easy to see that COP has less downside (and therefore, less absolute downside risk) to account for, boosting the overall valuation. From a longer-term perspective, the estimated growth rate for XOM is more desirable, but all growth rates are lower than my applied discount rate, so we see the long-term price target decline, as in the valuation chart above.

Another aspect contributing to COP's higher valuation is the management's commitment to repurchasing stock. Historically, XOM and CVX have been more consistent with repurchases, but for 2010 and so far in 2011, both have diluted their shares while COP has repurchased. After reading Jeffrey Sheets' comments on their recent buy-back efforts (and assurances of future efforts), I believe we'll see an even better looking 2011. They have already bought back over 5% of outstanding shares (~$2.5 B) in the last few months, so they are clearly putting their money where their mouth is.

From a technical standpoint, the recent dip provides us with a supported buying opportunity as the recent price decline has eased on shrinking volume at a previously established reversal point.


(Click to enlarge)

All three are also ranked highly on Motley Fool's CAPS, with XOM and CVX receiving 4-stars, and COP earning the coveted 5-star ranking.

I am recommending a Buy on COP, preferential to XOM and CVX, because I believe it has less downside, higher beta, higher dividend yield, and is technically poised for a reversal to the upside. However, I do believe that all three have a near-term positive upside in store.

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