ConocoPhillips: Neutral Is The Biggest Positive

| About: ConocoPhillips (COP)
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A key analyst could only upgrade ConocoPhillips to Neutral despite a lagging stock price. .

The oil market is moving back towards production growth while the independent energy company is upside down on profits and free cash flow. .

The investment thesis remains negative until the company is on the right side of the energy curve. .

The good news is that ConocoPhillips (NYSE:COP) got an upgrade. The bad news for shareholders is that the analyst only sees the stock worth a slight bump from the current price despite some positive views on the company.

Source: ConocoPhillips website

ConocoPhillips ended 2015 at about the same levels as the stock now trades mid year in the mid-$40s. My investment thesis for a while on the large independent E&P firm is that oil prices would stall far below where the company needs to see prices to cover even the reduced spending levels.

Meager Upgrade

Analyst Phil Gresh from JPMorgan upgraded ConocoPhillips to Neutral on the back of the stock lagging a peer group this year. The analyst doesn't see anything necessarily bullish on the stock outside of a stock price that hasn't kept up with the group.

The biggest issue for the energy producer is that oil peaked around $50/bbl and all signs point to ramped up production at those levels that will cap prices. Not only did the Baker Hughes weekly report show the biggest increase in North American rigs drilling for oil in six months, but also OPEC is producing oil near record levels.

OPEC collectively grew production by 300,000 b/d in June to 32.73 million b/d. So as Brent Crude surpassed $50/bbl, OPEC produced the highest total since August 2008. A big reason for the production gains is the ramp up from Iran without any corresponding declines. Iran is no producing 740,000 b/d above the December levels.

Upside Down

The upcoming Q2 earnings release on July 28 before the market opens will tell a lot about the near term for ConocoPhillips. The company has cut capital spending to the bone, reduced the dividend, and crucial global oil prices possibly peaked for the year. If ConocoPhillips can't get close to free cash flow breakeven, the market might have to wait a long time.

As a reminder for Q1, the company produced $0.7 billion in cash flow from operations while paying out $2.1 billion in capex and dividends. In the end, ConocoPhillips borrowed $4.5 billion during the quarter to only increase the cash balance by $2.8 billion as even working capital cut cash balances by $0.4 billion.

The combination of higher energy prices with oil touching $50/bbl during June and spending the quarter mostly above Q1 prices, ConocoPhillips will provide some insight on what the financials look like in a near-$50 oil environment.

The biggest concern is that the energy producer along with the sector remains upside down. ConocoPhillips needs higher prices to produce profits and positive free cash flow, yet the industry started drilling again when oil prices hit $50/bbl.

Analysts forecast a $0.64 loss for Q2 and only a $0.40 loss for Q3, yet oil prices are headed back down. The company remains on the wrong side of profitability where the market wants to ramp up drilling.

COP EPS Estimates for Current Quarter Chart

COP EPS Estimates for Current Quarter data by YCharts


ConocoPhillips remains a difficult stock to own as company struggles to produce profits and free cash flow in this commodity environment. As long as the independent E&P is upside down when the market wants to increase drilling, the stock should be avoided. Turning neutral on the stock is the new positive.

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.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.