ConocoPhillips Does It Again, Say Hello To FCF

| About: ConocoPhillips (COP)
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Summary

Overall, a solid earnings report from ConocoPhillips.

Free cash flow generation, a dividend increase, share buybacks, and debt reduction, with more good news to come.

There were plenty of positive operational gains realized during the quarter, but no major new pieces of info came out on that front during the release.

Expect to hear more about its divestment program throughout the year, with an eye on its San Juan operations.

International court awards ConocoPhillips $380 million over Ecuador's expropriation of Burlington Resources' assets back in 2009, and there is a good chance the firm will see that cash.

Leading into ConocoPhillips' (NYSE:COP) Q4 results the super-independent announced that it was increasing its quarterly dividend by 6%, equal to an annualized payout of $1.06/share. What made this piece of news particularly interesting is that is comes just under a year after cutting its dividend by roughly two-thirds (from an annualized $2.96 to $1/share) when oil markets were deep in the downturn, and was a vote in favor of a sustained recovery in the sector.

The dividend increase was a positive surprise for me, I wasn't expecting that until a couple of quarters down the road but as a shareholder I'm glad it happened. Now that ConocoPhillips' results are out the market has a better idea of management's rational.

Favorable financial updates

During Q3 and Q4, when energy prices were slightly lower than the 2017 YTD, ConocoPhillips was able to generate enough operating cash flow net of working capital changes to cover both its capital expenditures and its dividend payments. This, combined with a favorable macro environment relatively speaking, prompted management to have greater confidence in Conoco's cash flow generating ability.

Keep in mind Conoco still posted a loss of $35 million, which when adjusted for special items goes up to a loss of $318 million, largely due to a DD&A expense of $2.061 billion. As that is a non-cash charge representing (primarily) the recognition of the cost of the projects Conoco has completed and the associated depletion of those reserves, with the cash aspect already realized on the balance sheet, its operating cash flow streams moves up to $1.753 billion before working capital effects.

Including working capital effects which consumed a net $240 million in cash (factoring in both operating and investing related changes), Conoco's net organic cash flow generation clocked in at a little over $1.5 billion in Q4. That was able to more than cover its $1 billion in capex spending and $313 million in dividend payments, along with $126 million in share buybacks.

Asset sales, which raised a little under $900 million, helped Conoco retire $1.4 billion in debt in Q4 and was attributed to part of management's reasoning behind the repurchases. During its conference call management commented that investors should expect to here periodic updates on its divestiture program throughout the year but didn't say much more than that, other than its San Juan position was receiving a good amount of interest and that bids would be coming in within the next few months.

ConocoPhillips is maintaining its commitment to return 20% - 30% of its operating cash flow to shareholders. Dividend payments that are sustainable and manageable in the current environment represent most of that, with strategic buybacks being implemented at a pace that Conoco's management was coy about (for a reason, the company wants to repurchase as much stock as possible for the lowest price within the parameters of its cash flow position).

Reading into the bits of info Conoco put out, it seems dividend increases will be the main way the firm wants to reward shareholders with buybacks representing a nice cherry on top. One thing management did bring up was that the pace of its asset sales would be a big determinant in its $3 billion repurchasing plan, so when news of a sale comes out expect to see some more aggressive share count reductions.

The biggest takeaway from Conoco's Q4 results is that it is now in a sustainable financial position. Free cash flow generation in a ~$49 WTI/Brent world paints an optimistic picture going forward. Conoco's operating costs are projected to move down by half a billion dollars this year, while its $5 billion 2017 capex budget is on par with the $4.9 billion (less than expected) it spent last year.

Production comes in strong

Even as the super-independent spent less than forecasted its production base (adjusted for asset sales) still grew by 3%, the top end of its guidance. Conoco is guiding for adjusted 0% - 2% output growth this year with its unconventional position playing a key part in that. That will see its production base grow from 1.54 million BOE/d in 2016 to 1.54-1.57 million BOE/d this year.

By the middle of 2016, Conoco was running just two rigs in the Eagle Ford and one in the Bakken, leading to production declines. To turn that picture around Conoco added four rigs to each of those plays by early-2017. What's also very interesting is the firm deployed a rig to its unconventional Permian division, which is targeting resources in the Delaware Basin at the China Draw area. By early-February another rig will be added to its Permian division.

Management noted that a third rig is expected to hit the Permian sometime this year, which may also operate in the Niobrara play for part of 2017. This rig will target both conventional and unconventional plays in the Permian and if it does hit the Niobrara play, will be used for appraisal, delineation, and optimization purposes to set the stage for full field development later on.

Investors should expect to here a lot more operational updates, particularly in regards to the Permian, throughout the year as unconventional drilling activity is aggressively ramped up. The increases in the Eagle Ford and Bakken/Three-Forks plays were expected but the additional rigs hitting the Permian and Niobrara indicates that improvements in the macro oil picture have brought about a renewed confidence in developing ConocoPhillips' domestic resource base.

Around a third of Conoco's production base doesn't begin to decline for a little over a decade, enabling the firm to push down on its capital expenditures (2016 budget was half of 2015 budget) while still generating growth. The ramp up at the Australia Pacific LNG venture will provide a major boost to Conoco this year as the second train was brought online in Q4, aided by additional increases from its FCCL (Foster Creek and Christina Lake expansions were brought online last year) and Surmont oil sands ventures as well.

Final thoughts

ConocoPhillips' Q3 and Q4 results proved that the super-independent was able to rise above its massive cash flow shortfall situation, and going forward, that there is plenty of room for additional financial and operational gains to generate strong returns for shareholders (including myself).

Updates regarding operational improvements were positive but light on new information. Management noted that drilling and appraisal activity would continue in Chile and Colombia this year, indicating that past results (including two exploration wells recently drilled in Chile) must have been favorable enough to merit the additional spending but that's all that was given.

Pivoting up North to Alaska, management highlighted that the Willow discovery could house over 300 million recoverable barrels of oil and that 3D seismic activity was underway, but that was about it. Not bad, but not anything that wasn't already known which indicates management may be waiting until its Q1 earnings report or its annual investor meeting in May to offer up material operational updates.

This earnings release was more about ConocoPhillips showcasing its ability to deliver on cutting costs (capex and OpEx), bringing projects online (second train at the APLNG complex, such as the non-operated Alder project in the North Sea, the Malikai oilfield JV in Malaysia, the operated Drill Site 2S development in Alaska, and expansions at the FCCL JV targeting Alberta's oil sands resources) and delivering on its production growth targets, rewarding shareholders (dividend increase and share buybacks), and being able to stick with fiscal discipline even as energy prices move higher.

Overall, a solid quarter for ConocoPhillips and one that reinforces my bullish sentiment. Investors with a long term investing horizon looking for a top tier way to play a rebounding oil & gas sector should take a look at ConocoPhillips.

As an added bonus, ConocoPhillips just announced that the International Centre for the Settlement of Investment Disputes had awarded the firm $380 million for assets Ecuador illegally expropriated from Burlington Resources (which Conoco purchased in 2006 after announcing the deal in 2005) back in 2009.

However, ConocoPhillips will have to pay Ecuador $42 million "for limited environmental and infrastructure impacts associated with the operations of the Consortium." Considering Ecuador recently paid Occidental Petroleum Corporation (NYSE:OXY) roughly a billion dollars over assets the nation expropriated, it isn't unreasonable to assume ConocoPhillips will get to see that cash.

Disclosure: I am/we are long COP.

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.