ConocoPhillips: Slightly Expensive At $60.60; Buy On Weakness
Summary
- ConocoPhillips is the largest independent oil producer in the world, and enjoys the advantage of holding the highest quality oil producing assets in the industry.
- However, absolute oil production is decreasing, and management has no interest in expansion despite oil rising higher.
- The company's current valuation is slightly expensive compared to its competitors.
- The author recommends a hold (and watch) for COP at $60.60. Look to buy the company at $55.00 per share.
Introduction
ConocoPhillips (NYSE:COP) is the largest independent oil producer in the world, and its shares have performed relatively well as of late. The company enjoys incredible competitive advantages in holding high quality assets, but its production growth prospect is lacking. After considering the company's strategy and a variety of factors, the author recommends a hold (and watch) for the share at $60.60, and a buy for the shares at $55.00. These opportunities should come frequently.
Here are some more key facts about the company:
Share Price: $60.62 per share
Market Cap: $69.40 billion
Dividend Yield: 2.0% and projected to grow
ConocoPhillips' Competitive Advantage – Extraordinary Quality Assets
ConocoPhillips has an incredible competitive advantage in holding some of the highest quality oil producing assets in the industry. Without going too much into details, here is a short summary of its global oil producing assets the company holds:
| Type | Reserve | Supply Cost | Major Locations |
| Unconventional Plays | ~8BBOE | $35/BBL | BC, Delaware, Eagle Ford, Bakken |
| Conventionals | ~4BBOE | $30/BBL | Alaska, UK, Indonesia, Malaysia |
| LNG/Oil Sands | ~3BBOE | $35/BBL | Alberta, Qatar, Australia |
Source: Page 22-24, COP's investor report.
To summarize COP’s assets, they have an average breakeven cost of under $40 WTI, and can continue production for at least 20 years with minimal capital spending, according to CEO Ryan Lance. The company's assets have the lowest breakeven cost in the industry, and can sustain current production rates for decades.
Source: COP's February Investor Update
The author views owning oil producing assets much like owning land in monopoly, where holding and developing the best areas will yield incredible returns over time. All in all, these high quality assets are an extraordinary advantage for COP and its shareholders, which should guarantee long term performance for the company and support its share prices and dividend payments.
Long Term Strategy - Concerns Regarding Lack of Growth
ConocoPhillips' long term strategy is to take advantage of current world-class quality assets and use the free cash flow to pay down debt and buyback shares. The company’s goal is to reduce debt to $15 billion by the end of 2019, and to spend the rest of the money incrementally increasing the share buyback program. Here’s a summary of COP’s progress so far in achieving these goals:
| Q1 2017 | Q2 2017 | Q3 2017 | Q4 2017 | |
| Debt Paid, Net | 839M | 3.24B | 2.51B | 1.28B |
| Share Buyback (in monetary value) | 158.0M | 980.0M | 972.0M | 953.0M |
Source: COP's Cash Flow Statement.
In the author’s opinion, COP’s strategy is sound given the company’s competitive advantage of holding high quality legacy assets. However, the strategy’s benefits to shareholders in the long run are minimal at best because interest rates are still at historic lows and company’s shares are at multiple year highs. A closer look at the company’s annual report indicates that COP’s (absolute) production will decrease moderately in 2018 from the 2017 levels:
The absolute oil production will decrease for ConocoPhillips in 2018.
This decrease in production may be worrying to current and prospective shareholders, and cannot continue going forward. To the author, it is troubling why the company is still sticking to a $5.5 billion capital spending plan in 2018 (although it is up from $4.5 billion in 2017). As the price of Brent has increased from $50 to $65, the company will have an additional free cash flow of around $3 billion in 2018, and management seems to be sticking to the plan of paying down debt and buying back shares while ignoring expansion. As oil prices continue to grow, the absence of increased capital spending and production growth seems rather troubling to the author. Although the current strategy certainly will not hurt investors in the short term, ConocoPhillips and its management is definitely not extending its competitive advantage and generating additional shareholder value.
Energy Sector Under-Performance and Possible Effects on COP
Although COP enjoys an incredible competitive advantage when compared to other oil producers, the entire energy sector has under-performed woefully during the past year and half. In fact, the S&P 500 Index has averaged a return of 23% in 2017, while the energy sector only averaged slightly above 5%. The sector's under performance is could be very concerning for ConocoPhillips, as individual stock returns generally follows the sector's performance in the long term. Fortunately for COP shareholders, the company's shares performed relatively well during 2017 though an under-performing sector is still a concern going forward.
Source: COP's February investor update.
Recent News - $250M Sale of Non-core Assets in Permian
Recently, ConocoPhillips has closed on a $250 million sale of assets in the Permian Basin area. These sale will have minimal effects on company operations because the areas sold are mostly undeveloped and unused by the company. Using this money, COP is buying acreages in Louisiana and Canada, and will start drilling in 2018.
In the author’s opinion, this is very good news as management looks to sell some of its unused assets at very high prices. (Many companies are moving into the area and paying up to $76,000 per acre - see here) In the same time, COP is using the money and looking to grow production. Although this is good sign, the author is looking at more of these moves in the months to come.
Valuation and Recommendation
See below for a summary of a few valuation metrics for ConocoPhillips as compared to its major competitors. All in all, the company is not cheaply valued at all, and may even be priced slightly above its fair valuation. In the author’s opinion, an entry into the company at the current share price of $60.60 is a fair deal at best despite the company’s extraordinary competitive advantage.
| Company | P/E Forward |
| ConocoPhillips (COP) | 24.51 |
| Exxon (XOM)* | 17.95 |
| Chevron (CVX)* | 19.34 |
| Occidental (OXY)* | 26.25 |
| EOG Resources (EOG) | 23.70 |
*Although integrated majors are different from COP and include assets in refining, the majority of their revenue and assets still come from their oil producing upstream segment.
After comparing the valuation of COP to its competitors, the author recommends investors to hold current shares, watch COP, and look to accumulate shares at around $55 per share. These buy-on-dip opportunities will come very frequently with the company, due to the stock's relatively high volatility for its market cap. In fact, COP frequently rises and falls 2% to 3.5% on a daily basis when oil prices are fluctuating, which is about 200% to 300% the volatility of other large cap energy companies, such as Exxon Mobil.
Conclusion
In conclusion, ConocoPhillips is an incredible oil producer holding very sustainable and impressive competitive advantages. However, the energy sector has under-performed as of late and the company's shares are at multi year highs. As a result, the author recommends a hold for the company at current prices of $60.60, and a buy at a lower price of $55.00.
This article was written by
Analyst’s 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.
My recommendations are based on my personal opinions after thoroughly researching the company. If you like my analysis and wishes to enter into a position, please do additional research including carefully considering the opinions in the comments section. Also, please properly size your positions conservatively. If you disagree with any part of the analysis or have anything to add, please do explain your valued opinion in the comment section below. Thank you so much in advance.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.