ConocoPhillips Has High Upside Potential In 2012

| About: ConocoPhillips (COP)

What's the advantage of being the third biggest player in a stock category? Well, for one thing, expectations are lower for you than they are for your "top dog" peers. For another, you know where your competition is heading and what it will take to close the gap. Finally, the stock analysts who follow your industry may be looking with more scrutiny at your competitors, giving number three a chance to fly under their (often highly critical) radar.

ConocoPhillips (NYSE:COP) is one of those number-three stocks. The third largest US-based integrated energy company by market cap, ConocoPhillips is one of the big boys in a highly profitable industry. Of the six so-called SuperMajors (the biggest of the world's publicly traded oil and gas producers), ConocoPhillips ranks sixth behind Exxon Mobil (NYSE:XOM), Royal Dutch Shell (RDS-A), Chevron (CVX), BP (BP), and Total (TOT). Only Exxon Mobil and Chevron outearn ConocoPhillips among US oil producers.

As one of the biggest players in the industry, ConocoPhillips has interests in the exploration and production, refining, marketing and distribution of petroleum products. In addition, it has operations that produce chemicals, biofuels, solvents, and even alternative energy products. This is a truly diverse energy company, and I believe one that's worth a closer look.

Recent Numbers

The law of large numbers applies to nearly every company, and ConocoPhillips is no exception. The larger a company grows, the harder it is to continue at the same pace. In 2011, ConocoPhillips had revenues of $251 billion. This was a greater than 25% growth rate from the prior year, and one of the biggest percentage gains among its peers - although it was a slight decrease from the 2010 growth rate.

For the future 5 year period, the average growth target of the analysts who follow the stock is a meager 4.6%. I feel this is way too low a number, given the expected increase in oil and natural gas prices, and a turnaround in the world's economies. If we were to use a less conservative growth target of 8%, the company's PEG ratio would be under 1.00. On a per share basis, the company earned $2.02 last quarter, an increase from $1.32 per share in the previous quarter.

Finally, a historic multiple for ConocoPhillips is around 11.5 times annual earnings. The current multiple of 8.5 times represents a 35% under-valuation. Peers such as Chevron and Exxon Mobile command forward multiples of 9 and 10.5, despite lower expected growth rates. If we apply the historic multiple to ConocoPhillips stock at current levels, we arrive at a per-share price of $102. Presently the stock is trading at around $76 per share.

Future Catalysts

In addition to the under-valuation on a growth and earnings-multiple basis, ConocoPhillips has other exciting prospects in the pipeline (pun intended). It was reported last year that ConocoPhillips will be splitting into two companies in April 2012. The refining and marketing assets of the company will be spun off as Phillips 66, a throw-back to the original name, while the E&P side of the company will retain the ConocoPhillips name. Holders of the stock will receive one share of Phillips 66 stock for every two shares they hold of ConocoPhillips.

This split is widely expected to unleash value in both segments of the business. The refining arm will no longer have the capital debt rate of an E&P company, while the ConocoPhillips business will get to leverage expected upside in the future price moves of oil and natural gas. As an operator in relatively safe areas of the world, the new stand-alone will reap the benefits of global tensions in the oil markets, with any of the actual risk.

Another catalyst for this stock is a recently announced joint project between ConocoPhillips and a group comprised of BP, Exxon Mobil and TransCanada. In an agreement with the state of Alaska, a $26 billion pipeline is to be built, which will carry up to 70,000 barrels of oil per day to the Trans-Alaska Pipeline System. This joint project will open up resources in the North Slope region for each of the companies to explore. It is expected that more than 200 million cubic feet of natural gas per day will be extracted from this area. A natural gas liquefaction terminal will also be developed as part this project and may involve the new Phillips 66 refining company in its operation.


As with any potential stock investment, we must take a look at the risks involved. An integrated oil company's stock is an inherently riskier investment, simply due to the effects of market fluctuations in its products. Typically oil companies have a higher beta rating, meaning that they are more volatile than the overall market. ConocoPhillips has a beta of around 1.2, meaning that it is 20% more volatile than the average stock.

ConocoPhillips also has a less than consistent revenue history, having been all over the map in the past five years. While this is somewhat expected in the industry, it makes for a wild ride along the way. In 2008 alone, the value of the company dropped nearly 40%. But, if you can pick up the stock on dips like this, ConocoPhillips is likely to reward an investor handsomely over time. And if you have time to wait, this undervalued gem pays out a nice 3.8% dividend as well.

In a nutshell, ConocoPhillips is a company with lots of possible upside, and downside that's no greater than its peers. Future catalysts leave open plenty of room for growth, especially considering the upcoming split between the two sides of the business. If you're an investor looking to participate in the oil and gas industry, this may just be the right stock for you.

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

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