Factors That Will Drive ConocoPhillips’ Stock Price

by Trefis Team
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ConocoPhillips (NYSE:COP), one of the largest independent oil and gas companies, showed a remarkable improvement in its March quarter performance, driven by the recovery in commodity prices and the company’s efforts to bring down its break-even price. In addition to this, the US-based company has sold its Canadian assets, and raised $10.6 billion in cash, which it plans to utilize to reduce its leverage and enhance its shareholder returns. Thus, despite the volatility in the commodity markets, we expect that the extra cash from the Canadian deal will enable ConocoPhillips to optimize its capital structure, which will prepare the company to deal with the future course of commodity prices. Based on these factors, we have revised our price estimate for the company to $53 per share, which is 16% higher than its current price.

See Our Complete Analysis For ConocoPhillips Here  

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Source: Google Finance; US Energy Information Administration (EIA)

Aggressive Asset Sales Will Boost Profits

Given the turmoil in the commodity markets, ConocoPhillips’ profitability has deteriorated severely over the last three years. Thus, in order to survive in the downturn, the company has been divesting its non-core and low-margin assets over the last few quarters. At the beginning of the year, the company had expected to close asset sales of $5-$8 billion in 2017. However, as the commodity prices rebound sharply in the first quarter, the company managed to divest its Canadian oil sands and San Juan Basin assets in March and April respectively, enabling the company to achieve its asset sale targets way ahead of schedule. On the one hand, the two deals will generate proceeds of over $16 billion for the company, which it is likely to utilize to create a leaner capital structure and enhance shareholder returns. On the other hand, ConocoPhillips will be able to improve its margins due to the elimination of low-margin assets from its portfolio and focus on rich oil plays.

However, on the flip side, these deals could reduce the company’s operations, and, in turn, production in the coming quarters. For instance, ConocoPhillips’ Canadian assets produced roughly 280 MBOED, while the San Juan play contributed 115 MBOED to the company’s output. With the finalization of these deals, the company has revised its production guidance for 2Q’17 as well as for full year. Yet, we believe that streamlining its portfolio and concentrating on key oil plays will allow the company to improve its margins, and offset the impact of lower output.COP-Q&A-1Q17-6

Reduced Break-Even Oil Price Will Augment Operations

To cope with the ongoing oil slump, ConocoPhillips has been working towards reducing its break-even oil price by shedding its low-margin assets, and focusing on low-cost oil plays. At present, the company holds a resource base of 14 billion barrels of oil equivalent (BBOE), which can be categorized into conventional, unconventional, and LNG and oil sands. The resource base has an average cost of supply of approximately $35 per barrel, as opposed to $40 per barrel prior to these deals. This means that even if the commodity prices stagnate at last year levels, the oil and gas company will make higher profits on a year-on-year basis, since it has managed to bring down its operating costs notably.

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That said, ConocoPhillips’ break-even oil price (cost of supply plus other day-to-day expenses) is still around $50 per barrel. While this is significantly lower compared to the break-even price of $75 per barrel in 2014, this implies that the company can make profits only if oil trades at $50 per barrel or more. Thus, despite the company’s  relentless efforts to keep its costs under control, the pace and magnitude of the commodity market rebound will continue to play a critical role in the company’s future value.

Higher Share Buyback Will Enhance EPS & Shareholder Value

Unlike its counterparts who are expanding their output to leverage the anticipated recovery in commodity prices, ConocoPhillips is focused at creating higher value for its shareholders through higher share repurchase and dividends. The company aims to pay 20% to 30% of its cash flows from operations to shareholders through dividend and share buybacks over the next few years. In this regard, the company had previously planned to repurchase $1 billion worth of stock in the current fiscal year and up to $3 billion by 2019. However, with the sale of its Canadian assets, the exploration and production (E&P) company has authorized an additional sum of $3 billion for its share repurchase program to be completed over the next three years. With this, ConocoPhillips aims to buyback $3 billion in stock in 2017, and a total of $6 billion by 2019.

At first, the move appears to be an aggressive one, as the total share buyback pool accounts for almost 10% of the company’s current market capitalization. However, on a closer look, it seems a judicious use of the surplus funds that the company will receive as part of the Cenovus deal. Not only will the decision allow the company to optimize its capital structure, but will also augment its earnings per share in a weak and uncertain oil price environment.

Besides this, ConocoPhillips also increased its quarterly dividend to 26.50 cents per share in the March quarter of 2017, representing an increase of 6% over the December quarter 2016. This not only indicates that the company’s cash flow position has been improving over the last few months, but also reaffirms the company’s willingness to share its progress with its shareholders. In fact, the company aims to maintain a sustainable dividend through the commodity cycles going forward, and focus on growing its dividend at a modest rate annually.

Lower Leverage Will Improve Returns

Apart from repurchasing a considerable amount of its own stock from the proceeds of their asset sales, ConocoPhillips also plans to pare down a sizeable portion of its long term debt over the next couple of years, with an aim to improve its credit rating in the market. As per the latest company presentation, the management expects to repay $7 billion of debt in 2017, and maintain a net debt position of $15 billion at the end of the year. The company will further reduce its long term obligations to $15 billion (gross) by 2019. With reduced debt on its books, ConocoPhillips will be able to achieve its target of “A” credit rating by the end of this decade. In fact, both S&P and Moody’s have improved their rating outlook for the company on the news of debt reduction and higher share buyback.

Additionally, lower debt obligations will shrink the company’s interest expense on an annual basis. The company will save roughly $300 million in interest in 2017, and another $150 million between 2018-2019, if it manages to deliver on debt reduction targets for the year. This will allow the Houston-based company to boost its bottom line, even when commodity prices continue to be depressed.

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In a nutshell, we believe that while ConocoPhillips’ is closely correlated to the recovery in commodity prices, the company is taking unabated measures to weather the current commodity slowdown. With a low break-even price, reduced debt levels, and higher shareholder returns, the company is likely to return to profitability before the end of this year.

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