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With Low Oil and Gas Prices - Are Earnings Justified?
Posted by: Victor Selva (IP Logged)
Date: October 31, 2013 04:50PM

The oil and gas industry is highly competitive, and this could adversely affect companies’ profitability, as well as their ability to grow and manage their businesses. Earnings highly depend on crude oil and gas prices movements, which are unstable and amply volatile. With this uncertain scenario, let's take a look at two other companies in this sector and see which one is doing better and thus stands as the best investment.

ConocoPhillips
(COP) is the largest independent oil and gas exploration and production (E&P) companies in the world. In the U.S. is the largest independent exploration and production firm, doubling its closest competitor in terms of production volumes. The company explores for, produces, transports and markets crude oil, bitumen, natural gas, LNG and natural gas liquids on a worldwide basis. At Dec. 31, 2012, activities in 30 countries including the U.S., Norway, the UK, Canada, Australia, offshore Timor-Leste in the Timor Sea, Indonesia, China, Nigeria, Algeria, Libya, Malaysia, Qatar and Russia.

Low-Risk International Position


Operations in Europe contributed 16% of worldwide liquids production and 12% of natural gas production in 2012. Canada contributed 15% and 20% and the Asia Pacific/Middle East region contributed 10% and 16%, respectively. The company believes that growth will come from major projects in the North Sea, Malaysia, and its LNG project in Australia. In North America, growth will be attained by its positions in the Eagle Ford, Permian and Bakken.

Proceeds from Recent Asset Sales

In July 2013, ConocoPhillips raised its quarterly dividend to $0.69 per share ($2.76 annually), up 25% from 2010. With a yield of 3.63%, company´s dividend is the highest of E&P peers. Considering a negative scenario of declining oil prices, the firm should ensure the dividend by its recent asset sales like the Lukoil interest for $9.5 billion (in 2011), $12 billion of non-core asset sales, and the completion of the downstream spin-off (in May 2012). All this cash generates good liquidity; the cash to debt has declined from 0.28 to 0.17 in 2012. This year the company expects $20 billion from the proceeds of $10.5 billion on the sale of its $5 billion stake in the Kashagan project, the $1.05 billion sale of its Cedar Creek Anticline properties and $4 billion in other assets.

In terms of valuation, the stock sells at a trailing P/E of 12.2x, trading at a premium compared to the industry average of 10.6x. Analysts’ expectations imply a forward P/E of 11.82. To use another metric, its price-to-book ratio of 1.9 indicates a premium versus the industry average of 1.22x and the price-to-sales ratio of 1.53x is above the industry average of 0.57x.

Maybe Too Late

Marathon Oil Corp. (MRO) is organized into three segments North America Exploration and Production, International Exploration and Production (12%), and Oil Sands Mining. Operations are concentrated in the U.S., Angola, Canada, Equatorial Guinea, Indonesia, the Iraqi Kurdistan Region, Libya, Norway, Poland and the UK.

Acreage Positions

The company is focused on U.S. growth by developing liquids-rich shale play positions, a strong position in the core of the Eagle Ford shale, where it holds 230,000 net acres. Also, the company holds more than 400,000 net acres in the Bakken, its largest position. These acreage positions in liquids-rich shale are key drivers for long-term growth.

International Exploration

Growth assets include discoveries in Iraqi Kurdistan, select Gulf of Mexico blocks and Canadian assets. Exploration is focused on Poland, Iraqi Kurdistan, Norway and the Gulf of Mexico. The success in those regions could provide additional long-term growth. For 2013 management expects an annual production growth rate of 8% to 10% which seems to be attainable. The main risk that the company faces, apart from political risks in countries like Libya, is that exploration projects are several years away from production.

Its P/E multiple on a trailing-12 month basis is 22.4 and the forward P/E multiple is 11.44. The current dividend yield is 1.9%, which is considered not enough to protect the purchasing power and is below the industry median of 3.55%.

Finally, I always like to see of one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity.

Company ROE Compared to Industry Mean (=10.8)
ConocoPhillips 17.6 Above
Marathon 8.7 Below

It is very important to understand this metric before investing in a high-growth company.



Final Comment

In my point of view, the strong acreage portfolios, the low-risk international exposure, and strong cash flow, makes of ConocoPhillips the most attractive choice. Hedge fund gurus like Jim Simons, Ray Dalio and Jeremy Grantham added this stock to their portfolios and I would advise fundamental investors to consider adding this stock to theirs as well.

Disclosure: Victor Selva holds no position in any stocks mentioned.



Guru Discussed: Jeremy Grantham: Current Portfolio, Stock Picks
Jim Simons: Current Portfolio, Stock Picks
Stocks Discussed: COP, MRO,
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