In this article, let's take a look at ConocoPhillips (COP, Financial), which is the largest independent oil and gas exploration and production (E&P) companies in the world. In the U.S. it is the largest independent exploration and production firm, doubling its closest competitor in terms of production volumes. Let's explore some reasons more closely to see if they are valid enough to invest in this stock.
Impressive size
If we account for production volumes, it is twice as large as its closest peer. With operations in Europe, Canada and the Asia Pacific/Middle East region, the company believes that growth will come from major projects in the North Sea, Malaysia and its LNG project in Australia. Moreover, it should benefit from an increase in natural gas prices, as it still holds a large amount of Lower 48 natural gas reserves.
Well positioned
This giant holds large acreage positions in the Eagle Ford, Permian and Bakken that can be developed with attractive economics while delivering high cash. Further, its SAGD assets in Canada are the lowest-cost and best-performing of all. Further, a rebound in natural gas prices will benefit the firm because it holds a large position in U.S. natural gas.
Growth prospect
The company plans about 400,000 barrels of oil equivalent per day of production by 2017. Additionally, these projects are going to contribute to a higher margin. As a matter of fact, the firm is targeting a 3% to 5% margin growth which we consider good and achievable. With the addition of these projects, the company's portfolio should deliver higher returns as well as cash flow in the near future. Cash flow is generated from the divestiture of noncore assets. The company has reached agreements for almost $14 billion in asset sales.
Dividends
Dividends have been paid since 1934. Months ago the company announced that its board of directors raised its quarterly dividend to 73 cents per share, an increase of 5.8%. This was the second dividend increase since the company separated its downstream operations in May 2012. The first one was in July 2013 when it raised its quarterly dividend to $0.69 per share ($2.76 annually), up 25% from 2010.
Revenues, margins and profitability
Looking at profitability, revenues grew 3.52%, but earnings per share slightly decreased in the most recent quarter compared to the same quarter a year ago ($1.64 vs $1.65). During the past fiscal year, the company increased its bottom line. It earned $6.43 versus $5.90 in the prior year. For the next year, Wall Street is expecting a contraction of 3.4% in earnings ($6.21 versus $6.43).
The gross profit margin is considered high at 41.13%, and the net profit margin of 15.05% is above the industry average.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| COP | Conoco Phillips | 17.62 |
| OXY | Occidental Petroleum Corp. | 14.13 |
| BP | BP PLC | 7.67 |
| Ă‚ | Industry Median | 9.76 |
The company has a current ROE of 17.62% which is higher than the one exhibit by its peers Occidental Petroleum Corp. (OXY, Financial) and BP PLC (BP, Financial). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. It is very important to understand this metric before investing, and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 9.5x, trading at a discount compared to an average of 11.5x for the industry. To use another metric, its price-to-book ratio of 1.55x indicates a premium versus the industry average of 1.33x while the price-to-sales ratio of 1.44x is above the industry average of 0.66x. At that PE, the stock is relatively undervalued and seems to be an attractive investment relative to its peers.
As we can see in the next chart, the stock price has an upward trend in the five-year period.
Final comment
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 depend highly on crude oil and gas prices movements, which are unstable and highly volatile.
Reasons like the large positions in the Eagle Ford and Bakken with promising returns, the position in natural gas that will benefit the company in a scenario of favorable natural gas prices and the proceeds from assets sales that guarantee dividends, make me feel bullish on this stock.
Hedge fund gurus like Jim Simons (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), Ken Fisher (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Ray Dalio (Trades, Portfolio), Murray Stahl (Trades, Portfolio), James Barrow (Trades, Portfolio) and Bill Frels (Trades, Portfolio) added this stock to their portfolios in the first quarter of 2014, as well as Pioneer Investments (Trades, Portfolio).
Disclosure: Omar Venerio holds no position in any stocks mentioned
