A Rich Oil Play, if You're Patient

 | Mar 07, 2013 | 10:00 AM EST  | Comments
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The market continues to grind higher, and the S&P 500 is slowing drawing closer to its previous highs like a moth to a flame. I've been growing more cautious as the market has gotten deeper into this rally as it seems as though the indices are getting more overdue for at least a minor pullback.

If we do see a decline, one stock I'll continue to buy will be ConocoPhillips (COP). I've been invested since early 2012, as it's in the early innings of a major transformation that I believe will reward shareholders significantly over the next five years. The company -- which has been an integrated oil major with assets throughout the globe -- is undergoing a multiyear repositioning to one of the world's largest independent exploration-and-production concerns, with an increasing amount of production coming from North America. It's also shifting its capital budget to increasing development in U.S. shale plays, away from its prior heavy investment focus in liquefied natural gas and oil sands.

The company has strong acreage portfolios in the Bakken, Permian and Eagle Ford shale formations. It has also picked up additional acreage recently in relatively newer shale plays, such as Wolfcamp and Avalon in Texas -- and, amid increased cash flow over the next five years, this should allow a substantial lift to annual production, margins and dividends. The effort achieved a major milestone in April 2012 with the spinoff of its refinery assets in Phillips 66 (PSX), which has risen some 80% since it became public. The company is in the process of selling some assets in less geopolitically stable regions of the world, such as its recently completed sale of a $5 billion stake in a project in Kazakhstan.

On a side note, Conoco was a major player in Venezuela, having first invested in the country in the 1940s, though it is currently locked in arbitration/litigation over the seizure of its assets there. It is too early to assess what impact, if any, the recent death of President Hugo Chavez will have on its litigation efforts and/or possible restart of operations in the country. However, it should be a watch item.

Away from this, the company's overall asset sales in 2012 were north of $10 billion, which will be used primarily to target raising production in its shale acreage. Through these efforts, Conoco is targeting production growth of 3% to 5% annually over the next five years. Over the time span, it also believes it can see a similar 3% to 5% yearly improvement to margins.

The primary attraction of ConocoPhillips right now is the 4.6% dividend yield, which provides a solid reason to be patient as the company's transformative efforts start to bear fruit. The company has also used its cash flow to buy back $10 billion or more of its stock in both 2011 and 2012. The stock is selling at less than 10x 2014 projected earnings, and is even cheaper on an operating-cash-flow basis, selling at around 5x OCF. The stock may not be the sexiest pick, but for patient value investors looking for a high-yield play that's heading in right direction, it fits the bill.

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