Don't Sell ConocoPhillips

 | Apr 22, 2014 | 6:00 PM EDT  | Comments
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Shares of ConocoPhillips (COP) have gone up by quite a bit lately. In fact, since June of 2013, Conoco has outperformed not only its peers but also the broader market. While Conoco's independent peers are down slightly since June of 2013, Conoco is up by over 22%.

COP Ychart

So, is it time to sell? Absolutely not. Conoco is up due to a number of factors, and those factors are only getting stronger. Conoco has industry-leading production growth, steadily improving margins, and an unparalleled exploration program, which provides exciting prospects in both the shale and the oil sands. And despite the rise in share price, Conoco is still trading well within the range of its peers.

Conoco's plan is to grow production by between 3% and 5% until 2017. The centerpiece of this growth strategy is the Eagle Ford. Production there will grow by 20% annually until 2017. This is based on a peak production estimate that was recently revised upward by 40%. Unlike other operators here, Conoco is not all about maximizing volume. In fact, Conoco has deliberately gone a bit slower in order to apply production expertise from other locations in which it operates, thereby improving efficiencies in the Eagle Ford. For example, Conoco is the only Eagle Ford operator with an integrated "command center," which monitors well activity 24/7 in real time. This is just one example of best practices, but suffice it to say that Conoco is getting more value out of its wells than is anyone else in the Eagle Ford, as the chart below shows.

COP NPV per well

Conoco balances this shale growth with long-lived Canadian oil sands assets. And just like in the Eagle Ford, Conoco is a top-tier operator in the oil sands.

Beyond 2017, Conoco is pouring capital into the Niobrara in Colorado, the Wolfcamp in Texas and the Duvernay and Montney in Canada. Such shale-centered focus is unparalleled among "super major" peers, and I believe that these efforts will yield high-growth, high margin assets just as the Eagle Ford and Bakken have.

While growth is one side of the coin, cash flow is the other. Conoco is growing cash flow by improving margins. Conoco has pretty much finished selling its low-margin assets and is now investing heavily in projects that will yield a 30% and even 40% margin. Many of these investments are in deep water, oil sands and the shale.

Essentially, Conoco is playing catch-up with peers Chevron (CVX) and Exxon Mobil (XOM), both of whose per-barrel margins are significantly higher than Conoco's. Among super-major peers that are worthy, Conoco is most like Statoil (STO), which has similar, lower, margins and returns on capital employed. I believe that Conoco's long-term goal is to bring per-barrel margins up to that of Chevron's and Exxon's levels. With the investments it is currently making, I believe Conoco will fulfill this goal.

COP Peers vs. book value

Valuation wise, Conoco is right in the range of its peers, but with all of these successful improvements, the company should eventually be trading at the top end of this range (along with Exxon). Consider this: Conoco's 3%-5% production growth outstrips all three of its peers. Statoil should grow at 3%, and 3% is the top end of Exxon's range. Conoco's margins and returns will improve, too, especially as the Eagle Ford, at some point, hits peak production, GOM discoveries come online, and other high-margin shales begin to develop. In short, I believe that Conoco will not be fully valued until it trades on par with Exxon.

Here are a couple quick references as to where I got my numbers:

Quick reference:

Statoil production growth:

ExxonMobil production growth:

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