ConocoPhillips Is Pumping

 | Nov 05, 2013 | 7:00 AM EST
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We are bullish on energy stocks, in part because we like the greater stability of higher-yielding stocks and in part because we believe these stocks are attractive at current oil prices. But wholly apart from liking this sector, we are also always on the prowl for companies that have improved their business model and, as a result, could be due for an upward revaluation.

One energy stock that has this higher yield and business catalyst is ConocoPhillips (COP). Two years ago, the company spun off its refining segment into Phillips 66 (PSX), leaving investors with a large pure-play independent oil and gas exploration-and-production company under new executive leadership.

The new CEO, Ryan Lance, has done a remarkable job of exiting non-core assets in ConocoPhillips' international portfolio. In particular, the firm has sold off large positions in oil and natural gas properties in former Soviet Union territories. On Oct. 31, ConocoPhillips closed on a key $5.4 billion sale of the Kashagan oil field in the Caspian Sea.

Management has primarily been redeploying sales proceeds into boosting North American oil and liquids production in the Bakken and Eagle Ford fields. The Bakken volumes are up 31% over the past year to 334,000 barrels per day. The Eagle Ford volumes are up 66% to 126,000 over a similar time frame. Management has also been reinvesting in the Permian Basin, Western Canada, the North Sea, Malaysia and Australia in order to boost production.    

As a result of these initiatives and better-than-expected earnings, ConocoPhillips' share price has risen from the mid-$50s level at the time of the spinoff to a recent price of $73. We believe there are more opportunities for management to enhance shareholder value from continued production growth opportunities and an improving cost structure.

On the margin side, management would ultimately like to expand the current 46% operating margin ratio. ConocoPhillips should be able boost this ratio to 56%-plus, in line with industry leading peers such as Occidental Petroleum (OXY), Apache (APA) and Devon Energy (DVN), which operate at 56% to 60% margins. The normalization of this operating margin ratio should materially boost earnings.

Management has also not forgotten about rewarding its shareholders. A key mechanism for this has been a generous dividend. The company currently pays a dividend of $2.76 per share, resulting in an above-average yield of 3.70%. Investors were initially skeptical that ConocoPhillips could maintain its dividend, but given the recent upswing in production and earnings, it appears that the company will be completely self-funding by 2017. Management has been reiterating its commitment to not only maintain but to increase ConocoPhillips' dividend in the coming years.  

ConocoPhillips' story has been improving each quarter as the volumes, margins and earnings ramp up. In addition, the high dividend yield provides lift for the stock in lower-interest-rate environment as investors search for high-dividend-yielding names. The stock is still reasonably valued at 11.6x 2014's EPS estimate of $6.28. 

Bottom line, ConocoPhillips still has many levers for pumping both its earnings and its valuation higher. Despite a nice recent run, investors should still be able to benefit from buying ConocoPhillips.

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