Of the large cap oil and gas stocks, ConocoPhillips (NYSE:COP) has been one of the better performers year-to-date, with shares rising over 20 percent. While some analysts are cautioning that the shares have run too far, I think there is still more upside ahead.
ConocoPhillips set itself apart from its mega-cap integrated oil peers by splitting its upstream and downstream businesses into separate entities. ConocoPhillips is the upstream business and Phillips 66 (PSX), is the downstream business. For those who aren’t familiar with this terminology, an upstream business is one that is involved in exploration and production, whereas a downstream company is in the business of refining oil and gas and turning them into products that are ready for the marketplace. Both stocks have performed extremely well since the split, as now there are two management teams running two companies with highly specific business models.
In doing this, ConocoPhillips has done a couple of things that should benefit shareholders. The first is that it has streamlined its business. Now that it can focus on just one thing it can operate more efficiently. The second thing it has accomplished is that it has leveraged its profits to the rising oil price. A downstream business only benefits when the oil price rises if the price of gasoline and other oil-based products rise at a faster rate. Otherwise, a rising oil price hurts these companies’ businesses.
As a result, ConocoPhillips has been able to grow its profits while many of its peers have stagnated in this area. It has also been able to expand its production given its new focus. The company is very active in exploration and production throughout the world, although it has been especially active in the Eagle Ford shale region which is one of the richest shale oil deposits in the world. ConocoPhillips has been benefitting from the rise in hydraulic fracking, and this has served to increase the company’s profitability.
With the stock breaking out, it seems that the market has finally recognized the company’s initiatives and the value that it is adding, and while the shares are overbought in the near-term, it can rise significantly higher.
Right now, despite the 20 percent rise in ConocoPhillips shares this year, it trades at only 13-times earnings compared with the S&P 500, which trades at 22 times earnings. It also pays a 3.2 percent dividend versus the S&P 500, which pays a paltry 1.8 percent dividend. Furthermore, the oil price has been rising; oil has risen about 10 percent for the year, and it is sitting near multi-year highs. However, it has averaged a lower price than this, which means that the company was able to generate last year’s earnings at a lower oil price. With $105+/bbl. oil becoming the norm, there is an excellent possibility that going forward the company’s earnings will be much stronger than it was in the trailing 12 months. This rise in oil price compounds the company’s growth, which means that going forward the company can grow its earnings in the double digits, and possibly more.
Meanwhile, investors are still not giving these oil companies the credit it deserves while they are willing to pay absurd valuations for large cap companies outside the oil space because of its consistent earnings. While it may take some time, I think this disparity will come to an end over the next year or two. This means higher prices for shares of ConocoPhillips and its peers and lower prices for many of the consumer staple stocks and retailers that the market is currently overvaluing.
ConocoPhillips is an excellent investment going forward that generates a lot of cash-flow and rewards its long term shareholders with dividends and periodic stock repurchases. It has run a lot and so I would wait for a pullback of maybe 8 percent – 10 percent, at which point I would take a long-term position.
Disclosure: Ben Kramer-Miller has no position in ConocoPhillips.