ConocoPhillips: Why Investors Should Be Positive

ConocoPhillips (COP) has dropped more than 30% in 2015, which is not surprising since the company has been hit hard by weak oil prices. In fact, last quarter, Conoco's top line was down more than 40%, even though the company beat bottom line estimates. Additionally, Conoco announced that it will cut its capital spending further. The company now plans to spend $11 billion as capital expenditure this year as compared to the prior forecast of $11.5 billion.

Trying to overcome the weakness

Additionally, Conoco has lowered its operating cost guidance by $300 million as well.

Although we cannot expect a sudden turnaround in oil prices, but Conoco seems to be taking the right steps to reduce costs that will help it do well in the long run as macroeconomic fundamentals improve. In fact, the latest capital expenditure cut takes down Conoco's spending forecast from $13.5 billion in January this year.

More importantly, the company estimates to maintain this level of capital expenditure for the next three years, which is a smart move given the volatility in the end market. However, looking at the weakness in the oil and gas markets, analysts at Oppenheimer anticipate that ConocoPhillips will face free cash flow deficit of $5.5 billion in the current fiscal year and $1.8 billion in 2016.

However, this should not be a matter of great concern as the gap could be filled by additional borrowing. Moreover, the company has sufficient financial stability for funding its dividends in the current environment as it has generated operating cash flow of almost $11 billion in the past year. Additionally, the latest cost and capital expenditure cuts put in place by the company will allow it to mitigate the weakness in pricing and lend some strength to the cash flow position going forward.

Will oil prices improve?

Looking forward, the macroeconomic cues are quite appealing for the oil industry. Recently, Merrill Lynch upgraded the energy sector to overweight, citing that the timing is perfect for an oil recovery. According to Savita Subramanian, a leading equity strategist at Merrill Lynch, oil has hit bottom and valuations in the sector are at thirty year lows. This has opened significant room for an upside rally in the coming years.

In fact, crude oil soared 27% in three days recently, which is the biggest three day rally in 25 years. As such, ConocoPhillips CEO Ryan Lance is optimistic about a price recovery. While addressing an OPEC seminar in Vienna, Lance had said, "It is hard to envision it (the oil price) going back down to the $40s. We see world restoring demand (growth) to 1.1 or 1.2 million bpd double what it was over the past few years."

Conclusion

These are significant developments, and analysts project ConocoPhillips as a better shale operator when compared to its peers who run the risk of facing steeper output declines. However, ConocoPhillips does not have an ideal valuation at present.

Currently, its forward P/E of 27 is quite depressing as compared to the trailing P/E of 22, indicating that its earnings will remain under pressure. However, considering its strong cost cutting moves, the company will be able to strengthen its performance going forward. Moreover, its price-to-sales multiple of 1.43, as compared to the industry average of 3.01, reflects that the stock is undervalued at current levels. Therefore, in the light of these facts, ConocoPhillips could be a good long-term bet as the oil market improves.

Published on Sep 4, 2015
By Yaggyaseni Mittra

Copyrighted 2016. Content published with author's permission.

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