Is ConocoPhillips Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does ConocoPhillips (NYSE: COP  ) fit the bill? Let's look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell ConocoPhillips' story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's look at ConocoPhillips' key statistics:

COP Total Return Price Chart

COP Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

(67.3%)

Fail

Improving profit margin

151.3%

Pass

Free cash flow growth > Net income growth

(60.7%) vs. (17.8%)

Fail

Improving EPS

0.1%

Pass

Stock growth (+ 15%) < EPS growth

127.7% vs. 0.1%

Fail

Source: YCharts.
*Period begins at end of Q2 2010.

COP Return on Equity Chart

COP Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

7%

Pass

Declining debt to equity

11.4%

Fail

Dividend growth > 25%

25.5%

Pass

Free cash flow payout ratio < 50%

159.6%

Fail

Source: YCharts.
*Period begins at end of Q2 2010.

How we got here and where we're going
Things don't look particularly good for ConocoPhillips in its second assessment, as this oil and gas producer has lost three out the of seven passing grades it earned last year, falling to a middling four-out-of-nine score. The spinoff of Phillips 66 (NYSE: PSX  ) appears to have decimated both revenue and free cash flow, but the company's profitability has certainly enjoyed a new freedom from refinery operations. ConocoPhillips' shares have enjoyed one of the strongest growth rates of any major oil and gas company, but this renewed optimism may not last if the company can't bring its dividend payouts back in line with its free cash flow. Can ConocoPhillips overcome these weaknesses, or will its recent progress be undone? Let's dig deeper to find out.

Despite (or possibly because of) the post-recession surge in domestic energy production, large energy players such as ConocoPhillips and ExxonMobil (NYSE: XOM  ) have struggled in recent months as a result of plunging West Texas Intermediate, or WTI, crude oil prices, which has undermined the profitability of domestic oil. As a result, U.S. oil inventories rose by more than five million barrels, which point toward slowing demand in the fourth quarter. Fool contributor Bob Ciura points out that ConocoPhillips tends be to at greater risk from falling oil prices now that it can no longer capitalize on favorable crude oil spreads in refining operations. In contrast, ExxonMobil's refining business might provide it with a cushion, as it generates more profit by capitalizing on the difference between WTI and Brent prices.

My Foolish colleague Arjun Sreekumar notes that second-tier large U.S. oil and gas companies have been divesting their non-core resources to focus on onshore North American oil and gas assets. ConocoPhillips recently sold off its stake in Kashagan, a multibillion dollar oil project in Kazhakastan, as well as its midstream assets in the Caribbean and its Clyden assets in Canada. In the past year, the company also sold off its Nigerian assets in a deal worth $1.8 billion. ConocoPhillips' rival Apache (NYSE: APA  ) has also recently divested one-third of its Egyptian oil and gas assets and its Gulf of Mexico assets.

ConocoPhillips still expects huge growth opportunities from its 130,000 acres in Colorado's Niobrara shale. Arjun Sreekumar notes that ConocoPhillips has also doubled its output to 121,000 barrels per day from the Eagle Ford in the second quarter. The company is expecting to grow its production at a rate of 3% to 5% annually over the next five years.

Another opportunity lies in the Freeport LNG export venture, which ConocoPhillips jointly owns with Michael Smith. This natural-gas exporter has submitted its expansion plans to the Department of Energy, which will allow it to increase its LNG exports to non-free trade agreement countries, particularly India, which needs copious quantities to run its fast-growing electric grid.

Putting the pieces together
Today, ConocoPhillips has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

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