Does ConocoPhillips Deserve a Premium Over Competitors?

The major international oil sector as a whole is trading at a low valuation. However, one standout company is ConocoPhillips (NYSE: COP  ) , which is currently trading at a valuation that on several different metrics is similar to larger peers such as ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) . 

Strictly speaking, Conoco is an independent exploration and production (E&P) company, while Exxon and Chevron are major integrated producers. That said, as an E&P company, Conoco should have wider profit margins and be more desirable as an investment than even Exxon (the world's largest international oil company.)

Company

Trailing-12-month P/E

EV/Daily production

EV/Proved reserves 

Conoco

12

$74

$12.9

Exxon

12

$103

$16

Chevron

10

$88

$21

Sources: Finviz, Yahoo! Finance and respective annual reports. Trailing-12-month ratios.

As we can see, Conoco is trading at a discount to its larger peers on both a EV/daily production and EV/proved reserves.

However, there are some indications that Conoco deserves a premium over its larger cousins. The most prominent of these is the company's profit margin. Based on fiscal second quarter numbers, Conoco's operating margin stood at 28%. Chevron's operating margin was under 10%, while Exxon reported an operating margin of 16%. Higher-margin businesses usually demand higher premiums as they are obviously more lucrative.

More money
Conoco's operating margin grew after the spinoff of Phillips 66, as refining operations are usually low-margin. Based on Phillips 66's fiscal second quarter results, the company's operating margin was a minuscule 3.4%. Furthermore, if we look at full-year fiscal 2011, before the Phillips spinoff Conoco's EBIT margin was a tiny 5%. At the end of the fiscal second quarter of this year, Conoco had an EBIT margin of 28%.

I should also note that Conoco generates a cash margin of $40 to $45 per barrel on average for each barrel produced. Chevron, on the other hand, is averaging $23.88 as of the first half of 2013. This indicates that Chevron's production is significantly more expensive than that of Conoco.

It would appear that thanks to the spinoff of its low-margin business, Conoco is more profitable than both of its larger peers. For this reason, the company does deserve a small premium.

Less spending
Hang on, there's more! Not only is Conoco more profitable than its larger peers, but the company is also generating more free cash. Thanks to high capital spending as well as low returns from refining operations, Chevron and Exxon have been free cash flow negative during the first half of this year. Exxon in particular has had to bolster its cash flows with $7.8 billion in debt issuance during the first half of the year. Chevron has also been forced to rely on $7.8 billion in debt to boost cash flows during the same time period.

Meanwhile, Conoco's high-margin operations have kept cash generation high. As a result, the company has been able to pay back nearly $1 billion in debt during the first half of this year. That said, Conoco still has the highest net-debt-to-asset ratio of the trio, with net debt amounting to 15% of its assets. Still, the debt appears to be legacy, or pre-spinoff. As the company is paying down debt instead of increasing it like Exxon and Chevron, Conoco still appears to be the best of the bunch.

Foolish summary
All in all, it would appear that Conoco does deserve a slight premium over its larger peers. Despite the fact that Conoco is relatively small compared to Exxon and Chevron, the company is more profitable and is managing capex spending more effectively. 

Companies that are more profitable than their peers usually trade at a premium to the sector. In this case, Conoco does not. Because of this I think the company looks slightly undervalued.

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  • Report this Comment On November 16, 2013, at 5:02 PM, neamakri wrote:

    yes I am ignorant but can read English. You did not define EV so the top 1/3 of your article was meaningless.

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