ConocoPhillips: Why It's (Finally) Time to Get Cautious

An oil pump in North Dakota, one of Conoco's key North American oilfields.

If you frequently browse Yahoo! or Google Finance for articles on ConocoPhillips (NYSE: COP  ) , you'll notice there's a lot of love for the stock from retail investors. To be sure, ConocoPhillips has been very good to investors since its June 2012 split from its refining business. At that time, Conoco was priced in the mid-low $50 range. The stock now trades at just over $85. When one factors in the dividends, which back in 2012 represented a yield of over 5%, it's easy to see why the retail investor is so high on ConocoPhillips. The company's production growth, margin improvement, and fantastic dividend yield made it a great value when compared to the other big U.S. oil companies.

That dynamic, however, is changing. While Conoco's five-year growth and margin expansion plan is still under way, we are now more than halfway through that plan, and the horizon beyond looks decidedly less certain. And as we will see, after a gain of about 60% over the last two years, Conoco is no longer cheap when compared to its peers. 

Chart courtesy of Yahoo! Finance.

A good run
This chart compares the relative performance of ConocoPhillips with its two U.S. peers, ExxonMobil (NYSE: XOM  ) and Chevron (NYSE: CVX  ) . Since August of 2012, Conoco is up by 60%, almost twice as much as Chevron. Effectively, ConocoPhillips was playing catch-up over these two years. From a valuation standpoint, Conoco is now much closer to its peers than it used to be. Consider each company's respective book value and EBITDA-to-enterprise value.

  ConocoPhillips ExxonMobil Chevron
Book Value 2 2.5 1.67
Enterprise Value/EBITDA 5.27 7.53 6.48

As you can see, Conoco still isn't the most expensive of these three (Exxon is), but Conoco is no longer trading at an obvious discount, either. When we compare dividend yields, a similar picture emerges. At 3.3%, Conoco's yield is now very close to Chevron's 3.25%.

Live by the shale...
Since 2012, Conoco's annual production growth has generally outpaced that of its peers thanks to the company's heavy investment in the shale. Shale oil has provided Conoco with not only high production growth but also better margins. It's safe to say that Conoco's decision to be an early mover in the shale turned out to be a big win.

But the longer-term future of North American shale oil is much less certain. Many experts believe that the U.S. will see a glut in light sweet crude oil within just a few years. Unfortunately, there is a congressional ban on crude oil exports. While gasoline can be exported, there is not enough refining capacity to handle the expected supply of just a few years ahead. This suggests that there could be substantial volatility ahead for domestic oil prices, and this could put an end to Conoco's steady growth prospects. This is likely the reason why the company gave guidance only until the end of 2016. Conoco will probably make due on its production growth estimates through 2016, but there are good reasons to believe this momentum will not continue past that time. 

The easy money has already been made
ConocoPhillips has been a good investment, and it could very well continue to be one. This article is not a call to sell. In fact, Conoco could easily continue its pattern of double-digit returns for the next two years. However, ConocoPhillips is no longer the stand-out buy that it used to be, and I believe that the biggest gains have already been made.

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  • Report this Comment On June 27, 2014, at 4:50 PM, PEStudent wrote:

    Conoco has 4 deepwater sites in the Gulf of Mexico that have oil but which haven't been exploited yet. How much will these factor in to Conoco's sales?

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