ConocoPhillips (COP -8.60%) has undergone a major transformation over the past few years that has repositioned it to thrive at lower oil prices. This year alone the company has jettisoned more than $16 billion of assets, which along with other initiatives have pushed its breakeven level from $75 a barrel to below $50. That said, despite all the progress, analysts continue to give the company the cold shoulder. In their view, ConocoPhillips is just too big for its own good since it can't grow as fast as rivals.
A lukewarm reception
Earlier this month, for example, Bernstein downgraded the stock to market perform saying that despite all the assets sales it's still too diversified. That diversification mutes the company's growth prospects compared to its peers, which can increase production at a much faster clip these days. Goldman Sachs, likewise, has a muted view on the oil giant, evidenced by its neutral rating. While its analysts like the company's business transformation, and see the sale of the bulk of its Canadian oil sands assets to Cenovus Energy (CVE -9.54%) as a major positive, they don't see any reason to be excited about ConocoPhillips' prospects.
Driving these downbeat views is the fact that ConocoPhillips' expects its production to be flat to up 2% this year, before factoring in the impact of recent asset sales. Further, given the company's capital allocation priorities, it would only increase production by a 2% annual rate in future years at $50 oil. Though, as oil improves so would its growth prospects, with the company estimating that it could deliver up to 4% annual growth at $60 oil and as much as 8% higher production at $70 crude.
However, that's just not an enticing rate for analysts considering that rivals can deliver double-digit increases at those oil prices. For example, EOG Resources (EOG -7.80%) estimates that it can increase its U.S. oil output by 15% annually through 2020 at $50 oil, with the potential to deliver 25% annual crude oil growth at $60 oil. Further, EOG Resources could finance that growth and its dividend within cash flow at those oil prices. Meanwhile, Marathon Oil (MRO -10.94%) anticipates that it can deliver 10% to 12% annual production growth through 2021. Further, it can finance that growth and pay its current dividend while living within cash flow at $55 oil. For most analysts and investors, those higher growth rates are much more appealing.
Comparing apples to oranges
One thing worth noting about those rates is that both EOG Resources and Marathon Oil are growing off smaller bases than ConocoPhillips. For perspective, Marathon's companywide output averaged 393,000 barrels of oil equivalent per day (BOE/d) last year while EOG Resources' U.S. crude production averaged 278,300 barrels per day. Both are a fraction of ConocoPhillips' daily output, which averaged more than 1.5 million BOE/d last year. Given the law of large numbers, which suggests that as a company grows in size it's harder to maintain a higher growth rate, ConocoPhillips faces an uphill battle in attempting to expand output as fast as these rivals.
That said, ConocoPhillips isn't even trying to match the growth rates of its competitors. That's because the company plans on returning a significant portion of its excess cash flow to investors instead of using it to drill new wells. For example, during the first quarter, the company generated nearly $1.8 billion in cash flow from operating activities. However, it only used about $1 billion on capex, while returning $450 million to investors via dividends and buybacks and using the excess to strengthen its balance sheet. Put another way, the company only used about half its cash flow to maintain and grow output and returned about 25% to investors. Contrast that allocation percentage with Marathon Oil, which generated about $500 million in cash flow last quarter and spent $450 million on capex while returning just $50 million to shareholders, which works out to a 90%/10% split. EOG Resources, meanwhile, returned about 13% of its cash flow to investors last quarter, though overall it outspent cash flow on growth and shareholder returns, funding the difference with asset sales.
Most of ConocoPhillips' rivals have chosen to reinvest the bulk of their cash flow and nearly all the proceeds they receive from assets sales on new wells. Because of that, these companies can grow at a much faster pace, especially when considering that they already produce at a lower rate. ConocoPhillips, on the other hand, has chosen a different path. Its aim is to return 20% to 30% of its cash flow to investors each year, including any proceeds it receives from asset sales. Because of that, the company intends on spending as much as $6 billion buying back its stock over the next few years. To put that into perspective, the company spends $5 billion per year on capex, suggesting that this money could drive meaningful growth. That said, the company believes its capital allocation approach will fuel double-digit total returns for shareholders, which would create more value for investors than it could by just drilling more wells.
While it's true that ConocoPhillips' larger size makes it harder for the company to grow as fast as rivals, that's only part of the story. The other factor at play is the company's decision to allocate a larger percentage of its capital to shareholder returns instead of growth. The company believes that this approach will lead to higher total returns for investors over the long term, especially if oil prices stay lower for longer.