Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

ConocoPhillips Stock Upgraded: What You Need to Know

By Rich Smith - Jul 17, 2019 at 2:43PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Rising oil prices and a falling share price have Merrill Lynch feeling bullish.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

West Texas Intermediate (WTI) crude oil is selling for just shy of $58 a barrel today, down 15% from a year ago, but up 11% over the past month.

Outside U.S. borders, Brent is the favored flavor of crude oil, and it's showing less volatility, but similar dynamics -- down 11% over the past year, but up 6.5% over the past month (and still more expensive than WTI at a per-barrel price of about $65).

Happily, ConocoPhillips ( COP -0.21% ) is "exposed to all the good bits" of the oil market, says investment banker Merrill Lynch -- and that's why it's upgrading ConocoPhillips stock.

Here's what you need to know.

Oil rig silhouette with an orange sunrise in the background

Image source: Getty Images.

Upgrading ConocoPhillips

Early this morning, Merrill Lynch announced it is upgrading shares of ConocoPhillips to buy and assigning a $75 price target -- up $10 from its last target. You can find one of the analyst's reasons right up there in continuing premium prices earned from selling Brent oil rather than WTI. As Merrill explains in a note covered on TheFly.com, 75% of the oil ConocoPhillips sells is Brent, and the company has managed to avoid the "worst of onshore price dislocations" with WTI.

Granted, this hasn't translated into great performance for ConocoPhillips stock, which is down 15% over the past year, and performing worse than peers Exxon ( XOM -0.64% ) and Chevron ( CVX -0.63% ). But as Merrill further explains, this may be more the fault of investors ignorant of ConocoPhillips' strengths, than of ConocoPhillips itself.

Cash is king

What are these advantages? Let's start with the cash. With $8.3 billion in cash on its balance sheet and a debt load of $15.9 billion, ConocoPhillips may not be in a "net cash" position, exactly, but its balance sheet looks a lot healthier than, say, Exxon's -- at $39.9 billion more debt than cash -- or Chevron's ($28.5 billion in net debt).

Merrill goes so far as to call ConocoPhillips' balance sheet "pristine."

And it's getting even pristine-r.

By the end of this year, in fact, Merrill estimates that ConocoPhillips could have as much as $10 billion in cash on hand -- enough loot that the company could "potentially" decide to pay out a special dividend to its shareholders and/or buy back stock.

Free cash flow is pretty nice, too

But where is all of this cash going to come from? From free cash flow, of course -- the actual cash profits that the company earns, as opposed to the net income that it reports under generally accepted accounting principles (GAAP). According to S&P Global Market Intelligence's last tally, more than 90% of the net income ConocoPhillips reports under GAAP is backed up by cold, hard free cash flow.

Last year alone, the company generated $6.1 billion worth of the stuff, and after a strong Q1 2019, its FCF number now reads closer to $6.6 billion generated over the last 12 months.

The real reason to own ConocoPhillips stock

And this, when you get down to it, is the real reason that Merrill Lynch likes ConocoPhillips stock so much. Although shares may be down significantly over the past year, free cash flow is up. And in Merrill's estimation (as explained in a note on StreetInsider.com), the reason for the former is that investors have failed to recognize the latter.

They're not giving the oil giant enough credit for the cash it's churning out.

The upshot for investors

So as one of those investors that Merrill Lynch is talking about, how should you react to this upgrade?

Valued at $67.5 billion in market cap with net debt of about $7.5 billion, ConocoPhillips' $75 billion enterprise value is only 11.4 times trailing free cash flow (and only 10.4 times reported earnings). The stock sports a 2% dividend yield, and most analysts agree that the company will grow its profits at about a 7% annualized rate over the next five years.

To my mind, this means investors can expect a total return of about 9% annually on a ConocoPhillips investment today -- not quite enough to make the stock a bargain at 11.4 times FCF, but close. And if ConocoPhillips can find a way to keep on increasing free cash flow at the rate it's been growing these last few years, the stock could soon evolve into what Merrill Lynch says it already is:

A buy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

ConocoPhillips Stock Quote
ConocoPhillips
COP
$71.11 (-0.21%) $0.15
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
XOM
$60.89 (-0.64%) $0.39
Chevron Corporation Stock Quote
Chevron Corporation
CVX
$114.41 (-0.63%) $0.73

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
624%
 
S&P 500 Returns
140%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/05/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.