ConocoPhillips (NYSE:COP) is swimming in cash. The U.S. oil giant ended the second quarter with an eye-catching $6.9 billion in cash. However, as impressive as that sum is, it's about to get even bigger. That's because the company recently closed the sale of its U.K. exploration and production business while also sealing a deal to sell its Australia-West assets.
While the company has been using some of its cash to repurchase stock, it has mainly funded shareholder returns through operational cash flow. Because of that, the company seems like it might have some other plans for its growing cash pile.
The bank account is bursting at the seams
ConocoPhillips's cash position at the end of the second quarter was about $500 million more than it was to start the year. This increase came despite all the volatility in the oil market and the fact that it repurchased $2 billion of its shares. That's due to a combination of strong cash flow from operations and about $700 million in asset sales.
The company recently added to its cash position by closing the sale of its U.K. assets for $2.675 billion. Meanwhile, it will add another $1.39 billion in cash when it closes the sale of its Australia-West assets, which should happen in the first quarter of next year. Add those two infusions to the company's current cash position, and its balance is on track to top $10 billion in the coming months. That's a lot of money for a company that currently has a $62.4 billion market value.
What could ConocoPhillips do with its cash war chest?
ConocoPhillips has already announced plans to spend some of that money. It expects to buy back a total of $3.5 billion of its stock this year, implying that it will repurchase $1.5 billion in the second half. It also intends to spend another $3 billion on buybacks next year while also earmarking an incremental $500 million for the dividend after recently boosting it 38%. However, even if the company funds that entire outlay with cash on hand as opposed to operating cash flow, it will still have a huge war chest remaining.
The company has three primary ways to allocate this money:
- Use it to strengthen the balance sheet by paying off more debt
- Return it to shareholders via additional share repurchases or dividends, including paying a one-time special dividend
- Reinvest it to expand the business through either growth projects or acquisitions
While ConocoPhillips could use some of that money to pay off additional debt, it hit its targeted level of $15 billion last year. As a result, it already has a strong investment-grade balance sheet, making further debt reduction less likely.
The company also recently put out its 2020 capital allocation plan, which included the 38% dividend increase and a $3 billion share repurchase target. Given that guidance, the company doesn't seem to be in a hurry to send any more money back to investors.
That leaves the potential for ConocoPhillips to reinvest more money into expanding its business. That could come from increasing its capital expenditure budget or making an acquisition. While the company could boost capital spending, it likely won't go too much higher than the current level. That's because its primary focus is to generate free cash flow from operations at lower oil prices. Thus, the only plausible reason for the continued buildup of its cash pile is to position itself to make an acquisition.
ConocoPhillips puts mergers and acquisitions into three buckets:
- Small, incremental transactions that boost its interest in existing assets or adds acreage near its current position
- Medium-sized bolt-on acquisitions and acreage deals
- Corporate M&A
The company makes small deals all the time, which doesn't cost much money. Therefore, that bucket wouldn't eat into its cash position. The third bucket, in the meantime, seems less likely given the high premium often associated with corporate deals. The high price tag eats into returns, which destroys shareholder value. That's why investors have started to sour on oil market M&A in the last year.
The second bucket, on the other hand, is where ConocoPhillips likes to focus. That's because these can be high-return deals that bolster an existing position. Last year, for example, the company made two deals to enhance its operations in Alaska.
ConocoPhillips has already stated that it would like to get bigger in the fast-growing Permian Basin. That desire could be why the company is currently building up so much cash. It might see some opportunities to make a deal that would move the needle for investors.
An interesting storyline to watch
Thanks to recent asset sales, ConocoPhillips' already-massive cash position is on track to grow to more than $10 billion in the coming months. While the energy company plans to send some of that money back to shareholders, it didn't boost its 2020 capital return plan as much as it could. That may indicate that it's holding back so that it can pounce on an acquisition opportunity. If the company can find the right deal for a great price, it could create a lot of value for investors in the coming years. That makes it an intriguing oil stock to watch these days.