ConocoPhillips (COP -1.03%) has spent the past three years transforming its business into one that can thrive at lower oil prices. The energy company reset its dividend, cut expenses, and sold higher-cost assets. These moves helped reduce the oil price level it needed to break even while giving it the cash to shore up its financial situation. As a result, it has become a cash flow gushing machine with a cash-rich balance sheet, which has it well-positioned to prosper in the coming years.
That was one of the key takeaways of the company's recent analyst and investor day, where it unveiled its new 10-year plan. One of the highlights of its long-term strategy is that it expects to return a jaw-dropping $50 billion to its investors over the next decade by continuing to grow its 3%-yielding as well as repurchasing more stock. Those shareholder returns should create significant value for investors who hold on for the long haul.
Drilling down into the 10-year plan
The foundation of ConocoPhillips' strategy is its top-tier portfolio of low-cost oil and gas assets. The company currently controls 15 billion barrels of oil and gas resources that have supply costs of less than $40 a barrel. Because of that, these assets generate significant cash flow above that level, which gives it the funds to continue developing its assets with plenty left over to return to investors.
In ConocoPhillips' view, its assets can generate a jaw-dropping $120 billion in cash over the next decade, assuming oil averages around $50 a barrel, which is below the current price of around $57 a barrel. That's an impressive sum for a company that currently has an enterprise value of $67 billion.
The company intends to reinvest about $70 billion of that money into high-return projects to develop its oil and gas resources. That works out to an average of about $7 billion per year, which is enough to grow its output by more than 3% annually.
That investment plan level will enable ConocoPhillips to generate about $50 billion in free cash flow over the next ten years or about $5 billion annually. The company aims to use about $20 billion of that money to pay a growing dividend and the rest to buy back its stock. To put that buyback into perspective, it's enough money to retire nearly half of its outstanding shares at the current stock price.
Protecting the downside while leaving the upside wide open
One of the key fuels to ConocoPhillips' strategy is the price of oil, with the company basing its plan on crude averaging $50 a barrel. However, a stable price at that level is unlikely to happen, given how volatile oil has been over the years. Because of that, the company has stress-tested its plan for lower crude prices. It has also built in a lot of optionalities so that it can enjoy the full benefit of higher prices.
One of the main sources of the company's downside protection comes from its cash position, which stood at $8.4 billion at the end of the third quarter. The company sees that as a strategic asset as it gives it the cushion needed to weather lower oil prices. That cash balance, for example, will enable the company to fund its base plan for three years if oil slumped to an average of $40 a barrel. Meanwhile, it also gives the company the optionality to capture opportunities that might emerge during another deep downturn, such as the ability to acquire additional low-cost oil supplies at an excellent value.
In addition to that downside protection, ConocoPhillips has plenty of upside to higher prices. If crude oil is above $50 a barrel, it will generate more cash flow than it needs to support its base place. It has three ways it could use that additional cash flow:
- Return more money to investors by accelerating dividend growth, increasing its buyback level, or paying contingent variable dividends (i.e., special dividends that it pays if crude hits a key pricing level).
- Make new resource additions such as accelerating the development of a discovery or acquiring more drillable land.
- Further strengthen its balance sheet by increasing its cash position or paying off more debt.
The company's massive cash cushion makes it one of the lowest risk stocks in the oil patch. Meanwhile, its wide-open ability to benefit from higher prices means it has as much reward potential as its large peers.
A top-flight oil stock
ConocoPhillips stands apart in the oil patch. Thanks to its vast portfolio of low-cost oil and gas assets, it's on track to produce a fantastic gusher of cash in the next decade. If oil averages $50 a barrel, it will be able to send its investors $50 billion via a steadily growing dividend and consistent buyback program, which is an astonishing amount for a $60 billion company. Add in its upside to higher prices and well-protected downside, and this oil stock appears poised to create a significant amount of value for its investors in the coming years, making it one of the top stocks in the sector to buy for the long term.