Investing is full of trade-offs, from great companies that are expensive stocks to O.K. companies that are cheap stocks. Maybe you found a company with amazing growth, but it's generating losses. Or great earnings and a growing dividend but low growth in the underlying business. It's also common to find companies and conglomerates with diversified business units and pure-play companies.
Pure-play companies have high exposure to one thing and try to do that thing well, whereas diversified companies try to do many things well. That will leave the diversified company better prepared to manage risk at the expense of dampening upside. But it also leaves the pure-play company better positioned to grow. Here's why pure-play stocks can be such great investments but also risky, and why ConocoPhillips (COP -0.50%) could be a great buy now.
Pure play or not?
Some of the best stock investments over the last decade or two have been pure-play tech companies. Netflix (NFLX -0.69%) comes to mind. Its business plan essentially has been to reinvest all of its cash flow to produce more content so that it can attract new subscribers, have a high renewal rate, and raise prices. That strategy worked very well when there was a lot of growth potential.
But today, there's much more competition in the streaming sector. For example, Amazon and Walt Disney participate in the streaming sector. But they aren't pure-play streaming companies like Netflix.
Walt Disney is able to generate more lasting value from the content it produces than Netflix because Walt Disney has its theme parks, film franchises like Marvel and Star Wars, and a merchandise business that all benefit from its hit movies and shows. Similarly, Amazon has a library of films that people will likely continue renting over time. So in the case of streaming, the capital-intensive nature of producing content just to keep existing subscribers engaged, even though most of that content will soon go stale and have little to no residual value, is a case where being a pure-play streaming company today seems like a bad business model.
The Netflix example is worth pointing out because although streaming used to be a great pure-play investment, I would argue it's better to go with Disney or Amazon now than Netflix.
Why ConocoPhillips is a great oil and gas company
The streaming discussion is important because it can show the dangers of operating a pure-play business model when competition rises and the competition has a better business model than you do. But ConocoPhillips is no stranger to competition. It has been through ups and downs and has built a business strategy to handle them.
Oil and gas is an industry in which being a pure-play has its advantages. And ConocoPhillips demonstrates this perfectly. Unlike integrated oil and gas majors, such as ExxonMobil or Chevron, it mostly operates in just the exploration and production side, which is known as the upstream business. The company basically has one goal: to produce crude oil and natural gas at the lowest cost possible and sell it for the highest price possible.
It can't really control the price; the market does. But it does have more control over the average price at which its portfolio can break even, and where those plays are located. ConocoPhillips' decision to focus mainly on U.S. onshore shale plays in the Permian Basin, Bakken, and other areas in Oklahoma and Texas makes it less susceptible to geopolitical instability in other countries. Operating in these areas at the lowest cost possible is exactly where ConocoPhillips has focused its attention for years. And the results speak for themselves.
In 2021, ConocoPhillips recorded its highest free cash flow (FCF) since 2007. But what's really impressive is that the company was able to generate slightly positive FCF in 2020 even though West Texas Intermediate (WTI) crude averaged $39.17 per barrel in 2020.
Calculated and prudent spending relative to its peers has given it one of the lowest break-even costs in the business, which protects it from downside risk when oil and gas prices are low while also giving it a lot of upside. Investors looking for a company that makes more money when oil and gas prices go up, but can also make money when oil prices are, say, $40 a barrel, should look no further than ConocoPhillips.
The company has said that it can break even, including its dividend payment, at around $40 oil. In its fourth-quarter 2021 earnings call, it said the portfolio currently has a break-even point, excluding the dividend, at around just $30 oil. It's hard to find a break-even point that low, which is why ConocoPhillips takes a pass on a lot of less-profitable plays and buys back its own stock instead.
A transparent investment
ConocoPhillips might invest in low-carbon ventures here and there. But ultimately, it's just going to keep doing what it does best. Of course, the company faces long-term risks, such as reduced demand for fossil fuels over time and lower oil and gas prices. But it is also a fairly easy-to-understand business. For investors looking for a well-run upstream oil and gas company that can profit from higher energy prices but still return positive FCF even if prices fall by 60%, ConocoPhillips could be a stock worth looking at.