Buying This Dirt-Cheap High-Yield Dividend Stock Could Be a Genius Move in 2023

Like many oil and gas stocks, ConocoPhillips (COP 1.23%) crushed the broader indices in 2022. But just because the stock is up while the market is down doesn't mean the exploration and production (E&P) company is overvalued.

Here's why ConocoPhillips is poised to shine in 2023, outlast future oil and gas downturns, and distribute gobs of dividends to its shareholders.

Image source: Getty Images.

Managing downside and capitalizing on upside

What separates ConocoPhillips from its competitors is its capital discipline. The company has a track record for avoiding overinvestment during boom times and weathering downturns.

2020 was a nightmare year for E&Ps. But ConocoPhillips managed to finish the year free-cash-flow (FCF) positive, a testament to its prudent portfolio of low-cost production. 

ConocoPhillips also has the kind of balance sheet that should allow it to go out and acquire acreage on the cheap to further lower its cost of production, a luxury that many of its competitors can't afford during downturns. The most recent example is ConocoPhillips' acquisition of Concho Resources, which was completed in January 2021. 

The acquisition was a major success. In 2021, ConocoPhillips notched its highest annual net income and FCF since 2013, the year before the crash of 2014. And the momentum carried over to 2022. ConocoPhillips' trailing 12-month (ttm) net income sits at a staggering $18.1 billion -- the highest ttm net income in company history, and over double the $8.1 billion the company earned in 2021 net income.

ConocoPhillips' was able to acquire Concho and boost capital expenditures the last few years without damaging its balance sheet. In fact, ConocoPhillips has one of the best balance sheets of the major E&Ps when you look at its low debt-to-capital.

COP Debt To Capital (Quarterly) data by YCharts

The company also sports a net total long-term debt position of just $6.5 billion, which is very low given its size. 

An attractive dividend

A core part of the investment thesis for ConocoPhillips is its growing ordinary dividend and its variable return of cash (VROC). Unlike other companies that pay quarterly dividends and have fairly regular scheduled raises, ConocoPhillips provides shareholders the best of both worlds through a reliable and growing quarterly ordinary dividend and a VROC that directly passes along profits to shareholders.

In its Q3 2022 press release, the company announced it was raising its ordinary dividend by 11% to $0.51 per share, or $2.04 per year. The increase kicked in for the Q4 ordinary dividend. In total, the company paid $4.99 in total dividends per share in 2022 -- a 4.4% yield at the current stock price. Here's a look at its last year of both VROC distributions and ordinary dividend payments.

Data source: Yahoo! Finance 

In the table above, you can see that as the company's profits grew as the year went on, it directly passed along those profits to shareholders through a higher VROC. What's more, investors can expect eight dividend distributions in a 12-month period instead of the usual four. The higher distribution frequency is particularly attractive for investors that are supplementing income in retirement or regularly rely on income from dividend stocks. 

Risks worth watching

ConocoPhillips has a framework that aims to keep its cost of supply below $40 per barrel of oil equivalent (boe). And some of its newer projects even have a cost of supply in the low $20 per boe. 

Despite the low-cost profile, ConocoPhillips is highly sensitive to oil and natural gas prices.

For 2022, the company estimated that for every $1 change in Brent (the international benchmark) crude oil price, there would be an $80 million to $90 million change in its cash flow and a $110 million to $120 million change in its net income. And for every $1 change in West Texas Intermediate (the U.S. benchmark) crude oil price, it would mean a $115 million to $125 million change in its cash flow and a $105 million to $115 million change in its net income.

ConocoPhillips is more sensitive to the WTI price since it is heavily invested in onshore U.S. shale, like in the Permian Basin. The company's production mix for 3Q 2022 was 51% crude oil, 30% natural gas, 15% natural gas liquids, and 4% bitumen. Most of its natural gas supply is in the U.S. And for every $0.25/MCF change in Henry Hub natural gas prices, ConocoPhillips expects a $90 million to $100 million change in its cash flow and net income.

Put another way, if WTI oil prices fall $10 per barrel from the current price of $74.40 to an average of $64.40 in 2023 and Henry Hub prices fall $0.50/MCF from the current price of around $4.10/MCF to $3.60/MCF, investors can expect more than a $1.25 billion hit to both net income and FCF, a decrease in VROC payouts, and a more expensive valuation for the stock.

A reasonable valuation

ConocoPhillips' price-to-earnings (P/E) and price-to-FCF ratios currently sit at very low levels of 8.2 and 8, respectively. What makes the stock so dirt cheap is that its profits and FCF could get cut in half, and it would still have a below-market valuation. Granted, ConocoPhillips has suffered some major losses in the past 10 years. So its P/E ratio could look inflated or discounted depending on the cycle.

The takeaway here is that the stock is inexpensive for investors that believe that oil prices will stay above $60 per barrel. And even if they fall below that, ConocoPhillips is well positioned to outlast a downturn.

A balanced investment for 2023 and beyond

What makes oil and gas companies -- and especially E&Ps -- difficult to invest in is that they are heavily vulnerable to factors outside of their control. When approaching a stock in the space, it's better to focus on how the company manages what it can control.

ConocoPhilips has an excellent balance sheet, a track record for gaining market share during downturns and not overly investing during times of expansion, a growing ordinary dividend, a VROC that directly passes along profits to shareholders, and an inexpensive valuation.

If 2023 is another great year for oil and gas, ConocoPhilips will likely be another big winner. But even if commodity prices fall, the stock should remain a good value and a reliable passive income source through its ordinary dividend.