If you're looking to profit from high oil and gas prices, you've come to the right place. ConocoPhillips (COP 0.10%) is one of the largest U.S.-based exploration and production (E&Ps) companies.
Upstream companies like ConocoPhillips are in the business of producing and selling oil and natural gas. So higher prices as well as demand outpacing supply directly benefit ConocoPhillips.
However, E&P companies are also extremely vulnerable to oil and gas downturns. The sweet spot is to find an E&P with plenty of upside from higher prices but also a strong asset portfolio that can do well even when prices are relatively low. It's also important to find a company with a strong balance sheet and low leverage to ride out a particularly brutal downturn.
Here's why ConocoPhillips sits in this sweet spot, and why it's the perfect oil stock to buy in September.
Image source: Getty Images.
Changing tides
After the oil and gas crash of 2014 and 2015, many E&Ps started adopting business models centered around positive free cash flow (FCF) and prudent spending. Investors had grown intolerant of the old adage "drill, baby, drill," which opens the door to massive profits during growth cycles only to have everything come crashing down during downturns.
In response, many E&Ps started paying down debt and selling assets that depended on a high oil and gas price to turn a profit. It no longer mattered how much oil and gas an E&P could produce, but rather how much it could produce and still break even at a low level.
ConocoPhillips is executing its strategy
In April, ConocoPhillips held an analyst and investor meeting to discuss how its business is doing since resetting its strategy in 2015. ConocoPhillips' CEO Ryan Lance had the following to say about how that strategy is playing out:
We have streamlined our portfolio through acquisitions and divestitures to create an asset base that has significant low cost of supply resources. Now you're going to hear that term "low cost of supply" a few times today. We kind of like it. It's a bit of our North Star. I probably should have checked what the over-under was on how many times we would say that, but I'm sure a few of you are keeping track. But it's that portfolio that is really driving the cash flow growth and the returns growth at our mid-cycle price of $60 WTI [West Texas Intermediate]. And the proof point -- history shows that we are stronger, a bigger resource base, a better balance sheet, and we have grown this company over the last four years competitively. And we've done this while being a better environmental steward.
The $60 per barrel WTI, which is the U.S. benchmark, is an important threshold for ConocoPhillips because it's where it can reinvest in the business, significantly grow the dividend, and buy back stock. However, another important level is $35. ConocoPhillips' 10-year plan is to have breakeven FCF at just $35 per barrel while growing its FCF by 11% per year.
The good news is that ConocoPhillips has already proved the resilience of its portfolio. The COVID-19 pandemic wreaked havoc on oil and gas companies. But it also provided a good stress test to see how a company could perform during a period of low prices. The average WTI crude oil price in 2020 was $39.16 per barrel, but the month-to-month variance made it an incredibly challenging year to navigate. The lowest monthly average was $16.55 per barrel in April, while the highest was $57.52 per barrel in January. To its credit, ConocoPhillips eked out $87 million in positive FCF in 2020, a year when many other E&Ps were FCF negative.
Spending within reason
The company was an early adopter of the low-cost-of-supply strategy. And even though oil and gas prices are strong right now, it continues to stay true to its North Star.
COP Free Cash Flow Per Share data by YCharts.
If we look at ConocoPhillips' FCF and capital expenditures over the last decade, we see that 2015 to 2019 marked a rapid decrease in spending and an increase in FCF. Over the last couple of years, ConocoPhillips has boosted its capital expenditures, but it is doing so within reason and not at the expense of its balance sheet.
ConocoPhillips has a total net long-term debt position of less than $10 billion, which is very low for a company of its size. Its debt-to-capital ratio, a leverage metric that shows how dependent a company's capital structure is on debt, sits at a 10-year low of just 25.7%. In other words, ConocoPhillips can afford to gradually boost spending, especially if it is doing so on quality assets that leave it equipped to handle a downturn.
ConocoPhillips can be a lifelong holding
When oil and gas prices are soaring, it's easy to be tempted to jump into a company that is going to really cash in from higher prices. But the upstream industry is already so risky as it is, especially given the importance of climate change and the uncertain role oil and gas will play in the ultra-long-term energy mix.
ConocoPhillips has done a phenomenal job staying levelheaded and executing its goal to deleverage the balance sheet and improve the quality of its assets. The company performed relatively well in 2020, and it is staying true to its strategy at a time when it would be easy to open the floodgates on spending.
All told, ConocoPhillips is a conservative company in a cyclical industry. Despite being up 263.8% over the last three years, it remains the best long-term way to invest in a strong oil and gas market.
