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3 Reasons Why This Energy Stock Is No Joke

By Matthew DiLallo - Apr 1, 2013 at 2:00PM

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Today might be April Fools' Day, but this energy company is no joke. It has a plan in place to grow both margins and production, which should yield excellent future returns for its investors.

Finding a great energy company to invest your hard earned dollars in isn't an easy task. You really have to be careful which company you choose as each has its own set of risks that needs to be considered carefully. Some companies are leveraged to the hilt, while others produce too much of a poorly priced commodity.

The good news is that several energy companies do have a great balance between risk and reward. One of the best, in my opinion, is ConocoPhillips (COP 0.39%), which I believe will reward investors for years to come.

Repositioned and ready to grow
ConocoPhillips is in the final stages of a multi-year repositioning plan. The company has been shedding assets in order to get down to a core base from which it can grow both production and margins. Today the company has a strong balance sheet and a solid plan to drive shareholder returns.

After spinning off its refining arm into Phillips 66 (PSX -0.60%) last year, ConocoPhillips became a pure-play exploration and production company. Still, it has asset diversification between both conventional and unconventional resources, as well as operations both onshore and offshore. This rebalanced portfolio enables the company to focus on organic growth with the goal to invest in high-margin projects.

Margins will be a key focus of the company. While Phillips 66 is currently enjoying solid margins thanks to its growing access to cheap North American crude oil, this has not always been the case. Now the repositioned ConocoPhillips doesn't have to worry about compressed refining margins driving down overall margins. That's one example of why the company believes it can grow its margins by 3%-5% annually over the next few years. Conoco believes this will deliver $6 billion of incremental cash flow to its bottom line.

Visible production growth
In addition to visible margin growth, Conoco plans to grow its production by 3%-5% per year through 2017. To get there it plans spend about $16 billion per year. More than half of these funds are targeted to development projects designed simply to offset the natural production decline across its portfolio.

Growing production is harder than you'd think. Consider the fact that oil giant ExxonMobil (XOM 0.79%) has only grown its production by 1% annually over the past decade. Further, despite planning to outspend Conoco by a two-to-one ratio, Exxon only expects to grow its production 2%-3% over the same time frame.

While Conoco is starting from a lower base, the drivers here are its major projects which will start to come on line over the next few years. These projects are in lower-risk geographies and are focused on liquids-rich opportunities, and will be the key drivers to deliver that future production growth.

Solid plan to grow the dividend
While Conoco plans to plow about $16 billion per year in future cash flow back into its business, that's only 75%-80% of its expected cash flow. The 20%-25% left over is earmarked to reward investors through additional buybacks and dividends. Conoco already has a very compelling dividend that yields nearly 4.5%; however, as the company executes on its plan, it believes that dividend can begin to head higher in the future.

My Foolish take
While ConocoPhillips has been one of my top energy holdings for years, I've never been more excited about its future as I am today. The formula here is a pretty simple; margin growth plus production growth equals higher shareholder returns. That's why I think this company is no joke, and one you should consider if you want to add some energy to your portfolio. 

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Stocks Mentioned

ConocoPhillips Stock Quote
ConocoPhillips
COP
$105.02 (0.39%) $0.41
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
XOM
$91.86 (0.79%) $0.72
Phillips 66 Stock Quote
Phillips 66
PSX
$93.79 (-0.60%) $0.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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