Source: ConocoPhillips.
ConocoPhillips (COP -0.04%) was the first oil stock I ever bought. I've yet to sell one share. Instead, at times, I've added to my position by following the advice of Peter Lynch: "the best stock to buy may be the one you already own." With a little extra cash sitting around in my retirement account, I find myself considering again whether it's time to buy more ConocoPhillips stock.
Why ConocoPhillips thinks I should buy
The investment thesis for ConocoPhillips is quite simple. The company plans to grow its production and margins by 3%-5% per year all while offering a compelling dividend to investors. It's a classic growth and income stock well suited for a retirement account.
The reason ConocoPhillips can offer both growth and income is because it's focused on growing margins and not just production. As the following slide from a recent investor presentation points out, ConocoPhillips is investing its capital into developing its highest-margin production.
Source: ConocoPhillips Investors Presentation.
From the above slide, we can see that the company's highest-margin production, North American Unconventional, will see the highest growth over the next few years. Meanwhile, its lowest-margin business, North American Gas, will actually see production decline.
It's this focus on margins that's expected to drive cash flow growth in the years ahead. The company expects its cash flow to grow by 6%-10% annually, which, as the following slide notes, could yield $20-$23 billion in cash flow by 2017.
Source: ConocoPhillips Investor Presentation.
If the company can achieve its goals, it could boost its cash flow by over $7 billion from last year's total. This additional cash flow would give the company the ability to deliver very strong dividend growth, which would further set it apart from its dividend-pinching independent oil and gas peers.
Source: ConocoPhillips Investor Presentation.
While all of that sounds great, it doesn't necessarily mean it's time to buy the company's stock. For that, we need to drill down even deeper into its numbers.
Drilling down into the numbers
First, I will compare ConocoPhillips to those same independent oil and gas peers. Specifically, I'm using EOG Resources (EOG 0.55%), Pioneer Natural Resources (PXD 1.18%), Devon Energy (DVN 0.58%), and Chesapeake Energy (CHKA.Q), as these are the top independent oil and gas producers in North America. In order to decide if today is a good time to buy ConocoPhillips' stock, we need to see its value relative to these independent oil and gas peers. We're going to take a look at a broad cross-section of valuation multiples to really drill down into the value the market is placing on this particular sub-sector of the energy industry. Here's what we see when looking at the trailing-12-month averages of four popular energy valuation multiples.
| Company | Price/Earnings | Enterprise Value/EBITDA | Enterprise Value/Total Revenue | Price/Tangible Book Value |
|---|---|---|---|---|
| ConocoPhillips | 11.6x | 4.9x | 1.9x | 1.8x |
| Chesapeake Energy | 27.1x | 6.3x | 1.9x | 1.4x |
| Devon Energy | 18.6x | 6.8x | 3.4x | 2.2x |
| EOG Resources | 28.4x | 7.9x | 4.0x | 3.5x |
| Pioneer Natural Resources | 42.5x | 16.4x | 8.6x | 3.5x |
Source: S&P Capital IQ.
As we can see, ConocoPhillips is among the cheapest large independent oil and gas producers across nearly all metrics. That provides us with a good foundation to say that, at least relative to its closest peers, ConocoPhillips' stock is cheaper. And yet, that chart doesn't tell the whole story.
Next, we are going to take a closer look at how ConocoPhillips' valuation today compares to its historical average. What I'm going to do is compare its current valuation to the average over the past two years and then an average over the past 10. The reason I'm going to pull out the two-year average is because it spun off its refining, midstream, and chemicals business into Phillips 66 (PSX 1.51%) in 2012. Here's what we see.
| ConocoPhillips | 2014 | Independent Average | Historical Average (Last 10 Years) |
|---|---|---|---|
| Price/Earnings | 11.6x | 11.0x | 8.7x |
| Enterprise Value/EBITDA | 4.9x | 4.7x | 4.9x |
| Enterprise Value/Total Revenue | 1.9x | 1.7x | 0.9x |
| Price/Tangible Book | 1.8x | 1.7x | 1.9x |
Source: S&P Capital IQ.
What's pretty clear from those numbers is the fact that ConocoPhillips did indeed unlock value by spinning off Phillips 66 as several of its valuation multiples are higher now that it is an independent company than its 10-year historical average. Further, the company's valuation in 2014 is a bit higher than its average valuation over the past two years, so it's not exactly dirt cheap at the moment, but it's not overly expensive, either.
Investor takeaway
The bottom line here is that, compared to its independent oil and gas peers, ConocoPhillips is pretty cheap, but it's not a screaming value. However, when we look a the total package of margin-driven growth, dividends, and valuation, it's hard to argue against the fact that now is still a pretty good time to buy ConocoPhillips stock.
