The word safe can be defined as "protected from or not exposed to danger or risk; not likely to be harmed or lost." If we were to apply that definition to a stock, it would suggest a company that is protected against an extreme outside risk factor that could cause the stock price or its dividend to fall dramatically. Given what has happened to ConocoPhillips' (COP +0.17%) stock and dividend over the past year, it's appropriate to say that it doesn't exactly fit the definition of a safe stock:
Having said that, while investors hoping for safety have been disappointed after both their investment in ConocoPhillips and its income stream have declined sharply over the past year, it is still among the safer oil stocks.
Exposed to risk
As an oil producer, ConocoPhillips is exposed to a number of risks, not the least of which is the volatility of oil prices. In fact, when looking at the risk factors in its annual report, this is the first one listed, with the company warning that "[o]ur operating results, our future rate of growth and the carrying value of our assets are exposed to the effects of changing commodity prices." As the company goes on to note:
Prices for crude oil, bitumen, natural gas, natural gas liquids and LNG can fluctuate widely. Globally, prices for crude oil, bitumen, natural gas, natural gas liquids and LNG have recently experienced significant declines from their historic levels during 2013 and 2014, with continued global production increases that have outpaced demand growth, leading to a large observed rise in global inventory. Prices for Brent crude oil, WTI crude oil, Henry Hub natural gas and natural gas liquids in the fourth quarter of 2015 have all declined more than 40% when compared with prices in the fourth quarter of 2014, and there are no indications the price declines will reverse themselves in the immediate future.
This decline in prices has a direct impact on its cash flow, which affects not just its ability to maintain and grow its production but its dividend as well. It's because prices have been so weak that it has been forced to eliminate growth-focused spending and reduce its dividend in order to better balance cash flow with those two outflows:
Image source: ConocoPhillips investor presentation.
Still, the company has been much better able to deal with lower oil prices than many of its weaker competitors, as evidenced by its continuing to pay a dividend while at least maintaining its current production rate. That's partially due to its geographic and asset diversity, as well as its relatively strong balance sheet.
All is not lost
It's that balance sheet strength that should prevent the company from getting anywhere close to the brink of bankruptcy, which is where we find a growing number of oil and gas producers these days. Instead, ConocoPhillips boasts of an investment grade credit rating, though that was recently downgraded from A1 to Baa2 based on the assumption that its debt levels would rise over the next two years above the targets for an A1 rating.
Image source: Anadarko Petroleum.
That said, a Baa2 rating implies easier access to credit and better borrowing rates than companies with lower ratings. That makes it a safer bet than Anadarko Petroleum (APC +0.00%), which just had its credit rating downgraded below investment grade due to its already higher relative debt levels. That elevated debt led its rating agency to assume that the company's financial flexibility would be diminished to the point where it could no longer maintain production. In fact, the only reason Anadarko Petroleum will be able to maintain its production in 2016 is by selling assets, resulting in flat adjusted production. Furthermore, in having its credit rating downgraded from Baa2 to Ba1, it suggests that Anadarko Petroleum faces major uncertainty about its ability to meet its financial obligations should industry conditions worsen whereas ConocoPhillips credit rating implies that it is less vulnerable in that situation.
Worst yet was the fate of smaller, less diversified Whiting Petroleum (WLL +0.00%), whose credit rating slashed five levels as opposed to the two level drops for ConocoPhillips and Anadarko Petroleum. In Whiting Petroleum's case, its credit rating was reduced from Ba2 all the way down to Caa1, with its credit rating agency citing a "heightened risk of a debt restructuring," which in a worst-case scenario could cause Whiting to reorganize via bankruptcy. Also, Whiting Petroleum's credit rating suggests that it has substantial current financial risks, as shown by the fact that it needed to slash its capital spending by 80% for 2016. Because of that cut, Whiting Petroleum is in the process on winding down its fracking operations, which will cause its production to decline by 18.5% over last year's average.
Investor takeaway
ConocoPhillips isn't as safe as most other large-cap stocks because it is directly exposed to volatile commodity prices. That being said, compared to a lot of other oil stocks, it is a much safer investment because of its strong balance sheet, which earns it a much higher credit rating. That strength should protect investors from the potential of losing their entire investment, something that can't be said for some other other oil stocks right now.
