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ConocoPhillips: Slow & Steady Wins the Race

Posted by April 20, 2017

File Image (CREDIT: AdobeStock / (c) Edelweiss)

ConocoPhillips has beaten its 2017 asset sales target less than four months into the year, after shedding $30.8 billion worth of energy assets in six years.
But instead of a chorus of cheers on Wall Street, Chief Executive Ryan Lance is facing investor skepticism that the company can deliver growth from remaining oil and gas fields.
ConocoPhillips' most recent sales of Canadian oil-sands properties and U.S. natural gas wells for a combined $16 billion will part with nearly 30 percent of its proved reserves in order to deliver near-term shareholder payouts and pare debt. For a graphic, click
Lance told Reuters the sales to Cenovus Energy (CVE) and Hilcorp Energy Co will fulfill promises to reduce long-term debt by 42 percent to $15 billion, fund $6 billion in share purchases and help reshape the company for an era of low and volatile energy prices.
Drilling in two shale regions should help restore falling U.S. output by the fourth quarter.
"I don't worry about production and reserves in the company," he told Reuters in an interview, citing oil and gas fields that could be upgraded to proved reserves over time.
ConocoPhillips can achieve flat to 2 percent annual production growth on its properties, after adjustments for sales, and deliver shareholder payouts, he said.
But interviews with portfolio managers, former employees and industry analysts point to the frequent sales as a short-term fix. They worry ConocoPhillips (COP)' plan for modest production growth, flat capital spending and steady shareholder payouts pales in comparison to rivals that have retooled themselves to deliver sharply higher growth rates.
The danger of its reliance on fewer assets was driven home in recent weeks as a fire at a supplier hurt its ability to ship crude from oil-sands properties.
Mike Breard, who tracks energy stocks for Hodges Capital Management, said the strategy lacks appeal.
"If I wanted yield, I'd buy something else. If I wanted growth, I buy something else. I just don't see what customers would want to be in that in-between situation," Breard said.
The Houston company projects its daily production of crude and natural gas will fall 26 percent after the latest sales to about 1.16 million barrels of oil equivalent (boe). Barclays (BCS) expects overall it won't return to production growth on a full-year basis until 2019.
"They've sold a very valuable asset," said Marc Heilweil, senior portfolio manager at Atlanta-based investment firm Gratus Capital, referring to the oil-sands holdings.
The deal will "make it harder for them to fully replace reserves down the line" because shale-oil properties have shorter productive lives, he said.
To ensure growth, oil producers must continually add reserves to offset production and the natural decline that occurs in oil-and-gas properties.
In 2012, ConocoPhillips spun off its refining business, leaving the ranks of the large, integrated companies like Exxon Mobil Corp and Chevron Corp, and putting it among a group of mostly-small U.S. independent exploration and production companies.
Lance, who was the company's technology chief, became ConocoPhillips' chairman and CEO upon the spin off. He pledged to boost output by 3 percent to 5 percent annually by tapping its large pool of deep-water, oil-sands and conventional oil-and-gas properties. That goal ended two years later as prices collapsed, forcing it to borrow heavily to cover its spending on production. ConocoPhillips later cut its dividend.
Its lack of exposure to refining has helped its shares stand out recently. The company's stock is down 4.3 percent year to date, even after an about 9 percent jump following the March 29 disclosure of a $3 billion addition to its share buy backs. In contrast, Chevron is 11.5 percent lower and Exxon is off about 10.8 percent in the same period.
Of analysts with published ratings on the stock, 7 rate it a strong buy, 11 rate it a buy and 6 rate it a hold. That compares to Chevron with 6 strong buy ratings, 12 buy ratings and 3 hold ratings.
Last fall, Lance recast ConocoPhillips as an energy company able to offer steady shareholder returns on flat production spending of about $5 billion a year. It shaved its growth target to as much 2 percent, instead of up to 5 percent, and promised 20 percent to 30 percent of operating cash flow would go to holders via dividends and buy backs.
He insists the remaining assets can generate substantial cash from operations even if oil falls below $40 a barrel. ConocoPhillips is ramping up output from its Eagle Ford and Bakken shale wells, from another oil-sands property and liquefied natural gas (LNG) from operations in Australia.
Meanwhile, rivals have cranked up their production much faster. U.S. shale-focused companies project 15 percent volume growth this year, says consultancy Wood Mackenzie, and the larger oil producers such as Chevron are raising output and delivering fatter dividends.
ConocoPhillips will be producing an average 1.25 million boe a day in 2019, estimates Barclays. In contrast, Chevron projects its daily output this year will rise between 103,000 boe and 233,000 boe over 2016's average 2.59 million boe, excluding divestitures. Chevron pays a 4 percent dividend.
The risk for ConocoPhillips investors is the growth in production doesn't generate higher free cash flow for share buy backs, and the 2 percent dividend yield, about half that of Chevron, becomes the bigger part of returns.
Henry Smith, co-chief investment officer at Haverford Trust, which invests in companies offering revenue growth and dividend gains, sold ConocoPhillips shares ahead of its 2016 dividend cut and has not been tempted back by the new strategy.
ConocoPhillips' pledge to deliver steady returns and growth is appealing, said Smith. But, he added: "Exxon over the years has fit that bill." Haverford's oil-industry holdings are Exxon Mobil Corp, Chevron and Schlumberger NV, he said.
Tom Bergeron, an equity analyst at Frost Bank, also prefers other oil producers such as Chevron and Occidental Petroleum Corp for what he said is their expected growth and their higher dividend yields.
Lance, who worked summers as an oilfield roughneck while studying petroleum engineering in Montana, said he understands investors want proof the company can deliver regular payouts without the asset sales.

"It'll probably take performance through a cycle to demonstrate we have the position and the passion to deliver," he said, referring to the industry's boom and bust periods.


By Gary McWilliams

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