EUR 850.00 For Business Accounts Only

Morningstar | Upgrading Our Moat Rating and Increasing Our FVE for ConocoPhillips

We are upgrading our ConocoPhillips moat rating to narrow from none and increasing our fair value estimate to $76 per share from $61. We think ConocoPhillips has sufficiently improved its portfolio through cost reductions and divestitures, which combined with the addition of low-cost unconventional production growth warrants a narrow moat rating, as we now expect the company to deliver excess returns on capital at our midcycle oil price assumption of $60 a barrel. The increase in our fair value estimate comes after incorporating ConocoPhillips' portfolio transition including asset sales and future growth plans, adding in the $2 billion PDVSA settlement, and updating our model with higher near-term oil prices.

ConocoPhillips' cost improvements and divestitures during the past few years has left it well positioned for a wide range of potential oil price environments. It remains by far the largest U.S.-based exploration and production company by production volumes and retains its diversified asset profile, including unconventional onshore, offshore, liquefied natural gas, and some oil sands. However, it has sold a substantial amount of its lower-margin legacy assets, specifically North American natural gas properties. This combined with a 30% reduction in operating costs has reduced the cash flow break-even level--whereby the firm can pay the dividend and hold production flat--to $40/bbl, leaving ConocoPhillips able to withstand another decline in oil prices.

Though protected on the downside, ConocoPhillips is positioned to benefit from higher prices as well. After the divestments, liquids volumes constitute nearly 65% of the portfolio compared with 57% a few years ago.

ConocoPhillips plans to expand production about 5% through 2020, largely with liquids volumes, which should increase its oil exposure over time. Conventional and LNG volumes will be held flat as new projects backfill declines in Alaska, the North Sea, and Asia offshore. Meanwhile, growth will come from its unconventional assets where it aims for an increase in volumes of 20% through 2020 primarily from its large position in the Eagle Ford, but also in the Bakken and Permian.

The culmination of the improved profitability and growth is greater cash flow, which management plans to return to shareholders largely through repurchases, targeting a 20%-30% payout of operating cash flow annually. The plan mimics management’s plan before 2014, which focused on shareholder distributions; this time, however, the emphasis is on repurchases, not dividends, offering flexibility in the likely event of oil price volatility. The company repurchased $3 billion in shares the past two years and plans another $3 billion in 2018. Beyond then, it has a $9 billion authorization.