ConocoPhillips: Joining The Consolidation Wave With Marathon (NYSE:COP)

Last summer I called ConocoPhillips (NYSE:COP) steady, simple steady. Forwarding nearly a year further, we see the business participating in industry consolidation, after many of its major peers have embarked on significant M&A in recent times. With the purchase of Marathon Oil (MRO), ConocoPhillips adds scale while it is aggressively increasing payouts to investors, although they are not convinced just yet despite a higher dividend and relatively small premium offered.

Adding Marathon

ConocoPhillips announced an all-stock deal to acquire Marathon Oil in a deal valued at $22.5 billion if net debt is included. Terms of the deal dictated that investors in Marathon will obtain 0.2550 shares of ConocoPhillips for every share they own, implying a relatively modest 15% premium over the prevailing share price.

The deal adds high-quality and low-cost of supply, adjacent to existing US unconventional position of Conoco in key areas like the Eagle Ford, Bakken and Delaware basin, with real potential for synergies, as commented on by CEO Ryan Lance.

He furthermore claims that the deal is immediately accretive to earnings, cash flow and distribution per share, with synergies having the potential to create value over time. In fact, the full $500 million in cost and capital synergies are expected to be reached in year one after closing.

Addressing Capital Returns

Alongside the deal announcement, Conoco announced aggressive capital allocation practices. The quarterly dividend has been hiked by 34% to $0.78 per share, starting as of the fourth quarter when the deal is expected to close.

Trying to offset the dilution from the deal, Conoco aims to buy back $7 billion of its shares this year, with repurchases pegged at $20 billion in the first three years. Needless to say, the dividend hike is very substantial with dividend payments now trending at roughly $3.7 billion per annum, and that is even ahead of the shares issued to investors of Marathon.

What Is The Impact Of All Of This?

Going back to February, Conoco announced its 2023 results. Lower realizations made that revenues fell by nearly 30% to $58.6 billion as the company still cranked out impressive operating profits of $16.2 billion, with profits pretty evenly spread across the year. With the share count aggressively being reduced during the year, Conoco posted GAAP earnings of $11 billion and with the share count down to 1.2 billion shares, earnings just topped $9 per share.

Frankly, the company was returning to investment mode again, with capital spending of $11.2 billion surpassing the depreciation expense by about three billion. This aided in the growth of the business, with production in terms of oil-equivalent up to 1.83 million barrels per day, up nearly a hundred thousand barrels per day on the year before.

Despite the decline in earnings, after peak earnings in 2022 on the back of the Russia-Ukraine war, earnings power remained solid. An earnings number greater than $9 per share yielded a low teen earnings multiple with shares trading in a $100-$120 range for most of 2023, and that is even as earnings are down in a huge fashion from 2022. Moreover, the company kept optimizing its portfolio last year, including a $3 billion deal to acquire the remaining stake in Surmont.

Pegging earnings power around $8 per share in August of last year, I believed that shares traded at fair valuation, as fast forwarding to today shares have been trading dead flat.

The Implications

Frankly, the external environment for Conoco has been alright. The 2023 results came in stronger than I expected in August of last year, aided by production growth and solid energy prices, with prices holding firm early in 2024.

This lifted shares to highs of $135 per share in the spring of this year, but by now shares are back to the $115 level, with shares down $4 (nearly 4%) on the back of the deal announcement. Note that this implies a $5 billion value decline (excluding the to be issued shares to Marathon), arguably less than the premium offered for the shares!

Based on the first quarter earnings report, as released in May, Conoco operates with some 1.18 billion shares, which now trade at $115, for a $135 billion equity valuation. This excludes a current net debt load of $12 billion and change, for a $147 billion enterprise valuation.

Given the $22.5 billion deal for Marathon, this is a substantial deal, equal to 15% of the own valuation before the deal. In terms of sales, Marathon will add some $6.7 billion in sales, adding just 11-12% of sales to Conoco. Marathon produces just over 400,000 barrels of oil-equivalent per day, thereby growing production by around 21%, as this production typically yields lower revenues. Ironic is that the revenues per barrel from Marathon come in lower, yet its profit margins are quite decent.

Perhaps it was commentary by CEO Ryan Lance, which stated that the deal was only presented a couple of weeks ago, which is not a great comforting factor. Moreover, antitrust concerns could be real, although the company finds comfort in recent statements that the oil market is a global market and consolidation only impacts a very small percentage of this.

What Now?

The immediate reaction of shareholders in reaction to the deal likely seems an overreaction, as Conoco is likely doing the right thing in joining the consolidation spree here.

This comes after Chevron (CVX) announced the acquisition of Hess in a $53 billion deal, and Exxon Mobil (XOM) was even willing to spend $60 billion to acquire Pioneer. This is just part of the action, with multiple other deals pursued by other industry participants.

With Conoco upping the dividend payouts, and having seen a solid start to 2024, I am quite upbeat on this deal, and frankly believe that Conoco likely offers decent long-term value here, certainly as the share price reaction seems like an overreaction here.