ConocoPhillips Shifts Focus To LNG, Stock On Sale (NYSE:COP)

Liquefied natural gas tanker ship in sea

alvarez

ConocoPhillips (NYSE:COP) is certainly riding high these days. For a company that is breakeven in the neighborhood of $40/bbl WTI, the current oil and gas price outlook is quite rosy, to say the least. That’s especially the case considering COP’s well-timed acquisitions of Concho and Shell’s Permian assets and the resulting big jump in shale production. Now it would appear that Conoco, an early pioneer in LNG and owner of a strong LNG patent and asset portfolio, is shifting focus from shale to the global LNG market. This is another smart move by the company, and should enable it to maximize the value of the nat gas molecules it is producing in its L-48 shale portfolio, which now accounts for over 50% of total production. Meantime, COP is extremely cheap in my opinion. The forward P/E is only ~6x and there’s excellent potential for dividend upside given that COP, finally, instituted a variable dividend policy. Oil and gas prices are still strong. That being the case, the recent pullback in COP’s stock price has been way overdone and it is a BUY.

Chart
Data by YCharts

Let’s Talk Natural Gas

When the typical investor thinks of COP, they likely think of a big US shale player. And that’s certainly true. However, many energy investors likely do not know that COP also has a long and storied history in LNG. Indeed, COP’s Optimized Cascade process technology was first implemented at its Kenai, Alaska, LNG facility way back in 1969. Since then, COP has continued working on cost effective, high-value natural gas liquefaction solutions. Indeed, since Kenai COP has licensed the Optimized Cascade process to owners of 27 additional LNG trains.

Of late, COP has arguably been focusing on LNG. I say that due to the following relatively recent developments:

  1. In February, COP increased its ownership in APLNG (“Australia Pacific LNG”) by an additional 10%. That brings COP’s ownership stake in APLNG to 47.5% (Origin owns 27.5%, Sinopec 25%). COP’s FY2021 production from APLNG was 113,000 boe/d with full-year 2021 financial distributions of ~$750 million.
  2. In June, COP said it signed a deal with Qatar for a stake in its $29B North Field East expansion project that will boost the world’s No. 1 exporter of LNG. COP and QatarEnergy will form JV that will take a 12.5% stake in North Field East and COP will have a 25% stake in that JV. Exxon Mobil (XOM) is also participating in the North Field East expansion project. Note that COP already owns a 30% stake in the Qatargas 3 joint venture – a large-scale LNG project in Ras Laffan that began in 2003. The QatarGas 3 facilities have a production capacity of 270,000 boe/d (~75% natural gas and ~25% LPG/condensate) from Qatar’s North Field, which is the world’s largest contiguous conventional gas field.
  3. In July, COP and Sempra (SRE) signed an agreement to potentially and significantly increase its global LNG business via a 30% equity stake in Port Arthur Liquefaction Holdings with an LNG offtake equivalent to ~5 million tonnes per annum (“Mtpa”) from the Port Arthur LNG project. The first phase of the project already is permitted and will have two trains that are expected to have a combined capacity of ~13.5 Mtpa of LNG. COP is a top-5 natural gas marketer in the U.S. and will supply the gas for its 5 Mtpa offtake and could provide additional gas supply for the Port Arthur LNG facility.
  4. Earlier in July, Bloomberg reported COP was in talks with the state of Alaska and Hicorp for an Alaskan LNG facility for export to Asia. The project already has a permit for a 20 Mtga facility.

As you can see, COP is making serious investments in its global LNG footprint going forward. This is an excellent way for COP to diversify its portfolio while at the same time maximizing the value of its existing natural gas production. Given the current macro environment (Putin’s horrific war of choice in Ukraine, Putin weaponizing natural gas deliveries to Europe, strong global LNG demand, etc), the price of LNG has been very strong. The graphic below shows the price of Australian LNG. Note that despite the recent pullback, prices are still significantly more than 2x the price of the entire period of 2016-2021:

Australian LNG Price

GlobalLNGHub.com

Earnings

As reported in my May Seeking Alpha article on Conoco (see COP: A Lot To Like), the Q1 EPS report was very strong:

  • Earnings of $5.8 billion ($4.39/share).
  • Production was 1.747 million boe/d (~220,000 boe/d more than Q1 of the previous year due to the acquisitions).
  • COP’s average realized price for crude oil (52.4% of production) was $97.82/bbl.
  • Generated $3.9 billion in free-cash-flow (an estimated $2.98/share based on 1.307 billion fully diluted average shares outstanding at quarter’s end).
  • Bought back $1.4 billion in stock.
  • Declared a $0.70/share variable cash dividend on top of the $0.46/share regular dividend.

Valuation

Note that the Q1 report discussed above came on the heels of generating a total of $10.4 billion of FCF in FY2021, when COP was still digesting its Permian acquisitions. Clearly, the fact that COP generated $3.9 billion of FCF in Q1 of this year shows the company is on track for an even better year in FY2022. And even using the $10.4 billion of FCF COP generated last year, with a current market-cap of only $112.9 billion, and with long-term debt of $17.5 billion and cash of $7.1 billion (both at the end of Q1), COP’s enterprise value is only an estimated ~11.9x last year’s FCF. Combined with the current forward P/E of only 6x and there is only one word to describe COP’s current valuation: Cheap!

Risks

Of course, with O&G producers investors always are at the mercy of commodity prices and the cyclicality of the global O&G markets. As I have pointed out in my previous articles on the energy sector, the primary reason that the global oil market was tight prior to Putin’s invasion of Ukraine was that US shale oil producers, sitting on tens of billions of barrels of proven reserves (at $40/bbl WTI, let alone $100/bbl …), and with plenty of pipeline capacity to get it to market, simply decided not to drill more wells and very economically and relatively quickly bring that oil to market. That is, the energy company CEOs dropped the idiotic “drill-baby-drill” mantra and, instead, apparently decided that shale oil wasn’t “short-cycle” after all (even though they themselves had promoted that exact description for many years as a primary advantage of US shale). That being the case, there’s always the possibility that a few large US shale producers could decide to drop the discipline and “cash in” on current prices.

Regardless, current market dynamics continue to be very favorable for US shale producers, and it’s not just the price of oil: Shale producers’ associated gas production is delivering an unexpected windfall due to a big rally in the price of NYMEX gas:

NYMEX Nat Gas Price

Bloomberg

Note the red arrow and that throughout the entirety of Q2 (April – June), the price of NYMEX was mostly above $6/MMBtu, which not only was much higher than during Q1, but also ~2x the price that NYMEX averaged over the past five years. Conclusion: Oil and gas prices for Q2 look to be a huge tailwind for COP and their upcoming Q2 EPS report (scheduled for release on Aug. 4).

In the mid term, COP has been greatly overemphasizing stock buybacks over dividends directly to shareholders. Last year, COP returned 38% of CFO to shareholders. That’s the good news. The bad news is that of the $6 billion returned to shareholders, only $2.4 billion (34%) was in the form of dividends while 66% went to share buybacks ($3.6 billion). Shareholders deserve better and now that COP has instituted a variable dividend policy (long after peers EOG Resources (EOG) and Pioneer Natural Resources (PXD) had done so … and at a much lower relative level …), shareholders should expect more of a “fair shake” this year. Time will tell. However, from a FCF generation perspective, there’s obviously massive upside to COP’s dividend.

Longer term, one reason a company like COP is trading at such a deep “value” is likely because of the threat that EVs and renewable energy adoption pose. Most analysts expect EVs to account for ~50% of global new vehicle sales by 2030. That estimate – given the current very high price of gasoline and the number of lower cost EV options now hitting the market – is likely to be on the low side. Indeed, this is one reason COP’s over-emphasis on share buybacks irritates me so much is because management is effectively forcing shareholders to double-down on oil and gas production. Given the current macro environment, I’d much rather have my so-called “return of capital” be paid in dividends directly to me so that I can decide if I want to buy more stock (or not).

Summary and Conclusion

Despite the risks just discussed, the current macro environment is strongly bullish in my opinion and is likely to stay that way through the end of the year and perhaps even until there’s some kind of workable resolution to Putin’s war-of-choice on Ukraine. However, even if a settlement agreement was signed tomorrow, it could take many months to unwind the broken global oil supply chain. Meantime COP’s current growth strategy appears to be focused on growing its global LNG business, which is smart. LNG is very profitable and is the cleanest fossil fuel (other than hydrogen) and the perfect back-up for renewable power gen given that nat gas power gen can be started and stopped relatively quickly (much quicker than either coal or nuclear).

Bottom line: Given current O&G prices, COP is a FCF generating giant. The stock is currently extremely cheap based on either a FCF analysis (~12x) or from a forward P/E perspective (~6x). The dividend growth outlook is excellent. Add it all up and COP is a buy.

I’ll end with a long-term chart of COP’s stock price and caution energy investors who think “this time is different” to take a good look at the cyclicality of COP’s stock price over the past ~10-years and that it’s currently not far from the price it traded at back in 2015.

Chart
Data by YCharts

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