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ConocoPhillips, a Cheap Big Oil Play

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INVESTING November 18, 2008, 9:30PM EST

Marcial: ConocoPhillips, a Cheap Big Oil Play

ConocoPhillips’ strength in natural gas production and oil refining and recent oil deals in Russia and the Mideast make its beaten-down shares promising

The sharp drop in the price of crude oil—which traded at $55 per barrel in New York on Nov. 18, down from a record high of $147 in July— has taken the pizzazz out of the shares of energy behemoths that not too long ago were Wall Street’s top favorites. But for value investors, beaten-down oil stocks are an opportunity not to be missed.

In other words, now may be the time to snag a piece of Big Oil on the cheap.

One undervalued giant whose moves to improve and expand its reach have not been fully recognized on Wall Street is ConocoPhillips (COP). The stock has been slammed, sliding to 47 a share on Nov. 18 from a 52-week high of 95.96 on June 17. True, other oil issues and the rest of the stock market have also been pounded. ConocoPhillips, however, has a lot of positives that investors may be overlooking.

For starters, ConocoPhillips, the second-largest integrated oil company in the U.S.—and No. 4 in the world—is also North America’s largest natural gas producer and the nation’s second-biggest oil refiner. The company operates in 41 countries, but 71% of its revenues come from its U.S. operations.


In spite of the rapid and steep decline in oil prices, ConocoPhillips “remains an awesome company and [is] compelling when crude prices are in the 50s,” says Sheraz Mian, an oil analyst at Zacks Investment Research.

Mian recommends the stock as a buy and sees significant upside potential based on the company’s financial health now and prospects for growth—even with oil at its current levels. Like other analysts, Mian, whose earnings estimates were calculated when crude oil was selling at $90 to $100 a barrel, will likely have to reduce his estimates to adjust for the fall in prices. But he still expects Conoco to thrive. “I am more than confident that even if oil prices drop to the $45 level, ConocoPhillips will still be cash-flow positive and will be able to meet its capital and dividend requirements,” says Mian.

Through acquisitions, alliances, and joint ventures in the recent past, ConocoPhillips has become a strong contender to join the “supermajors,” the global elite of energy companies, according to Mian. The members of that top-tier group are ExxonMobil (XOM), Chevron (CHV), Total (TOT), BP (BP), and Royal Dutch/Shell (RDSA). In evaluating ConocoPhillips, he says, investors should no longer categorize it as a tier-two oil company, which should support an upward valuation of ConocoPhillips’ stock by Wall Street.

The company has significantly strengthened its upstream (refining) operations over the past few years through its acquisition in 2006 of Burlington Resources for $43.8 billion, Mian notes. Burlington was a major independent exploration and production company with significant reserves in North America focused on natural gas. And ConocoPhillips’ 2007 acquisition of a 20% equity stake in Russia’s major oil company, Lukoil, also significantly increased its upstream growth prospects. Lukoil provides access to the lucrative Russian oil market, according to Mian. Its stake in the Russian company, he says, already contributed to ConocoPhillips’ earnings in the first six months of 2008.


Then there are the alliances ConocoPhillips has formed in the Middle East. The signing of cooperation agreements with Abu Dhabi National Oil Co. and Saudi Arabia’s Aramco bodes well for the company’s outlook in that region, says Mian.

Adds Tiva Vital, oil analyst at Standard & Poor’s: “We expect near-term production increases” from ConocoPhillips’ oil projects in Canada and Russia and from natural gas in the Asia-Pacific region. Vital rates the stock a strong buy and expects it to move significantly higher.

ConocoPhillips’ extensive natural-gas assets could be a big contributor to its bottom line, especially if oil prices drop sharply from a global recession. “While gas continues to trade at a discount to oil prices, a colder-than-normal winter could provide a boost to gas prices,” says Fadel Gheit, chief oil analyst at Oppenheimer (OPY), who rates ConocoPhillips “outperform.” He believes the upside potential in the stock could significantly exceed the downside risk from a further decline in oil and gas prices.

Gheit notes that ConocoPhillips was the best-performing stock among major integrated oils in the past 3-, 5-, and 10-year periods ended Dec. 31, 2007. He expects that trend to continue. (Gheit owns ConocoPhillips shares.)

The bottom line for ConocoPhillips is that in spite of its assets and growth outlook, the stock “is the cheapest in the group based on all conventional valuation metrics,” says Mian.

Indeed, greater appreciation among investors of the company’s expanded refining assets and its solid U.S. natural gas reserves should help narrow the stock’s valuation discount to industry titans Exxon Mobil and Chevron. After all, ConocoPhillips may one day play in the “supermajor” league.

Unless otherwise noted, neither the sources cited in Gene Marcial’s Stock Picks nor their firms hold positions in the stocks under discussion. Similarly, they have no investment banking or other financial relationships with them.

Marcial writes the Inside Wall Street column for BusinessWeek. In 2008, FT Press published the book Gene Marcial’s 7 Commandments of Stock Investing.


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