ConocoPhillips Is A Strong Buy

By Arthur Pinkasovitch | July 20, 2011 AAA

Despite offering a hefty 3.5% dividend and committing to a $10 billion share buyback, ConocoPhillips (NYSE:COP) continues to trade with a low P/E of 9. In contrast, its major competitors, such as Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX), trade at multiples of 12 and 10.5, respectively. A substantial portion on the funds used in the buyback program were obtained from COP's disposition of its 20% stake in Lukoil (OTCBB:LUKOY); the asset sale of the remaining position was completed last quarter and generated $1.24 billion. An additional $5 billion to $10 billion of asset sales are expected within the next two years. The oil giant has been experiencing strong top and bottom line growth over the last 3 years, as current oil production is currently 1.7 million barrels of oil equivalents per day.
TUTORIAL: Commodity Investing 101

Unlocking Hidden Value
ConocoPhillips is in the process of spinning off its refining and marketing (R&M) business to its shareholders. The restructuring is subject to board approval but does not require a shareholder vote. Jim Mulva, chairman and CEO stated "Consistent with our strategy to create industry-leading shareholder value, we have concluded that two independent companies focused on their respective industries will be better positioned to pursue their individually-focused business strategies." Following the separation, ConocoPhillips will focus exclusively on its exploration and production (E&P) business, while the spun-off company will be a pure-play refiner.

The tax-free spin-off of the downstream operation will provide greater transparency of the business over that which can be achieved through an integrated corporation. The move will position ConocoPhillips as America's largest E&P pure play as the company continues to pursue its primary goal of improving return on capital employed. Joel Greenblatt, the famous hedge fund manager of Gotham Capital, is a strong advocate of investing in spin-off companies, in both the parent and the newly formed firm. He cites that spin offs have a historic pattern of outperforming the market because management is better able to align its focus on a particular area of expertise as corporate resources are distributed favorably to boost the fair value of both entities. ConocoPhillips notes such strategic rationale for the separation.

The exploration & production arm along with the midstream segments account for quarterly sales of $14.1 billion, or 25% of the overall firm. Refining and marketing produces the remaining 75% of ConocoPhillips' sales. Despite the substantial discrepancy in revenue between the E&P and R&M businesses, exploration and production carries a much greater net profit margin. For ConocoPhillips, the E&P segment operates with a margin of 19.7% while R&M faces a paltry margin of 1.1%.

The Bottom Line
The ConocoPhillips spin-off marks the second major event this year in the oil industry; Marathon Oil (NYSE:MRO) recently completed a spin-off of Marathon Petroleum (NYSE:MPC), its refining business. As previously stated, spin-offs often have the potential to create significant value for investors. A prime example is the divestment of Chipotle (NYSE:CMG) from McDonald's (NYSE:MCD). Since the separation, Chipotle is up 680%, while McDonald's shares have climbed around 150%. In the case of ConocoPhillips, because a large portion of management's compensation is in the form of restricted stocks and options, they have a strong incentive to see this spin-off succeed.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Analysis
  1. Chart Advisor

    A Total Stock Market ETF For Any Portfolio

  2. These stocks have been weak, and despite rallies, investors might be better served by selling or shorting as opposed to buying.
    Chart Advisor

    Time To Take Profits On These 4 Rallying Stocks?

  3. With its huge population and booming economy, China is tops for many emerging markets investors. Here's a leveraged ETF for those who want to double down.
    Stock Analysis

    This Leveraged ETF Is For China Bulls

  4. Chart Advisor

    Is Natural Gas About to Tank?

  5. Chart Advisor

    Is It A Breakout? See The Point-And-Figure Chart

Trading Center