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.
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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.
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