ConocoPhillips (IL/A): Earning its way to an improved valuation relative to other super-cap oils
Goldman Sachs July 27, 2005
ConocoPhillips's financial performance continues to make the case for further improvement in its valuation relative to the other super cap oils. In our view, Conoco is on pace to move to a premium to Chevron and potentially reach a Royal Dutch Shell-like valuation. While the company is clearly benefiting from having the right assets for the current macro environment, strategic, operational, and financial execution have been unquestionably strong for an extended period of time. Our In-Line rating on Conoco shares in the context of an Attractive coverage view continues to be a function of us seeing greater upside in our high-beta top picks and superior risk control in Exxon Mobil (OP/A) among the US-based super-cap oils. With that said, Conoco's fundamental outlook remains favorable and we expect the shares to continue performing well.
CONOCO EARNING ITS WAY TO AN IMPROVED VALUATION RELATIVE TO OTHER SUPER-CAP OILS
ConocoPhillips shares currently trade at 5.5X 2006E EV/DACF, which is in line with Chevron (5.5X), a modest discount to Royal Dutch Shell (5.9X), a somewhat larger discount to BP (6.6X) and Exxon Mobil (7.8X). With significantly improved returns on capital employed (ROCE) relative to the other super-cap oils and a now strong balance sheet, we believe Conoco is increasingly earning its way to an improved valuation relative to most of the other super cap oils. Though we would not expect Conoco to reach the valuation levels of Exxon, we think Conoco has the potential to move to a premium to Chevron and possibly reach Shell's valuation level.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Increased cash returned to shareholders. We believe Conoco has made the most of the strong commodity price environment thus far by staying committed to debt reduction and balance sheet improvement. With net debt-to-tangible capital reduced to 27% at the end of 2Q and on-track to fall below 20% by year-end, we believe the company will look to further increase cash returned to shareholders. On its 2Q conference call, management indicated that it is considering additional share buybacks, which heretofore have only been used to offset dilution. An announcement of an expanded program could be forthcoming at some point in 3Q. While we are not opposed to companies increasing capital spending or engaging in M&A activity, we believe that in the absence of truly value-added opportunities to spend, excess cash from high commodity prices should be returned to shareholders. We believe Conoco's use of free cash flow will be a key focus for investors in terms of contemplating further relative valuation improvement.
(2) Resolution of Venezuela tax disputes. Numerous press reports have indicated ongoing uncertainty regarding the tax status of foreign oil investments in Venezuela, where Conoco has major producing assets and opportunities for expansion. Management indicated on its conference call that it believes its relationship with the Venezuelan government remains strong, but that it does look forward to resolving any uncertainty that exists. While we do not think investors should over-react to headlines coming out of Venezuela, it is an important growth area for Conoco and any favorable resolution of tax uncertainty would likely be viewed positively to the extent the market believed such a resolution was in fact final.
(3) Continued progress in Russia/Lukoil venture. Though it is early and details are somewhat sparse, it appears that Conoco's investment in Lukoil shares and the Timan Pechora joint venture is off to a solid start. We believe Conoco's somewhat controversial strategy (in terms of the equity stake in Lukoil) of gaining access to Russian upstream opportunities makes sense for Conoco and has a better risk/reward than other M&A possibilities it might have considered.
2Q 2005 RESULTS BETTER THAN EXPECTED, A CONTINUING TREND FOR CONOCO
ConocoPhillips reported 2Q 2005 EPS of $2.21 (adjusted and reported), which was ahead of the $2.02 First Call consensus and our $2.00 expectation. Both E&P and R&M earnings exceeded our expectations, primarily due to better-than-expected realizations relative to the benchmark indicators in both segments. Conoco remains on-track to grow E&P production 3% in 2005.
UPDATING ESTIMATES
We have increased our 2005 EPS estimate to $7.94 from $7.63 to reflect the positive 2Q variance as well as higher expected results in 3Q and 4Q. Our EPS forecast is now $1.93 ($1.88 before) for 3Q and $2.03 ($1.98 before) for 4Q, with the positive variance a function of greater assumed price/margin realizations relative to the market than previously forecast. We have made no change to our 2006 EPS estimate of $8.70 nor our 2007-2010 normalized projections. Exhibit 1 shows a summary model for ConocoPhillips.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
