ConocoPhillips (IL/A): Another strong quarterly performance, analyst meeting the next key catalyst for shares - Goldman Sachs - October 26, 2005
With yet another solid quarterly performance despite interruptions from Hurricanes Katrina and Rita, ConocoPhillips continues to make the case for further improvement in its valuation relative to the other super-cap oils. Our In-Line rating on Conoco shares relative to an Attractive coverage view is merely a function of our preference for higher-beta domestic oil/E&P top picks given our bullish commodity price outlook. On an absolute basis, we believe Conoco has shown the ability to execute well and consistently in a strong commodity price environment and as such believe its shares can continue to perform well. At its annual analyst meeting scheduled for November, we expect Conoco to provide an update to its strategic plan for its various businesses including details on downstream spending, updates to its E&P production outlook, and progress in its Russia/Lukoil joint venture.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Annual analyst meeting in November. We expect ConocoPhillips to provide an update to its overall corporate strategic plan as well as an outlook for its various businesses. Although we will discuss our expectations and outlook for the meeting and company closer to the event, as is our normal practice, we expect Conoco to largely reiterate a 3%-5% E&P production growth target, provide details on its capital spending program including the planned $3 billion incremental refinery investments, and give an update on the progress in its Russia/Lukoil joint venture. In our view, the November analyst meeting will be a chance to showcase Conoco's much improved business fundamentals while also highlighting management's conservative yet opportunistic approach to capital spending.
(2) Use of free cash. With debt levels approaching Conoco's desired "minimum" levels, we believe the company will look to further increase cash returned to shareholders. In its 3Q conference call, management indicated that its capital program will be around $10-$11 billion order-of-magnitude (with more details to follow at the November meeting), which under a robust commodity price environment would still leave substantial free cash it can return to shareholders. Our $68/bbl WTI spot oil and commensurate commodity price estimates for 2006 suggests Conoco could generate up to $8 billion in free cash next year after dividends. Management has indicated a strong commitment to maintaining a competitive dividend program as well as a greater willingness to buyback shares.
(3) Potential North Slope natural gas pipeline. Although it is still early-going, Conoco management appeared constructive on the prospects of building a natural gas pipeline that will allow for gas from the North Slope fields of Alaska to reach US markets. Conoco's partners, ExxonMobil and BP, are currently in negotiations with the State of Alaska with possible news flow expected shortly. Even if an agreement is reached soon, however, we would not expect start-up to occur for another 10 years or so.
(4) Resolution of Venezuela tax disputes. While we continue to believe that investors should not 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 that the market believed such a resolution was in fact final. Management reiterated that it believes it has a strong relationship with the country of Venezuela, the head of PDVSA, the Energy Minister, and other authorities, and showed continued interest in looking for new opportunities in the region.
WE SEE 36%/95% UPSIDE TO TRADITIONAL/SUPER-SPIKE-ADJUSTED PEAK VALUES
For Conoco shares, we see 36% upside to our $84 traditional peak value and 95% upside to our $120 super-spike-adjusted peak values, relative to an 18% downside risk to a traditional trough valuation of $50. This compares to the super-cap integrateds on average showing 43% and 87% upside to traditional and super-spike adjusted peak values, respectively, and 13% downside risk to trough valuations. We see Conoco shares currently trading at 4.5X 2006E EV/DACF (enterprise value to debt-adjusted cash flow), versus a peer group average of 5.3X. In our view, 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. Conoco is now at a 13% discount to Royal Dutch Shell (5.2X 2006E EV/DACF), a gap that could further close, and trades in-line with Chevron (4.6X).
3Q 2005 RESULTS ABOVE EXPECTATIONS
Conoco reported 3Q 2005 EPS of $2.68 (adjusted and reported), ahead of the $2.57 First Call consensus and our $2.45 forecast. Both E&P and R&M earnings exceeded our expectations due to better-than-expected refinery throughput rates and realizations relative to the benchmark indicators in both segments. Per management guidance, we expect full-year 2005 E&P production excluding Conoco's interest in Lukoil to be flat versus 2004 levels--relative to earlier year expectations of a 4% growth--due to this year's heightened storm activity, unplanned downtime in Alaska and United Kingdom, and PSC impact in Indonesia.
UPDATING ESTIMATES
We are updating our 4Q and full-year 2005 EPS estimates, which now stand at $2.55 ($2.48 previously) and $9.20 ($8.90 previously). Our updated EPS estimates reflect actual 2Q results, updated E&P production profile, higher assumed earnings from international R&M, and minor other adjustments. We have made no change to our 2006-2010 EPS estimates. See Exhibit 1 for a summary model of 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. |
