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03/16/2007
Our primary analysis for ConocoPhillips (COP) is that high oil prices should continue
generating above normal earnings for the next several years.
The Facts:
COP is banking on a 20% stake in Russian Lukoil to shore up its dwindling North
American oil well production. A full 10% of production is expected to come from Lukoil.
The divesture of wells in Canada is negligible (less than 30,000 bpd) and is part of the
Burlington Resources acquisition agreement. The BR acquisition was an expensive North
American natural gas play coming in at $3 per 1000 cubic feet (Mcfe). As time goes on
the BR deal may turn out to have been a real bargain. The re-entry into Libya should
provide handsome profits on 45,000 bpd at a production cost around $5 per barrel! This
should more than make up for the Canadian loss. COP is counting on natural gas prices
remaining above $6.55 per Mcf; otherwise the BR acquisition becomes mathematically
problematic. We estimate that the average price per Mcf to be $7.30 in 2007 and $8.05 in
2008 providing COP with ample margins. COP is the largest natural gas producer in
North America.
The new refinery project in Yanbu, Saudi Arabia, in conjunction with Aramco and
Halliburton, should contribute to the refining division earnings as of H2 2011. This single
new 'Saudi sour' refinery project will have the capacity to supply 2% of U.S.
consumption. Chances are though that the refined product will end up in Iran (U.N.
sanctions?), India, China and other countries in the region. Iran exports crude yet imports
refined product.
Historically refining operations have had far lower margins than crude production. In
2005 production accounted for only 27% of sales yet was 62% of earnings. This was not
the case for 2006 as reflected in earnings. COP has a 36% stake in the Alaskan Prudhoe
Bay consortium. Prudhoe Bay represents approximately 15% of COP’s global oil
production (136,000 bpd out of 916,000 bpd). Excluding Q1 2007, we do not foresee
further production issues emanating from Alaska.
COP’s historical financial performance depicts a classic rollercoaster ride. Over the past
decade the energy sector has been highly volatile and COP consistently exemplified this
to an extreme, more so than some of its competitors. For this reason alone, COP has been
trading at a lower multiple to its peers. Though natural gas, in comparison with oil, is
highly volatile we believe that NG will remain above $6.55 throughout 2007 thus COP
should fair better than its competitors due to its heavier reliance on natural gas.
The question that an investor might ask is whether COP is the best of the breed. On the
surface COP looks very attractive. The stock is trading at a low multiple (6.8) and is
paying a nice dividend. However further analysis reveals a slightly different and
somewhat complicated picture.
Earnings Growth:
2006 2007 projection 2008 projection
Estimate Actual CrossProfit S&P CrossProfit S&P
COP 25% 24% 3% -13% 8% 4%
CVX 19% 23% -9% -19% 8% 8%
XOM 18% 17% 6% 4 to 5% 8% 6 to 7%
Risks? - Russian Roulette:
All those familiar with the Yukos travesty know that Vladimir Putin can not be trusted to
abide by international standards of commerce. The entire dismantling of Yukos was due
to mafia style politics. This is factually confirmed from the current events. Yukos could
have done exactly what the Russian government is doing now; sell off assets and pay off
the (alleged) tax bill and still be a viable business. We call this dormant disease Putinitis.
The question is when will the next outbreak occur? The market currently assesses a high
risk premium on Lukoil, though this risk factor may never materialize.
At CrossProfit we emphasize fundamental analysis and delve into technical analysis only
upon completion of rigorous fundamental analysis. Current (1 to 4 weeks) technical
trends are bearish verses the bullish intermediate (1 to 6 months) and long term (6 to 24
months) fundamentals. The CrossProfit evaluation line is based primarily on
fundamentals.
For those that are unfamiliar with the term, EOL = end of line. The evaluation line is a
twelve month forward looking line that specifies a risk/reward evaluation factoring in
market volatility and determines whether or not an investment opportunity exists.
Towards the ‘end of the line’ the line is usually less accurate as the evaluation was based
on data available a while ago. In plain English, the XOM evaluation line is the least
reliable because it ends at the end of this month (03/07).
Conclusion:
COP is a gamble on geopolitics including internal Russian politics. COP could turn out to
be the best of the three by far. A 73% reliance on the U.S. for revenue is most likely a
positive factor and natural gas prices will probably stay above $6.55. Should the Russian
based geopolitical risk diminish, a higher PE ratio is in order.
As of today there is little downside risk. Should Putin decide to play his hand tomorrow
the market has already factored in most of the collateral damage from Putinitis. Either
way COP is a stock to buy and hold for long term gains and dividends.
Summary:
The investment outlook for the oil and gas industry is positive. CrossProfit analysts
conclude that oil prices are expected to remain relatively high in 2007 and 2008. We use
the term 'relatively high' for oil above $45 per barrel.
Disclosure: This article was written by a CrossProfit analyst and does reflect the opinion
of CrossProfit.com.
http://www.crossprofit.com