As an analyst, I take a lot of interest in trying to find reasons the market stages some of the moves it makes. The factors, geopolitical, economic, or emotional, that drives trends over any time period can be widely varied, and sometimes it’s interesting to see not only what is influencing the market today, but also to look back and, with the advantage of hindsight, being able to evaluate whether a certain condition or element played a role in driving the market to the point it is at today.
Among the various macroeconomic factors I try to pay attention to is the ebb and flow of oil prices. I think oil is one of the most interesting commodities of all; no matter whether you drive a gas-guzzler, an electric vehicle or a hybrid, the truth is that oil is a factor in every sector of the market, with tentacles that reach into economic policy and most certainly into geopolitics.
While I don’t think oil prices caused the drop at the end of 2018 that saw the stock market test bear market lows by Christmas, I also believe that their role as a contributor to that broad-based momentum shouldn’t be ignored. Consider that at the market’s high point in late September, West Texas Intermediate (WTI) crude was running able $70 per barrel, but peaked at nearly the same point the market did above $75. From that point until the end of the year, the price dropped to a low point at around $42.50 per barrel. That’s a decline of more than 43% in about three months that absolutely had a hand in keeping pressure on stock market prices.
From that low point until the time of this writing, WTI crude has rebounded strongly, rising more than 30% to a current level at around $65 per barrel. That’s been pretty good news for oil stocks in general this year, and it’s helped the entire energy sector rebound by about 20% from that December low, as measured by the S&P 500 Energy Sector SPDR (XLE). You would naturally expect that to also work to the advantage of oil explorers and producers, especially the largest players like ConocoPhillips (COP), but it seems a little odd that while the sector has rebounded strongly, COP is up only about 5% year to date, and remains about 20% below the high it reached in September of last year above $80 per share. That means that there is still a lot of room for the stock to move.
The real question for investors, of course is whether the stock is likely to push to those levels. Fundamentally speaking, COP has a lot going for it, with healthy cash flow and very manageable debt levels that have been a product of a strict focus by management over paying a high, unsustainable dividend or pushing for heavy production growth. The company’s production targets have emphasized short-cycle onshore work that produces immediate cash flows. Most analyst forecasts put WTI crude prices between $58 to $67 per barrel through 2019 and into 2020, which should translate well for COP to continue delivering solid cash flows and high profit margins. Does that make the stock a smart value? Let’s find out.
Fundamental and Value Profile
ConocoPhillips is an independent exploration and production company. The Company explores for, produces, transports and markets crude oil, bitumen, natural gas, liquefied natural gas (LNG) and natural gas liquids. The Company operates through five segments: Alaska, Lower 48, Canada, Europe and North Africa, Asia Pacific and Middle East, and Other International. The Alaska segment explores for, produces, transports and markets crude oil, natural gas liquids, natural gas and LNG. The Lower 48 segment consists of operations located in the United States Lower 48 states and the Gulf of Mexico. Its Canadian operations consists of oil sands developments in the Athabasca Region of northeastern Alberta. The Europe and North Africa segment consists of operations and exploration activities in Norway, the United Kingdom and Libya. The Asia Pacific and Middle East segment has exploration and production operations in China, Indonesia, Malaysia and Australia. COP’s current market cap is $74.8 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased more than 151%, while sales growth was modest, increasing about 18.5%. In the last quarter, earnings declined by almost -17%, while sales increased a little under 2%. COP’s margin profile is impressive, with Net Income over the last twelve months that was 16.1% of Revenues, and improved to 18% in the last quarter.
Free Cash Flow: COP’s free cash flow is very healthy, at more than $7.2 billion for the trailing twelve month period and which translates to a Free Cash Flow yield of 9.71%.
Debt to Equity: COP has a debt/equity ratio of .46, a relatively low number that indicates the company operates with a conservative philosophy about leverage. They reported about $7.6 billion in cash and liquid assets in the last quarter, which along with operating profits that are more than adequate to service their debt, gives them excellent financial flexibility.
Dividend: COP pays an annual dividend of $1.22 per share, which translates to a yield of 1.85% at the stock’s current price. There are a lot of oil-related stocks that offer a much higher dividend yield right now, but I like the fact that COP has focused on the sustainability and quality of their dividend over trying to impress investors with a fat current yield they may be forced to cut down the road.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for COP is $27.85 per share and translates to a Price/Book ratio of 2.36 at the stock’s current price. Their historical Price/Book average is 1.76, which suggests that the stock is trading at a premium right now of more than -25%. Their Price/Cash Flow ratio offers an interesting counter-perspective, however since it is currently running about 59% below its historical averages. The historical Price/Book ratio puts the stock’s “fair value” target price at around $49, while the Price/Cash Flow valuation sets a much more attractive target above $100 per share.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red diagonal line traces the stock’s upward trend from September 2017 to September 2018; it also informs the Fibonacci retracement lines shown on the right side of the chart. The stock is currently sitting right on the 38.2% retracement line, which has been acting as strong for the stock for the last couple of months. If that support holds, the stock should turn back to the upside, but would need to push above $70 per share to break the resistance that has held the stock down to this point in the year. If the stock breaks down below support, it could drop to as low as $61 per share as shown by the 50% retracement line, with the next likely support at the stock’s 52-week low around $57.
Near-term Keys: The challenge for me of calling COP a bargain is the fact that the Price/Book analysis differs so greatly from the Price/Cash Flow analysis; if they at least both pointed in the same direction, I would be more inclined to buy the idea that COP is a bargain at its current price. As it stands, I think there is some downside risk over the long-term associated with the sustainability of oil prices above its current levels; I don’t think stable oil prices will be likely to provide a strong catalyst for COP to stage a major surge in price by itself. If, however, you prefer to work with shorter-term strategies, watch for a break above $70. That would be a strong signal to buy the stock or start using call options, with the stock presenting a good chance of testing its September high around $80 per share. A break below current support could also be a good signal to think about shorting the stock or starting to work with put options, with a short-term target price in the $61 area, or $57 if you see bearish momentum in the stock really start to pick up.