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When the Bleeding Stops

By Robert Rapier on November 1, 2016

ConocoPhillips (NYSE: COP) is my former employer, and it also happens to be the world’s largest independent exploration and production (E&P) company based on proved reserves as well as production of liquids and natural gas. ConocoPhillips operates in 21 countries and, given that scale and breadth, I always pay attention to its quarterly results.

The latest quarterly numbers were announced last week. Before delving into them, let’s review the history of the company.

ConocoPhillips was created by the merger of two integrated oil companies, Conoco and Phillips. “Integrated” means they explored for and produced oil, transported it to their refineries and refined it into fuel and petrochemicals for sale. The companies merged in 2002 to become the fifth-largest publicly traded integrated oil and gas company. But then in May 2012 ConocoPhillips bundled up the refining, petrochemical, and midstream assets (mostly pipelines and storage) and spun them off into Phillips 66 (NYSE: PSX). This left ConocoPhillips as a pure oil and gas producer.

The plunge in oil and gas prices hit ConocoPhillips pretty hard, while Phillips 66 excelled because refiners tend to benefit from low crude prices, trading out of sync with their suppliers. The share price of Phillips 66 doubled within a year of the spinoff, and over the past two years marked by the steep downturn in oil and gas prices PSX is up by 5% while COP is down by 36%.

Needless to say, ConocoPhillips’ performance has been disappointing, even in comparison with rivals. Among its peers, ConocoPhillips is one of the few to have a negative total return this year (down 3.7% year-to-date). In contrast, EOG Resources (NYSE: EOG) is up nearly 30% this year.

One of the reasons COP has lagged EOG, among others, is that it has a lot of high-cost production around the world. The company has also been spending a lot of capital for projects that were already in the pipeline when the price of oil crashed. As a result, it has struggled to generate free cash flow, and this forced the company to slash its dividend a year ago after previously assuring investors that it was safe.

The recently announced third-quarter results suggest the company is finally turning a corner.

ConocoPhillips has now reported lower capital expenditures for eight straight quarters. At the time of the downturn in oil prices in mid-2014, COP was spending more than $4 billion per quarter. In the latest quarter, the company’s capital expenditures fell below $1 billion. At the same time, COP reported an 18% decrease in year-over-year operating costs, and a 4% increase in adjusted production (to 1.557 million barrels per day) compared with the same quarter in 2015.

As a result, the $1.2 billion the company generated from operations was more than enough to fund both the quarter’s capital expenditures and the dividend. This was the first time that has happened since the downturn started. ConocoPhillips still reported a net loss of $1 billion given its substantial depreciation writeoffs, but it handily beat consensus estimates and nudged its annual production estimate up and capital spending budget down.

Expensive deepwater projects have long weighed on the bottom line, but the company is in the process of curtailing such capital-intensive efforts. ConocoPhillips’ past free-spending ways certainly left it in a deep hole once energy prices fell, but given my expectation of higher oil prices in 2017 — along with continued spending discipline — the next year should prove to be much better than the last two.

Investors seemed to agree, pushing up the share price 5% the day of the earnings announcement. But are these changes enough to start buying? Join us at The Energy Strategist to get our current recommendation on COP as well as EOG and other portfolio standouts.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)


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