ConocoPhillips analysis: a great defensive option with a big question mark

ConocoPhillips is a popular safe haven. A quality dividend company, but also plagued by a skeleton in the closet that could catch many an investor off guard.

COP is in the oil production business

Basic data

ConocoPhillips' core business is the production of oil and natural gas. The company owns and operates more than 10,000 wells and has operations in several areas, including shale oil and deepwater natural gas production. ConocoPhillips also owns and operates oil and natural gas distribution and transmission networks.

ConocoPhillips also seeks to diversify into other areas such as renewable energy and low-emission technologies. The company is also working to reduce its environmental impact and implement sustainability measures.

Risks associated with ConocoPhillips include fluctuations in oil and natural gas prices, which could negatively impact the company's performance and market value. Other risks include competition in the energy industry and government regulation, which may lead to loss of customers and reduced market value.

Company's core values

Current events

ConocoPhillips $COP+0.0% will most likely face a significant decline in earnings in the next year if the United States enters a recession and a softer demand outlook begins to impact market oil prices. Moreover, ConocoPhillips is very narrowly focused on upstream activities, making it more vulnerable to an economic downturn than its more diverse competitors.

ConocoPhillips' earnings multiple is expected to decline as investors factor in the possibility of cyclical earnings declines in the future.

EBITDA has grown each Q. Source

ConocoPhillips' fourth-quarter adjusted earnings were $2.71 per share, one cent less than estimates. Regardless, ConocoPhillips made a lot of money in 2022 thanks to high oil prices, which supported the company's upstream-focused business model. ConocoPhillips earned $3.4 billion in the fourth quarter, up 12% from the year-ago period, when the upstream company made an adjusted profit of just over $3.0 billion.

ConocoPhillips achieved an average realized oil price of $71.05 in 4Q-22, up from $65.56/BOE in 4Q-21 but down from $83.07 in 3Q-22. The quarter-over-quarter decline in the average realized oil price strongly suggests that ConocoPhillips will be forced to lower its 2023 earnings estimate.

ConocoPhillips' earnings were not the only metric that rose in 2022. During 2022, ConocoPhillips was awash in cash, and the company generated a record free cash flow of $18.4 billion.

ConocoPhillips' FCF was significantly higher than the $10.2 billion needed to cover the mining company's capital needs. ConocoPhillips distributes its free cash flow to shareholders through a combination of share repurchases, regular dividends and a variable income component based on the company's profitability.

Company Dividend Data. Source

This component can vary significantly over time and is strongly influenced by ConocoPhillips' realized average oil prices. Which can be seen in the chart at the end. ConocoPhillips returned $15.0 billion in share repurchases and dividends in 2022 as a result of unexpected cash inflows, representing 53% of ConocoPhillips' operating cash flow and 82% of the company's free cash flow.

Oil prices are likely to decline

The price of oil is the main question investors want to know the answer to. It's hard to say. Looking at history, however, it seems that large price increases have often been followed by equally sharp declines, creating a highly volatile earnings structure for energy-focused companies like ConocoPhillips.

Will a sharp rise be followed by an equally sharp fall? Source

And that, of course, will affect COP's future. And even in an economic downturn, the profit outlook for upstream companies like ConocoPhillips will be bleak.

ConocoPhillips' profits have historically been as volatile and unstable as the oil market, where changes in supply and demand can often cause large short-term price swings in either direction. ConocoPhillips is currently trading at 8x earnings. At first glance, that doesn't seem like a high price for a company that is currently flush with cash, but investors need to realize that the current earnings situation is unlikely to last for much longer. ConocoPhillips' potential for downside and price appreciation is largely influenced by the direction of oil prices in the market.

A positive outlook for the U.S. economy would imply strong earnings growth for ConocoPhillips. Conversely, an economic downturn would almost certainly lead to a significant decline in the company's earnings, which would have a significant negative impact. This is such a skeleton in the closet. The company is high-quality but heavily dependent on the price of oil.

On the other hand, the company has many strengths. It has low operating costs. Its average cost of supply is less than USD 30 per barrel. ConocoPhillips complements its low supply costs with a strong balance sheet. It has just that relatively low debt. This gives it a sufficient buffer to weather frequent periods of low oil and gas prices.

ConocoPhillips' low operating costs allow it to generate significant cash flow in the years ahead . The oil and gas company estimates that it can generate cumulative free cash flow of $80 billion by 2031, assuming oil prices average $50 per barrel.

The company expects to return a significant portion of its windfall profits to investors in the coming years . It plans to send them $10 billion in 2022 alone thanks to higher oil prices. ConocoPhillips is using a variety of methods to return cash to shareholders, including share buybacks, paying a growing quarterly dividend as it generates excess cash thanks to higher oil prices.

But again, it all depends on the price of oil.

Disclaimer: This is in no way an investment recommendation. This is purely my summary and analysis based on data from the internet and other sources. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.

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