PSX - ConocoPhillips Reports Strong Quarter Raises Dividend 14%: Too Late To Buy?

2023-11-02 13:54:37 ET

Summary

• ConocoPhillips reported strong earnings this morning, but its valuation is much higher than in previous years.
• The stock is no longer a value play, but can serve as a hedge against geopolitical chaos.
• Traders may consider buying the stock on momentum and selling if the U.S. economy starts to slow.

ConocoPhillips ( COP ) reported a strong quarter this morning, with earnings clocking in at $2.16 per share vs. estimates of $2.09. The company also announced a dividend hike of 14%. Over the years, Conoco has built a reputation for rewarding shareholders to the best of their ability, despite macro challenges at times. Conoco is known for its " variable special dividend " scheme that rewards shareholders based on the price of oil, notably, this doesn't show up in most online dividend yield tools - COP actually yields about 3.7% when you include the special dividends. Also, the company's 2012 spinoff of Phillips 66 ( PSX ) delivered strong value for shareholders, with a 14.8% annual compounded total return since inception, while Conoco itself has returned 10.9% over the same time period. This compares quite favorably with Exxon Mobil's ( XOM ) 6% annual return over the same period and with Chevron's ( CVX ) 7% annual return. Conoco was forced to cut its regular dividend during the mid-2010s shale hangover, but the long-term total shareholder returns speak for themselves.

With the run-up in the stock, does the valuation still make sense or are investors best off waiting for lower prices?

At Over 4x The Lows, COP Is No Longer A Value Stock

My first take is that the run in Conoco (as well as other major oil companies) is now overdone. The graph above shows you just how far the pendulum has swung since 2020 when people practically were giving away shares in energy companies. With COP stock up more than 4x from the bottom, I'm not certain that there's much meat left on the bone. Coming at this from another angle, COP is trading for about 13.1x current year earnings. A classic rule of thumb with oil companies is that they're expensive when they look "cheap" on a P/E basis and cheap when they look "expensive," because the earnings are basically zero when the stocks are at their cyclical trough, and the earnings are flush at the peak of the cycle when competition is induced to flood the market.

To my earlier point about special dividends not showing up on most online dividend screening tools, cyclical stocks like oil companies will rarely ever show up on value screens either, and when they do it will be when the companies are at their most expensive relative to the cycle. So if we're buying Conoco or any other oil companies here, we're not buying for value at 4x the previous lows.

But even if we're not buying for value, can we buy for momentum or as a hedge against chaos in the Middle East? For that, we can buy stocks like COP, with an eye toward getting out if the market turns strongly against us. Any material rise in the unemployment rate would crush oil demand (for example here's a graph of miles driven in the US before and after 2008). So you'd need to watch the nonfarm payrolls and unemployment claims numbers closely as by the time the official unemployment rate indicates that it's risen all of the big players have already traded in and out and you missed your chance to sell.

We can see that COP has great momentum, it's below its 2022 highs but still showing solid momentum. The raw share price that you see if you just Google COP stock doesn't include the dividends, so you're doing better than the long-term online graphs imply. It's basically a settled fact that COP has one of the best managements in the oil space now, some other well-run companies include Phillips 66 and EOG Resources ( EOG ). They could mess this reputation up if they want, the easiest way would be to announce a giant acquisition and overpay for a competitor. For example, Chevron's recent all-stock acquisition announcement of Hess Corporation ( HES ) was broadly given a thumbs down by the market. Occidental Petroleum Corporation ( OXY ) has been discussed as a takeover target again and again, but Warren Buffett may be the only natural suitor at this point.

But It's A Hedge Against Chaos

The oil saga between the Biden administration and OPEC has entered its next phase with the start of the Israeli ground offensive in Gaza . Oil spiked earlier in the month as the market assessed the possibility of a broader war in the Middle East, but the market has since calmed down. The history of the oil market shows that huge price gains are possible in short periods of time. For their part, the Saudis have continued with their previous plan of slightly cutting production to put the squeeze on the oil market. However, this has been more than offset by increased production from Nigeria, Angola, and Iran. The Biden administration has indicated that they may be willing to make a Qatari-brokered deal with Venezuela on the heels of a 500,000-plus person surge of Venezuelan migrants into the US. Of course, Venezuela promptly walked back the terms of the proposed deal.

There's a lot of politics here and a lot of different players, but the politics of oil are largely just about money. The Biden administration wants the price of oil as low as possible before the election, and OPEC wants the price of oil as high as possible. This means that various countries have a direct financial incentive to cause chaos. It's not impossible for oil to hit $200 under the right circumstances, and the best and easiest way to trade that possibility is to buy or hold shares (or call options) in a few well-run oil companies to hedge the rest of your portfolio. If the global economy tilts toward recession, you can quickly get rid of your oil stocks. This uncertainty is clear when you look at next year's earnings estimates for COP - the lowest estimate for earnings is $6.14 and the highest is $16.72. The disagreement from analysts is almost as wide for oil stocks as it is for notoriously volatile stocks like Tesla ( TSLA ). The oil market seems rather confident that the world will remain calm, but in the case it doesn't, oil companies are likely to be among the only winners.

Bottom Line

ConocoPhillips reported strong earnings this morning, but the valuation is much more expensive than it was a couple of years ago. While the shares are no longer a value play, it's a great hedge against geopolitical chaos. In light of these, I rate COP shares as a hold due to a higher valuation, but traders can consider buying the stock on momentum.

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