2023-12-21 22:29:57 ET
Summary
- ConocoPhillips recently increased its dividend rate by 14% due to strong free cash flow and earnings growth in a high-price market.
- OPEC+ members extended supply reductions into 2024 which is supportive of COP's free cash flow and dividend growth prospects.
- The company's high free cash flow return percentage and OPEC+ measures could result in a revaluation of ConocoPhillips' shares in 2024.
ConocoPhillips ( COP ) announced a 14% increase in its dividend rate in the third-quarter due to strong free cash flow and high prices for its core energy products. The energy firm is set to continue to benefit from high average prices in its business and investors can reasonably expect a significant return of cash through stock buybacks in FY 2024 as well. With OPEC+ members recently agreeing to extend their voluntary supply reductions into 2024, I believe ConocoPhillips could see a higher-for-longer petroleum price scenario that in turn may lead to higher dividend growth than what larger, more broadly positioned energy rivals like Exxon Mobil ( XOM ) and Chevron ( CVX ) could achieve.
Previous rating
I had a favorable view of ConocoPhillips in September, largely because some OPEC+ countries (Saudi Arabia and Russia mainly) announced voluntary crude supply limits which did have a stabilizing effect on energy prices. Petroleum prices, of the Brent sort, have found strong support in the $70 a barrel price range and average prices have trended up in the third-quarter. With OPEC+ countries recently agreeing to push supply limits into 2024, I believe ConocoPhillips has the potential to outperform its larger rivals in terms of dividend growth due to the fact that COP is a pure-play production firm.
New round of OPEC+ price measures set to support free cash flow growth
OPEC+ members, including Saudi Arabia and Russia, agreed to continue their price support measures at the end of November by extending voluntary crude supply cuts into next year... which should provide further tailwinds for energy prices. Amongst the countries that participated in the latest round to stabilize petroleum prices were, in addition to Saudi Arabia and Russia: Iraq, United Arab Emirates, Kuwait, Kazakhstan, Algeria, and Oman. These countries have agreed to take 2.2M barrels of oil equivalent per day off markets, starting 1st of January 2024.
In the third quarter, ConocoPhillips already benefited from an increase in average prices which rose 10% quarter over quarter to $60.05 a barrel. Strength in petroleum pricing therefore translated into significant free cash flow gains for ConocoPhillips and with recent price support measures to go into effect at the beginning of next year, I believe ConocoPhillips is set to experience higher free cash flow in FY 2024 as well.
ConocoPhillips achieved $2.9B in free cash flow in the third quarter, meaning the production-focused energy company earned a massive $1.1B more in free cash flow than in the second quarter. Year-to-date, ConocoPhillips achieved $7.5B in free cash flow. The free cash flow generated so far in FY 2023 did not rise to FY 2023 levels ($14.5B) which is when prices reached new records, but ConocoPhillips' free cash flow situation is still pretty strong.
The result is that the company can afford to return a high percentage of its free cash flow to shareholders. The company paid $1.3B each for regular dividends and stock buybacks in Q3'23, resulting in a free cash flow return percentage of a massive 90%. Year-to-date, ConocoPhillips has spent approximately $8.5B on its dividend and complementary stock buybacks.
ConocoPhillips' valuation vs. rivals
With such a high free cash flow return percentage and OPEC+ output measures supporting pricing, I am raising my fair value estimate which I expect to be realized in FY 2024. I believe ConocoPhillips could trade at 14-15X FY 2024 earnings which, using an updated earnings estimate of $10.47, results in a fair value range of $147-157. Currently, COP is trading at 11.2X FY 2024 earnings, so shares, at the mid-point, could have a 30% upside potential. ConocoPhillips is slightly more expensive than either Exxon Mobil or Chevron despite offering a stronger upside revaluation profile in a rising-price market.
Risks, potential for above-average dividend growth
ConocoPhillips has more upside in a rising-price market than other energy producers like Exxon Mobil or Chevron because ConocoPhillips is a pure production play. The other two companies, larger also in size, have other operations including refineries to smooth out earnings and free cash flow in falling-price markets. In other words, ConocoPhillips has more earnings and dividend upside in high-price or rising markets than its rivals, but also more downside risk due to its less diversified revenue base in falling markets. This implies that ConocoPhillips' dividend could grow at a faster rate than the dividends of Exxon Mobil and Chevron in FY 2024, in my opinion.
Most recently, ConocoPhillips raised its dividend by 14% to $0.58 per share. Exxon Mobil raised its dividend 4% in October while Chevron raised its dividend 6% at the beginning of the year.
ConocoPhillips also pays a variable return of cash ((VROC)) which depends on petroleum prices and is paid in addition to the normal quarterly dividend. The last-paid VROC rate was $0.60 per share in October. Normal and VROC together give shares of COP a forward dividend yield of 4%.
Final thoughts
ConocoPhillips' depends on a growing production output as well as stronger pricing for its core products in end markets, but the latter clearly is the more important factor right now for the company to achieve free cash flow growth. ConocoPhillips raised its dividend by 14% in the third quarter to $0.58 per share and the company is making additional VROC distributions to boost its capital returns. I believe the value proposition here is stronger than for Exxon Mobil or Chevron, in large part because ConocoPhillips is a pure-play production play with better dividend growth prospects in a stable or rising-price market. Since OPEC+ member countries also remain committed to supporting petroleum pricing in 2024, I see another strong year of free cash flow and capital returns ahead for ConocoPhillips.
For further details see:
ConocoPhillips: A Top Dividend Growth Bet For 2024 (Rating Upgrade)