ConocoPhillips Q2 Preview: Strong And Steady As She Goes (NYSE:COP)

ConocoPhillips (NYSE:COP) stock is -4.3% during the past year and has significantly underperformed both the S&P 500 (+19.5%) and The Energy Select Sector SPDR Fund ETF (XLE), which is +5.4%. In Q1, COP’s earnings of $2.03/share were down $0.35/share from the year earlier period. That was primarily due to lower average realized pricing ($56.60/boe vs. $60.86/boe) as Henry Hub natural gas realizations dropped from $2.92/Mcf to $1.57/Mcf. And domestic natural gas pricing continues to be weak (see chart below). COP generated $2.2 billion of free cash flow in Q1 and paid out the same amount in a combination of dividends and share buybacks ($0.9 billion and $1.3 billion, respectively). Today, I will revisit the big picture investment thesis for ConocoPhillips, update investors about the move it recently announced to better monetize its low-cost domestic gas production, and preview what investors can expect in the Q2 earnings report due out Aug. 1 (this coming Thursday). Meantime, note that COP stock is down ~18% from its recent April high of $135. That fact, combined with a still relatively strong and above mid-cycle oil price, compels me to reiterate my Buy recommendation.

Investment Thesis

As most of you know, COP is the biggest independent E&P company with large-scale operations in the Lower 48, particularly in the Permian Basin where it plans to plateau production at ~1.2 million boe/d by the end of the decade. COP has already plateaued production on its Eagle Ford and Bakken leaseholds, but the pending Marathon Oil Corporation acquisition (MRO) will significantly boost production in both those plays:

That said, I don’t really consider the Marathon acquisition to be “transformational” in any sense of the word, but – as the slide above implies – it simply further enhances COP’s already firmly established tier-1 L-48 shale position.

Conoco also has an estimated 225,000 boe/d of production from LNG assets in Qatar and Australia. With awarded interests in the Qatari North Field East and North Field South expansion projects, LNG production should grow to an estimated 300,000 boe/d once those projects are completed. COP also has significant existing production in Alaska and Canada, with excellent growth potential with the Willow Project in Alaska and unconventional resources in Canada’s Montney formation.

As you can see from the chart below and in the aggregate, COP’s last four dividend payments amounted to $3.85/share, which at Friday’s closing price of $110.86 equates to a yield of 3.5%. Note both regular and variable dividends are now paid on the same date instead of the previously staggered payout. Also, note that the variable dividend has fallen from $0.60/share in the second half of 2023 to $0.20 so far this year as a result of a pull-back in realized prices.

Regardless, the point here is that Conoco stock is throwing out a decent amount of income, and the higher realized prices are, the higher the payout is (i.e., the variable dividend). Combined with its tier-1, high-quality, low-cost asset base, COP offers investors a solid combination of income along with decent long-term capital appreciation potential.

Q2 Earnings Look-Ahead

According to Yahoo Finance, current Q2 and full-year 2024 consensus earnings estimates for COP are shown below:

As you can see in the graphic, COP is highly followed (i.e., by 22-25 analysts) and the consensus EPS estimate for Q2 is $1.80, which would be 11.3% lower on a sequential basis and relatively in line with year-ago results.

On the Q1 conference call, COP reported APLNG distributions in Q1 of $521 million as well as Q2 APLNG distribution guidance of $300 million and no change for FY24 distributions of $1.3 billion. The point here is that FY24 APLNG distributions were heavily loaded in Q1 and, as a result, should be taken into account when comparing quarter-over-quarter results.

For the second quarter production, COP guided for a range of 1.91 million to 1.95 million boe/d, which represents 2% to 4% yoy underlying growth. The midpoint of the Q2 guidance (1.93 million boe/d) compares favorably to the 1.90 million boe/d produced in Q1.

The FY2024 consensus EPS estimate of $7.91/share equates to a TTM P/E=14x, significantly above that of the XLE (8.4x), which is likely due to COP’s superior cash flow profile and high-quality asset base as compared to the energy sector as a whole.

Recent Developments

According to EnergyNow.com, which referenced a Reuters report, last week ConocoPhillips announced it had signed an agreement to book capacity at Belgium’s Zeebrugge LNG terminal for a duration of 18 years. According to the report, terms of the deal will start in April of 2027 and COP will be able to import and regasify 0.75 Mt/a (million tonnes per annum) of LNG at the Zeebrugge terminal for the lucrative European market. This is likely a direct result of COP’s partnership with Sempra (SRE), which I previously covered on Seeking Alpha (see ConocoPhillips: Despite the Biden Pause, Port Arthur LNG Is Full-On and Sempra Energy Pivots To LNG, But ConocoPhillips Is The Better Angle). It’s a wise move by Conoco to enable it to much better monetize its very low-priced dry-associated gas production from the Permian and Eagle Ford.

Apparently, COP also signed a long-term LNG sales and purchase agreement (“SPA”) to supply the Asian market starting in 2027. I do not currently have terms of that agreement, however, I suspect that it’s an agreement for APLNG-sourced supply given its more strategic geographic location for the Asian market (i.e., much lower shipping costs as compared to GoM-sourced supply – which is much more advantageous for the European market).

Risks

COP has been over-emphasizing share buybacks over the past few years and I would be remiss not to point out that most of the shares COP has bought have come back onto the market to fund acquisitions. This is the primary reason I much prefer dividends directly into investors’ pockets as compared to share buybacks that – at least in the energy industry – never really seem to reduce the outstanding share count over the long term. In addition, tying buybacks to cash flow – as COP is doing – pretty much guarantees the company will be buying back much more stock during up-cycles (i.e., when the shares are arguably always over-valued…) as compared to down cycles (when the shares actually offer significant value).

Last Friday, Yahoo Finance reported that energy analysts at Goldman Sachs and Citigroup think if presidential candidate Trump is elected, oil could fall as much as $11-$19/bbl. That’s due to Trump’s predictions that production growth will likely not be achieved while his vow to enact trade tariffs would be a bearish development for the global economy and for oil demand. Trump has previously said he may impose new tariffs on China ranging from 60% to 100%. If so, that would likely be very bearish for an O&G producer like ConocoPhillips.

Indeed, since I opined in my Seeking Alpha article back in January of 2021, ConocoPhillips: Ironically, President Biden Could Be Great For The Stock, ConocoPhillips’ stock has delivered a total return of 195% as compared to the S&P 500’s 42% – a much better performance compared to Trump’s four years in office:

As I have said on Seeking Alpha many times, we now live in a new Age of Energy Abundance, and all Trump’s “drill baby drill” mantra did was cause O&G CEOs to raise production into an already over-supplied market. Analysts doubt these companies will make the same mistake again.

Summary and Conclusions

COP is executing well on its 10-year plan of disciplined spending, slow but steady organic production growth, taking advantage of market opportunities for acquisitions, and rewarding shareholders with dividends and share buybacks. The current 3.5% yield is not overly attractive, but COP’s combination of income and long-term capital appreciation potential is. I’ll end with a five-year total returns comparison of COP vs. Exxon Mobil Corporation (XOM), Chevron Corporation (CVX), the XLE ETF, and the S&P 500 as represented by the Vanguard S&P 500 ETF (VOO) and note that COP has outperformed them all:

That said, over the past decade, the S&P 500 has crushed the energy sector and if I had to guess, the next 10 years won’t be much different because we will still live in the age of energy abundance: