1 Thing ConocoPhillips is Focused on Getting Right

By Markets Fool.com

Image Source: ConocoPhillips.

Continue Reading Below

The deep downturn in the oil market is forcing the industry to adjust to what appears to be a new normal. For ConocoPhillips , that not only means having the right portfolio for what lies ahead, but also allocating capital to deliver the best returns possible. In order to improve its returns the company has had to reset how it thinks about allocating capital, which was a topic that CEO Ryan Lance addressed on the company's first-quarter conference call.

Having the right allocation principals

On the call, Lance pointed listeners to the following slide and said,

Source: ConocoPhillips Investor Presentation.

On the right side of this slide are the capital allocation principles that describe our value proposition. Conceptually, the principles are similar to the ones we had at the time of the spin, namely, give cash back to shareholders, maintain a strong investment grade balance sheet and exercise disciplined growth. Obviously these elements have been reset, but this is still how we expect to deliver returns to the shareholders.

Continue Reading Below

Lance wanted to assure investors that its guiding capital allocation principals haven't changed since it became an independent E&P company, however, it has had to adjust to the current environment by resetting the elements of that plan. Lance then detailed these adjustments and by noting that,

Now let me go through these principles. We reset the dividend, but we still intend to return a meaningful portion of our cash back to our shareholders through a cash dividend. In February, we set the dividend at a level that we believe can be sustained through the price cycles but that also results in a competitive yield compared to the broad market as well as to the E&Ps. The dividend will remain a core part of our offering and we are targeting annual real growth in that dividend going forward. We remain committed to have a strong investment-grade balance sheet. The recent downturn has emphasized the importance of a strong balance sheet. We have set a target to get our debt to less than $25 billion. The pace of that debt reduction will depend on prices and asset sales progress, but de-levering is a top priority as we come out of the downturn.

As Lance notes, the company has shifted its top priority from maintaining its dividend at its prior rate to de-levering its balance sheet. That being said, it is worth noting that the company currently has less than $25 billion in net debt:

COP Financial Debt (Quarterly) data by YCharts

While total debt outstanding jumped last quarter to more than $29 billion, that's largely due to the fact that the company took advantage of the opportunity to raise $4.6 billion in low-cost debt last quarter. That debt bolstered its cash position, putting it in a much stronger position to weather a long downturn in oil prices. In other words, the company isn't about to start shedding assets to pay down debt, but that it will look for ways to prudently trim its debt as opportunities arise to get its absolute debt below the target level.

Getting the right returns

Next, Lance turned his attention to how the company will invest in growth going forward. He said that,

We have positioned the company to compete on financial returns. So despite having a large, low cost of supply portfolio, we won't grow for growth's sake. We will continue to be very disciplined about how we allocate our growth capital. We are in a strong position to do that as we come to the end of a significant major project investment phase. You will notice that we are stating that our growth could be on an absolute or per-share basis.

Lance points out that the company is shifting how it views growth going forward, with it no longer focused on absolute production growth, but also growth on a per-share basis. As such, the focus will be on returns, which is much more in line with what larger peers like ExxonMobil are focused on. This would seem to indicate that ConocoPhillips will allocate more capital to share buybacks in the future if that would deliver the highest return growth on a per-share basis. Buybacks have always been a big part of ExxonMobil's value proposition, with the company buying back 40% of its outstanding shares since Exxon merged with Mobil:

Source: ExxonMobil Investor Presentation.

These buybacks have provided a big boost to ExxonMobil's per-share production, which was up 48% from 2003 to 2013 despite the fact that its absolute production grew by a mere 1% annually over that same time-frame.

Exxon's focus on growth per-share instead of absolute growth for the sake of growth has also resulted in the company delivering strong returns on capital employed, which have led its peer group over the past five years:

Source: ExxonMobil Investor Presentation.

Given Exxon's success at generating peer-leading returns, ConocoPhillips sees this model being one worth emulating.

Investor takeaway

Lance concluded his discussion on the company's capital allocation reset by saying that, "financial returns are at the core of our value proposition. If we get the returns right, the rest will follow. We are committed to getting the returns right." In other words, the company firmly believes that by investing with a focus on returns over growth it will deliver much better performance through the commodity price cycle. That should lead to much less volatility for shareholders, both for the stock price and the dividend.

The article 1 Thing ConocoPhillips is Focused on Getting Right originally appeared on Fool.com.

Matt DiLallo owns shares of ConocoPhillips. The Motley Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.