Their names might rhyme, but Sunoco LP (NYSE: SUN) and ConocoPhillips (NYSE: COP) are two very different companies. Of course, it wasn't always that way. Both Sunoco and ConocoPhillips used to operate downstream businesses, but the companies exited refining in the last decade through sales and spinoffs to focus on gasoline sales and exploration and drilling, respectively.
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Despite the differences in operations and size -- ConocoPhillips is nearly 20 times larger than Sunoco LP -- both are in the middle of transformations meant to enhance the ability to deliver value to shareholders. Investors looking for opportunities created by rising oil prices may have both companies on their watchlist, but could be wondering which stock is the better buy. Let's take a nuanced look at each.
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The case for Sunoco LP
The growth-oriented master limited partnership hasn't done much to deliver value to shareholders in the last several years outside of its distribution payouts, which currently yield over 11%. Sunoco can use a series of complex restructurings as one excuse for its lackluster performance.
In 2014, Energy Transfer Partners swooped in to purchase the general partnership stake, then proceeded to unload fueling assets into Sunoco's lap. That should help growth in the long term, but it was accompanied by integration costs in the near term. And now two of its parent companies, Energy Transfer Partners and Sunoco Logistics Partners, are discussing a $20 billion merger. That likely means the former will be preoccupied with its own restructuring and unable to devote much financial aid to help Sunoco LP exploit available growth opportunities.
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While that's not ideal, management isn't sitting around waiting for a handout. Instead, it has crafted an impressive strategy that could grow revenue and profits by focusing on high-margin retail sales and lower debt levels to protect future distribution payouts.
The importance of retail locations to the recognizable brand cannot be understated: Merchandise and fuel sales from such locations contributed 69% of pro forma gross profit in 2015. Margins from retail fuel sales are 135% higher per gallon than comparable sales from wholesaler locations. Meanwhile, newer retail store layouts being rolled out across the company's portfolio generate 200% to 300% more cash flow than previous designs. The inclusion of branded food offerings, including Laredo Taco Company and Dunkin' Donuts, should go a long way in boosting growth from existing locations.
Taken together, investors have several good reasons to be optimistic about the direction of Sunoco stock. It looks likely that operating cash flow will have increased for a fourth straight year once 2016 earnings are released. Then again, the company has quickly grown its debt balances, too. But if Sunoco successfully lowers its debt levels and sees an increase in profits thanks to rising oil prices, then it could be a buy.
The case for ConocoPhillips
ConocoPhillips hasn't fared much better in delivering value to shareholders in recent years, but it, too, has begun to turn the corner. When oil prices headed for the toilet in 2014, the multinational oil company's breakeven cost stood at $75 per barrel of oil equivalent (BOE). Operations were bloated after years of global expansion, and it was racing to complete expensive megaprojects to reduce capital expenditures. Simply put, the company was not well positioned to react to the changing market.
Management responded to that wake-up call with a multipronged strategy aimed at increasing operational flexibility and creating shareholder value. A series of asset divestitures have ConocoPhillips on track to reduce its debt balance to just $20 billion by the end of 2018 -- the lowest total in over a decade. The completion of megaprojects and sale of non-core assets have also reduced the company's cash flow breakeven cost from $30 billion to $12 billion. That works out to roughly $50 per BOE at current production levels.
Moreover, ConocoPhillips believes it can grow production and revenue from assets already in place. That includes steady and predictable production from long-lived conventional resources and untapped growth in unconventional plays that are heavily concentrated in the United States. In all, the company can milk existing assets for 30 years of production.
Healthier finances and operations will combine to help ConocoPhillips execute against its goal to deliver total shareholder returns of at least 10% annually (it achieved 9.7% last year). That includes a near-term share repurchase program totalling $3 billion and dividend increases when cash flow allows. If oil prices continue to rise in 2017 and beyond, then the stock could be a buy.
Which company is the better buy?
While I think there are good reasons for both stocks to rise, I think ConocoPhillips is the better buy. The uncertainty surrounding Sunoco regarding its debt balance and parent company's addiction to complex mergers and restructurings are bigger risks than anything facing the independent oil company.
A combination of factors -- reducing debt, increasing operational flexibility, and lowering its cash flow breakeven point to just $50 per BOE -- should allow ConocoPhillips to make good on its promises to create value for shareholders for years to come. That's especially true if oil prices stabilize or continue to head higher from current levels.
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