U.S. oil giant ConocoPhillips (NYSE: COP) wants to set itself apart from rivals in the eyes of investors, with a top goal of delivering "superior returns to shareholders." That aim led the company to lay out five priorities for its cash flow:
- Invest the capital required to sustain its production rate and pay the existing dividend.
- Deliver annual dividend growth.
- Reduce debt to $20 billion to secure a top-tier credit rating.
- Pay 20% to 30% of cash flow from operations each year to investors, via dividends and buybacks.
- Use discipline when investing any excess cash flow to grow production.
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One thing that's clear from the plan is that ConocoPhillips' top priority is to return money to investors. That's also evident in the company's recently unveiled three-year operating strategy, which should see it return $7.5 billion in cash to investors in share repurchases alone by the end of 2020, with more money headed their way via a growing dividend. That combination of cash returns and prudent growth positions the oil giant to deliver a compelling total annual return, even if crude stays low.
With the transformation complete, it's turning on the taps for cash returns
About a year ago ConocoPhillips unveiled its strategy to create value for investors in an increasingly uncertain oil market, which included the five cash flow priorities listed earlier. However, the company also said that it would sell between $5 billion and $8 billion in assets in the three years that followed to accelerate its value proposition, with a plan to use the money to repurchase $3 billion in stock and pay off several billion dollars in debt.
Since that time the company has vastly exceeded its initial expectations, given that it's on pace to sell $16 billion in assets by year-end, driven by the sale of several Canadian oil and gas properties to Cenovus Energy (NYSE: CVE) for $13.3 billion. That deal and those that followed enabled ConocoPhillips to lower the cash flow break-even level of its current portfolio to less than $40 a barrel, because it mostly offloaded low-margin assets to Cenovus and other buyers. Meanwhile, ConocoPhillips used the cash proceeds to retire debt that lowered its interest expenses, and it repurchased shares, expecting to spend $3 billion on the buyback by year-end.
Those actions set the company up to generate more cash in the coming years. It estimated that, combined with its current cash balance, it can produce enough cash flow at $50 oil to:
- Sustain its current production rate and 2%-yielding dividend
- Increase that payout each year
- Reduce debt from $20 billion to $15 billion
- Repurchase $1.5 billion in shares each year
- Invest an additional $2 billion per year to grow production and margins by 5% annually, which would fuel 10% compound annual growth in cash flow
Even after allocating capital across those priorities, the company expects to end 2020 with about $4.5 billion in cash. Meanwhile, if crude prices rise, ConocoPhillips would generate even more excess cash, with a portion likely heading back to investors via buybacks, since that's the quickest way for the company to ensure it meets the target of returning 20% to 30% of cash flow to investors each year.
The best plan in the business
ConocoPhillips' updated plan is the most shareholder-friendly one in the industry: It consistently returns money to investors via an above-average dividend and steady repurchases, with built-in upside as oil prices rise. While several rivals recently unveiled shareholder-focused strategies, none go as far as ConocoPhillips. For example, Canadian shale driller Encana (NYSE: ECA) recently shifted the focus of its go-forward strategy from growing production to cash flow. As a result, Encana expects to increase cash flow by a 25% compound annual rate through 2022, which would produce $1.5 billion in excess cash over that time frame. However, other than continuing to pay a paltry dividend yielding 0.5%, Encana doesn't yet have a formal plan to return any of the money to investors.
Meanwhile, U.S. oil giant Anadarko Petroleum (NYSE: APC) recently announced plans to repurchase $2.5 billion of stock by the end of 2018. Anadarko would pay for those repurchases by tapping the $6 billion war chest of cash it built up during the downturn by selling assets. However, aside from that one-time authorization, there doesn't appear to be a sustainable plan to send cash to investors, since Anadarko's current operating strategy calls for it to spend all its cash flow on drilling more wells or expanding midstream infrastructure. That leaves it with little room to return cash above its minuscule 0.4% dividend once it exhausts its current cash balance.
The market is starting to pay attention, and you should too
ConocoPhillips' focus on returning cash has already paid dividends for investors, given that the stock has delivered a nearly 25% total return over the past year. That has eclipsed not only the red-hot S&P 500's slightly more than 24% total return, but is well above the sub-3% return of the average oil stock over the past year.
This outperformance versus its peers should continue, since none come close to rivaling its shareholder-first plan, which should deliver a blend of dividend income and growth over the next few years. That return potential makes ConocoPhillips, which can thrive at low oil prices, a top-notch oil stock to buy.
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