This year has been a transformational one for ConocoPhillips (NYSE: COP). The company strengthened its portfolio so that it can break even at an oil price of just $40 a barrel. It did so by selling low-margin non-core assets and then used the cash proceeds to shore up its balance sheet and return some of the excess to investors.
The market is beginning to take notice of these improvements, evidenced by the fact that the stock has vastly outperformed its peers over the past year. From its analyst and investor meeting in November 2016 to this year's conference earlier in the month, the stock had delivered a total return of more than 14% while most energy stocks declined in value.
Here's a look back at what ConocoPhillips did this year to fuel that outperformance in what has largely been another down year for the oil patch.
From aspiration to action
When ConocoPhillips unveiled its new operating strategy last November, it crafted a plan that should generate positive returns for investors even if oil prices remained volatile. That approach will have it focusing on allocating its cash flow on increasing shareholder value and not just production. Furthermore, the company stated that it wanted to accelerate its value proposition by selling $5 billion to $8 billion of low-margin natural gas assets, which would give it the cash to repurchase $3 billion in stock and repay a significant portion of its debt by 2019.
ConocoPhillips got right to work implementing this strategy in 2017, and within a few short months, it vastly exceeded its ambitious expectations. Thanks in part to the sale of several Canadian assets to Cenovus Energy (NYSE: CVE), the company is on pace to pull in $16 billion in proceeds this year. That provided it with the cash to achieve its three-year financial goals in just over a year, putting it on the path to repurchase $3 billion in stock and getting debt down to $20 billion by the end of 2017, which is nearly $9 billion below where it was in early 2016.
Transformed into a well-oiled machine
Not only has ConocoPhillips significantly improved its balance sheet, but it has turned into an ultra-low-cost oil company. For example, the sale of several low-margin Canadian assets to Cenovus was cash flow neutral to the company because it was able to offset the lost cash flow by cutting its interest expenses after using a portion of the proceeds to pay down debt. Meanwhile, by selling those properties and other high-cost assets like those in the San Juan Basin, ConocoPhillips pulled its average cost of supply down from $40 to $35 per barrel. As a result, the company can generate enough cash flow when oil is at $40 a barrel to pay its dividend as well as finance the new wells needed to offset the decline rate of legacy ones.
Given that ultra-low breakeven level, the company can generate significant excess cash flow at $50 oil to invest in new oil projects, buy back more stock, and pay off additional debt. In fact, over the next three years, ConocoPhillips anticipates spending an average of $2 billion per year on growth projects that should increase production by a 5% compound annual rate. In addition, the company expects to repurchase an average of $1.5 billion of stock in each of the next three years while paying off another $5 billion in debt by the end of 2019.
ConocoPhillips' plan gives investors the best of both worlds. They'll benefit from the upside of the company's growth projects, which should increase cash flow from operations by a 10% compound annual rate. Meanwhile, a portion of that cash flow will head in their direction via a growing dividend and the repurchase program. That should enable it to continue to generate positive returns for them even if oil falters.
Imitation is the sincerest form of flattery
The market is not the only one that has taken notice of ConocoPhillips' performance this year. Several rivals have recently unveiled similar strategies in hopes of mirroring its success. Anadarko Petroleum (NYSE: APC), for example, recently announced that it could repurchase $2.5 billion in shares by the end of next year. Also, Anadarko said that its 2018 plan would break even at $50 oil, which positions it to generate several hundred million dollars in excess cash next year if current oil prices hold up. Hess (NYSE: HES) also seems to be following the same blueprint. The oil giant recently announced that it would repurchase $500 million in stock next year. Hess also said it would pay off another $500 million in debt and pre-fund a major growth project, which would put it on pace to increase production and cash flow by a 10% and 20% compound annual growth rate, respectively, over the next three years.
2017 was memorable, but 2018 could be even better
While 2017 was mostly a transitional year for ConocoPhillips, it was a smashing success. Consequently, the company is now in the position to deliver steady growth and cash returns to investors in 2018 and beyond. That sets it up to keep outperforming rivals, especially since it has a head start on most of them considering that they're just starting to realize it has come up with what appears to be a winning formula.
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