Some article I read touted ConocoPhillips (COP) as a good dividend stock selling at 8 times earnings. I was skeptical. It turns out my suspicions were warranted. 2008 was a really bad year for ConocoPhillips. Those who say that 2008 was an aberration do not understand economics (Austrian economics). The Keynesian economists think that there will be no double-dip worldwide recession. Just like in 2008; they will be proved wrong by the markets. Natural gas and oil prices will go down from their present prices in a worldwide recession. Therefore, ConocoPhillips will go down back to something closer to the 2009 lows. Read on to see how I came to that conclusion.
ConocoPhillips (COP)
Price: $74.35
Shares: 1.28 billion
Market capitalization: $95.16 billion
What does the company do – ConocoPhillips is an international integrated energy company. In 2011, it produced 867,000 barrels per day of oil and natural gas liquids and 4.5 billion cubic feet a day of natural gas, primarily from the United States, Canada, Norway, and the United Kingdom. Proven reserves at year-end 2011 stood at 8.4 billion barrels of oil equivalent, 41% of which are natural gas. With refining capacity of 1.9 million barrels of oil a day, it's the third-largest refinery operator in the U.S.
Morningstar’s take - Faced with a tightening resource market, ConocoPhillips made significant acquisitions over the past decade to boost reserves and increase production. The ensuing fall in commodity prices made those acquisitions appear poorly timed, however. As a result, management changed course last year by selling assets and reducing investment. Now it is taking another step by spinning off the downstream assets into a separate company, potentially as early as May.
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Preferred stock: none
Bonds: $20.1 billion. COP paid $972 million in interest expenses in 2011. It earned $12.436 billion in the same year. The company has the interest covered 12.8 times over. The bonds are not a threat to the dividend at this time.
DIVIDEND RECORD: ConocoPhillips paid a $0.01 quarterly dividend in 1987. They are paying $0.66 per quarter this year. That is 6,500% dividend growth over 25 years. And they are a dedicated dividend payer because when most of the other spineless CEOs were cutting dividends near the depths of the markets in 2009 Conoco raised the dividend 15% when they had huge per share losses. Why can’t more executives have the fortitude that COP has.
Dividend: $0.66
Dividend yield: 3.55% COP becomes a high dividend stock with a dividend yield of 6% when the stock price drops to $44.00.
Dividend payout: 29% using 2011 EPS of $8.98 –OR- 29% using the alternative earning power excluding extraordinary charges
EARNING POWER: $3.61 @ 1.28 billion shares –OR- $8.83 @ 1.28 billion shares excluding the massive impairment charges in 2008.
(earnings adjusted for changes in capitalization – typically share buybacks and/or additional shares created)
EPS | Net income | Shares | Adjusted EPS | |
2007 | $7.22 | $11,891 M | 1,646 M | $9.29 |
2008 | ($11.16) | ($16,998 M) | 1,523 M | ($13.28) |
2009 | $2.94 | $4,414 M | 1,498 M | $3.45 |
2010 | $7.62 | $11,358 M | 1,491 M | $8.87 |
2011 | $8.97 | $12,436 M | 1,387 M | $9.72 |
Here is the CEO’s explanation from the 2008 annual report. You can decide for yourself if the impairments are not indicative of the strength of their underlying earnings.
Despite our progress, like the entire industry ConocoPhillips was severely impacted by falling commodity prices, tightening refining margins, and steep declines in share prices. The decline in market capitalization, as well as expectations for extended weakness in prices and margins, necessitated noncash impairments of goodwill related to our Exploration and Production (E&P) business, and to the carrying value of our LUKOIL investment.
These and other impairments in 2008 totaled $34.1 billion. As a result, despite record earnings through three quarters, we closed 2008 with a net loss of $17 billion, or $11.16 per share, compared with a profit during 2007 of $11.9 billion, or $7.22 per share. Our capital program during the year totaled $19.9 billion. Total debt increased to $27.5 billion, compared with $21.7 billion at year-end 2007.
We believe that the impairments are not indicative of the strength of our underlying earnings and cash flow, or the potential offered by our asset base. Exemplifying these attributes, if impairment charges and other similar items are excluded for both years, adjusted earnings during 2008 were $16.4 billion, or $10.66 per share, compared with $15.2 billion, or $9.21 per share, in 2007.
Alternative earnings excluding extraordinary impairment charges in 2008
EPS | Net income | Shares | Adjusted EPS | |
2007 | $7.22 | $11,891 M | 1,646 M | $9.29 |
2008 | $10.99 | $16,400 M | 1,523 M | $12.81 |
2009 | $2.94 | $4,414 M | 1,498 M | $3.45 |
2010 | $7.62 | $11,358 M | 1,491 M | $8.87 |
2011 | $8.97 | $12,436 M | 1,387 M | $9.72 |
Six year average adjusted earnings per share is $3.61 –OR- $8.83 (depending on whether you believe the CEO’s explanation). I don’t believe him because I think there is another worldwide recession coming that was delayed by central bank counterfeiting. The price of oil and natural gas will fall from their present levels in a worldwide recession. If this is true, then ConocoPhillips is not currently priced as cheaply as it is portrayed in the online P/E values.
Consider contrarian buying below $28.88 (8 times average adjusted EPS of $3.61)
Consider value buying below $43.32 (12 times average adjusted EPS of $3.61)
Consider speculative selling above $72.20 (20 times average adjusted EPS $3.61)
ConocoPhillips is currently trading at 20.6 times average adjusted EPS. This is stock is speculatively priced.
Here are the buy/sell prices if you believe their CEO and his explanation and Keynesian economics
Consider contrarian buying below $70.64 (8 times average adjusted EPS of $8.83)
ConocoPhillips is currently trading at 8.4 times average adjusted EPS. This is stock priced for value.
Consider value buying below $105.96 (12 times average adjusted EPS of $8.83)
Consider speculative selling above $176.60 (20 times average adjusted EPS of $8.83)
BALANCE SHEET – You can clearly see the $34 billion drop in assets and equity in 2008 caused by low oil prices. ConocoPhillip’s balance sheet is not strong.
Book value per share: $50.96 ($65.224 B equity / 1.28 B shares)
Tangible book value per share: $47.77 (equity above – $4.077B intangibles / 1.28 B shares)
Price to book value ratio: 1.46 (under 1.0 is good)
Price to tangible book value ratio: 1.55 (under 1.0 is best)
Current ratio: 1.12 latest quarter (over 2.0 is good)
Quick ratio: 0.78 latest quarter (over 1.0 is good)
Debt to equity ratio: 0.34 (lower is better) That is pretty low.
Percentage of total assets in plant, property, and equipment: 55% (the higher the better) Other long term investments comprised 23%, current assets comprise 19%, and intangibles were only 3% of total assets.
The working capital trend is negative
CONCLUSION – As usual, the best time to buy ConocoPhillips in recent years was in March 2009. It was a value investment back then. ConocoPhillips is a powerful dividend payer and grower. Their dividend is safe due to relatively low debt and a low payout ratio. However, the company is speculatively priced at this time a 20.6 time average adjusted earnings. Wise investors should have scaled out of it when it reached $72.20 back in February 2011. The balance sheet is weak when you look at the price to book value ratio and the current ratio and quick ratios. They might issue some more bonds or cut back on their capital expenditures to make up the difference between current assets and current liabilities. You can safely ignore this stock until it drops back to the $47 - $44 range were the tangible book value is almost even and the dividend is near 6%.
DISCLOSURE – I don’t own ConocoPhillips (COP).
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