A Tune-Up...and a Healthy Dividend

06/11/2013 7:00 am EST


Jack Adamo

Editor, Jack Adamo's Insiders Plus

This company is slimming down, has competitive advantages, and pays a nice dividend, says Jack Adamo of Insiders Plus.

Conoco Phillips (COP) is no longer an "integrated" company, after spinning off its retail sales network (gas stations) a few months ago.

The full predecessor company has had a long and profitable history, more than tripling in value in the last ten years. This despite the fact that the prior CEO made a few unwise acquisitions, especially a sizable stake in the Russian firm Lukoil, which it has since sold. The new CEO (since last June) is aware of these mistakes and is unlikely to repeat them.

Conoco continues to tune up its operations after the spin-off, disposing of non-core or underperforming assets as the opportunities present themselves. First-quarter revenues were down 8.9%, but only 2.9% excluding gains on asset dispositions, which were much higher last year.

The reason for the lower revenues is the drop in oil prices year-over-year. Almost three-quarters of revenues come from oil; the remaining comes from natural gas and natural gas liquids (NGLs). The company's average natural gas price rose by 4.1% for the quarter, but its oil price fell 5.3%, which had the main impact on the bottom line.

Overall production was up 1%, which is not great, but better than many oil companies whose production fell year-over-year. Moreover, Conoco achieved this despite increased downtime from weather-related events, so this is a good performance.

Also noteworthy is that the company's average price obtained for natural gas was well above the market price, indicating they made some savvy forward sales contracts that are paying off.

I'm a big fan of energy companies having most of their production in oil rather than gas. The gas price has historically been much more volatile than oil, and that should remain so for the foreseeable future.

Conoco Phillips has an advantage when it comes to gas. It is one of only two companies licensed to export liquefied natural gas.

And there's a lot of political wrangling over gas exports. One side says it's better to quarantine the commodity here, keeping prices low for domestic consumers and industry. The other side wants to allow exports, which would help the energy industry and presumably create jobs.

Due to this debate, the amount of gas that can be exported is limited, but restrictions are expected to be gradually lifted, and a few more export licenses granted. In any case, Conoco is ahead of the pack in its infrastructure needed to carry out exportation. These capabilities should be online within two years.

Getting back to the Q1 earnings report, net income from continuing operations, which excludes the income and sales price from assets sold, was down 2.4%. This is acceptable given the transition phase the company is in and the drop in oil prices.

More importantly, operating cash flow was 50% higher than earnings, providing a nice cushion. The company closed the quarter with $1.8 billion more cash and cash equivalents than it had at this time last year.

The dividend payout ratio was 40% for the quarter, which is comfortable enough, and down from 44.7% for last year. Long-term debt is 32% of capitalization and came down 1% this quarter from year-end, despite the company reducing the share count 4.4% through buybacks. So the balance sheet is good and getting better.

The stock yields 4.2% and has a 7% compound annualized growth rate in its dividend over the last five years. Its steady performance earns the company a place in our High Income Portfolio.

Buy Conoco Phillips. Take a 3% position with an eye toward increasing it if the market settles down.

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