We maintain our Neutral recommendation on ConocoPhillips (COP).
ConocoPhillips posted solid fourth-quarter 2011 results on the back of higher price realizations, partially offset by lower refining margins and higher taxes. While the company’s production declined, the impact on earnings was limited as the company has shifted its focus toward higher margin production of oil sands, acquired acreage in North American liquids-rich shale plays and signed production sharing agreements for deepwater blocks in Angola’s emerging subsalt play.
In the exploration arena, ConocoPhillips continued to expand its worldwide shale position and also resumed deepwater Gulf of Mexico drilling activities. The company’s exploration initiatives toward liquids-rich plays such as Eagle Ford, Bakken and North Barnett shale plays are gaining momentum.
We remain positive on the outlook for the new ConocoPhillips post-split, as it holds the promise of unlocking significant value. The idea behind the spin-offis to create value for shareholders who prefer volatility in the refining business.
As part of its three-year strategic plan to divest assets that do not fit its business model, ConocoPhillips divested low-return, non-core assets in the lower 48 and western Canada during 2011. The company completed the divestiture of its entire interest in LUKOIL in the first quarter of 2011 along with the selling off equity interest in a number of projects. The proceeds were deployed for portfolio optimization, debt reduction and to increase shareholder distribution.
ConocoPhillips is also poised to benefit from a pipeline of projects in Malaysia and the LNG project in Australia. The company continues to successfully exploit exploration opportunities around the globe.
During the fourth quarter, the company signed production sharing agreements for deepwater blocks 36 and 37 in Angola’s emerging subsalt play and increased its acreage by acquiring more than 100,000 acres in North America. Going forward, these are expected to augment production and revenues.
Although we are encouraged by the recent discoveries and the company’s new exploration efforts as well as a wider reserve base, lowering of production estimate to 1.55 million barrels of oil equivalent per day (MMBoe/d) from previous estimate of 1.6 MMBoe/d for 2012 remains a concern. This tepid expectation mainly confirms the company’s $10 billion asset sale venture that will likely hit Conoco’s output level in 2012.
However, as a company operating within the energy sector, ConocoPhillips remains vulnerable to unstable movements in crude oil and natural gas prices, as well as the volatile nature of the macro backdrop. We believe that any downtrend of the global economy will affect the supply-demand fundamentals of oil and gas, hurting the sales prices for crude oil, natural gas, refined products and chemicals.
With the use of ethanol and other bio-fuels gaining popularity among industry players, we believe that the demand for petroleum-based refined products will go down. This will likely dampen the margins and earnings of ConocoPhillips' downstream segment.
ConocoPhillips, the third-largest U.S.oil company by market value after ExxonMobil Corp. (XOM) and Chevron Corp. (CVX), holds a Zacks #3 Rank, which is equivalent to Hold rating for a period of one to three months.
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