U.S. Markets closed

Is ConocoPhillips the Best of the Battered E&P Group?

Fears about global growth, slack energy demand as well as the likelihood of a protracted U.S.-China trade war have soured investors on the energy sector. The group has been one of the worst-performing sectors in the S&P 500. This summer, the overall energy industry fell to its lowest share of the S&P 500 in 40 years. Even the slight boost the beleaguered group received in September, as investors shifted away from momentum and into beaten-down value stocks, seems to have already dissipated.

The entire energy sector has suffered from investor concern about the future of oil and gas and the rise of socially responsible investing. Yet, no matter the promise of renewables, the reality is that the world won't be weaning itself off of petroleum anytime in the immediate future.

In short, fears of the sector's demise may be premature. And, if exploration and production companies are destined to be in business longer than anticipated, there are a number of compelling reasons why ConocoPhillips (NYSE:COP) will be at the head of the pack.

Consider the following factors, that after the selloff, make Conoco especially appealing.

First, the company enjoys an attractive global resource base, which includes a leading position in the Eagle Ford basin region in Texas. In a recent report, UBS analyst Lloyd Byrne estimated that Conoco's asset base has a long shelf life and investors' fears about the company's ability to replenish its inventory are misplaced. Byrne believes the Eagle Ford region can sustain growth for over the next decade, while the Bakken basin can sustain flat production for more than a decade.

The company also enjoys a more geographically diverse asset base than most other exploration and production companies, which are predominantly focused on the fecund Permian fields of New Mexico and Texas. Conoco gets approximately half of its production from domestic assets, including Eagle Ford, Bakken, Permian and Alaska. But it also operates in Canada and has a stake in liquified natural gas facilities in Australia and Qatar.

Additionally, Conoco has a strong balance sheet and relatively low production costs that distinguish it from its peers. The company has one of the industry's more robust balance sheets, with net debt under $10 billion and a debt-to-annual pretax cash flow ratio below one; the exploration and production sector's average is two. This figure doesn't include a $1.7 billion stake in Canada's Cenovus Energy (CVE), which it received in consideration for selling some assets to that company in 2017.

According to UBS's Byrne, Conoco can generate free cash flow and pay its dividend even if oil drops to $40 a barrel. Although some worry about whether the company has enough inventory to replenish supply levels, Byrne estimates that Conoco's asset base will last for a long time, and that investors' fears on this score are misplaced. "The Eagle Ford area can sustain growth for the next decade plus, while the Bakken fields can sustain flat production for a decade plus, in our view," he wrote.

Even though the company's shares are down over 22% this year, the stock is still well ahead of the rest of the sector, as indicated by the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund (XOP), which is off more than 50%.

Another factor that makes the stock attractive is its aggressive dividend policy. The company increased its quarterly dividend this month by 38%, to 42 cents a share, giving a current yield of 3%. This ranks among the highest of major exploration and production companies in a sector whose overall dividend yields, relative to the S&P 500, have been dismal.

As part of its effort to make shareholder returns a major focus, Conoco also has committed to a share buyback program, targeted at $3.5 billion this year and $3 billion for 2020. All of this provides a "total yield," or dividends plus buybacks, of approximately 8%.

In order to maintain free cash flow sufficient with which to ensure returns are delivered to shareholders, the company plans to spend $6.3 billion on energy exploration and its goal is to keep average capital expenditures to $7 billion or less during the next decade.

The stock has a current price-earnings ratio of 9 and trades at 14 times projected 2019 earnings of $3.75 a share, which is a discount to Chevron (NYSE:CVX) and Exxon Mobil (NYSE:XOM), and comparable to other leading exploration and production companies.

Conoco is currently trading at $56.07 -- a 22% drop from its 52-week high of $71.82.

With its shareholder-friendly posture, adequate worldwide asset base and disciplined capital spending plans, as well as a healthy balance sheet, at its current valuation, Conoco could be well poised to move ahead of its competitors should the exploration and production sector rebound.

Disclosure: I have no positions in any of the securities referenced in this article.

Read more here:

Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.

This article first appeared on GuruFocus.