Oil prices have risen off of the lows reached following the mid-2014 oil downturn. That's been great news for most oil-related companies, since it means revenues are heading higher. The biggest beneficiaries are the companies most reliant on oil prices, like ConocoPhillips (NYSE: COP), which is up 85% since mid-January 2016, when oil prices started rising again. However, the downturn was an ugly reminder that what goes up can just as quickly go down. If you are considering an oil investment, forget ConocoPhillips and take a look at this pair of diversified energy giants instead.
The big problem
ConocoPhillips is a well-run company. In fact, it has been executing particularly well lately, with solid production growth and strong production growth expectations over the next few years. The problem is the company's lack of diversification. ConocoPhillips spun off Phillips 66 in 2012, jettisoning its downstream assets and leaving ConocoPhillips focused exclusively on exploration and production.
Image source: Getty Images.
That's an issue, because it means oil prices have a heavy impact on the company's performance. When oil prices are rising, ConocoPhillips' results will benefit hugely, and the stock will respond accordingly (note the swift stock advance since oil prices turned higher). But when prices are falling, the company will be hit harder than more diversified peers. And that proved true during the last oil downturn, when ConocoPhillips was forced to cut its dividend by 66% in 2016. For long-term investors, particularly those with an income focus, that's a big risk.
Better ways to play oil
This is why ExxonMobil Corporation (NYSE: XOM) and Royal Dutch Shell plc (NYSE: RDS-B) are better investment options. These two international oil giants are heavyweights in the upstream oil and natural gas drilling space, but they are also major players in the downstream refining and chemicals areas.
That's important because refining and chemicals use oil and gas as their key inputs. So, falling energy prices mean falling costs, which improves margins and, ultimately, the financial results of their downstream divisions. Having material downstream assets can help to smooth out the ups and downs of the upstream drilling business.
Earnings in Exxon's drilling business fell around 75% in 2015, when oil prices were plummeting. Earnings in its downstream operations, however, more than doubled that year as lower input costs buoyed results. Overall, Exxon's total earnings fell about 50%. Don't get me wrong, 50% is a painful number to see -- but it's much better than 75%. And the counterbalance of the downstream business was a key factor in Exxon's ability to keep raising its dividend each year through the oil downturn.
Shell's downstream earnings increased by 50% in 2015, while oil prices were weak. That helped to offset the losses it incurred in its upstream operations, driven by lower oil prices and a massive $7.4 billion one-time charge associated with asset writedowns (due to falling oil prices). Shell didn't increase its dividend each year through the downturn, but it didn't cut, either -- despite consummating a large opportunistic acquisition. The strength of the downstream business was a key support.
To be fair, Exxon and Shell both relied heavily on their balance sheets during this period to help maintain their dividends and to continue their capital spending plans. But ConocoPhillips' debt levels rose, too, and it still cut its dividend. One big difference is that ConocoPhillips didn't have the benefit of downstream assets to help soften the blow of the downturn.
Safety first is always a good call
Clearly you need to get into the deeper details with ConocoPhillips, ExxonMobil, and Royal Dutch Shell to decide which one is right for your portfolio. However, the difference in the company's core business models is vital to understand before you invest in ConocoPhillips' quickly rising stock. Instead of getting caught up in recent performance, a look at some history might show that you're better off owning a more diversified oil company like Exxon or Shell -- where you can collect reliable 4% and 5.5% yields, respectively, even if times get tough again.
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