Quick Pitch: Conoco-Phillips (NYSE: COP)--Long

(The following is a condensed write-up pulled from SumZero)

Source: Hedge Fund.
Location: New York, NY

Recommendation: Long

Current Price: $77.29
Target Price: $90.00
Timeframe: 1-2 Years

Thesis:
We have viewed the shares of ConocoPhillips (NYSE: COP) as undervalued for some time, and think the company’s planned spinoff of its downstream business will help to further unlock the stock’s underlying value. Our target price is $90.

COP’s strategy is centered on providing strong cash returns to shareholders, and we believe it continues to transition from a poor to a strong allocator of capital, providing additional benefits. Management’s goal is to return 40% of cash flow to shareholders annually. We also think management’s approach is much more return-focused than in the past, as evidenced by the lower returns associated with the assets it has sold as well as the projects it has canceled.

Due to the company’s aggressive share buyback program, production per share growth is expected to average 3%-5% per year over the long term. In addition, COP’s asset disposition program, which is focused on selling the costlier assets in its portfolio, should allow it to deliver near-term increases in net income and cash flow on a per barrel basis even without corresponding production growth. We think that this aspect of the company’s “shrink-to-grow” strategy is often overlooked by investors.

COP’s current yield of approximately 3.4% adds to its total return potential. We believe that margin improvement and greater capital discipline hold the key to potential share price performance, and that the company’s decision to pursue a spinoff of its downstream operations will be the next catalyst to push the shares closer to fair value.

At our $90 target price, the shares would trade at 11.3-times our 2012 EPS estimate and 11.1-times our 2013 forecast. In terms of historical ratios, the company’s trailing P/E of 8.5 is below the midpoint of the five-year historical range of 3.8-14.9.

 

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