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ConocoPhillips (COP)

ConocoPhillips (COP)

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Published by Saul Sterman
Stock analysis for energy companies; ConocoPhillips, ExxonMobil and Chevron as of 08/2006
Stock analysis for energy companies; ConocoPhillips, ExxonMobil and Chevron as of 08/2006

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Published by: Saul Sterman on Mar 28, 2007
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ConocoPhillips (COP) Refines its Profits
By CrossProfit
Our primary analysis for ConocoPhillips (COP) is that high oil prices should continuegenerating above normal earnings for the next several years.The Facts:COP is banking on an 18% – 20% stake in Russian Lukoil to shore up its dwindling North American well production. A full 10% of production is expected to come fromLukoil.The divesture of wells in Canada is negligible (less than 30,000 bpd) and is part of theBurlington Resources acquisition agreement. The BR acquisition was an expensive NorthAmerican natural gas play. The re-entry into Libya should provide handsome profits on40,000 bpd at a production cost of $5 per barrel! This should more than make up for theCanadian loss. COP is counting on natural gas prices remaining above $6.55 per Mcf,otherwise the BR acquisition becomes mathematically problematic. COP is the largestnatural gas producer in North America.Venezuela is no longer considered a viable reliable option for replacing existing production sites. American companies are not going to invest over a $100 billion todevelop the Orinoco region as long as Chavez is in power. Chavez is counting on China’sthirst for oil to step in and replace the Americans and French. There is plenty of heavycrude down there but right now no one is willing to risk spending billions to developthese new fields. As the Chinese would say, Chavez flipped on the Americans, what’s tostop him from flipping on us in ten years from now.The new refinery project in Yanbu, Saudi Arabia, in conjunction with Aramco andHalliburton, should contribute to the refining division earnings as of H2 2011. This singlenew ’Saudi sour’ refinery project will have the capacity to supply 2% of U.S.consumption.Historically refining operations have had far lower margins than crude production. In2005 production accounted for only 27% of sales yet was 62% of earnings. Lately thishas not been the case and has benefited COP. COP has a 36% stake in the AlaskanPrudhoe Bay fiasco. Prudhoe Bay represents approximately 15% of COP’s global oil production (136,000 bpd out of 916,000 bpd).COP’s historical financial performance (balance sheet, income statement/earnings per share etc.) depicts a classic rollercoaster ride. Over the past decade the energy sector has been highly volatile and COP consistently exemplifies this to an extreme, more so thansome of its competitors.Comparison to peers as of 08/25/2006:
ConocoPhillips (COP) verses Chevron (CVX) verses ExxonMobil (XOM).COP’s market cap = 109 billion, trading at a trailing PE of 6.1, dividend yield = 2.2%CVX’s market cap = 147 billion, trading at a trailing PE of 9.2, dividend yield = 3.2%.XOM’s market cap = 419 billion, trading at a trailing PE of 11, dividend yield = 1.8%.The question that an investor should ask is whether COP is the best out of the threecompanies. On the surface COP looks very attractive. The stock is trading at a lowmultiple (6.1) and is paying a nice dividend. However further analysis reveals a slightlydifferent and somewhat complicated picture.Fundamentals: (from our proprietary research/analysis)
Reserves Replacement:
COP = 109% (enables future production growth)CVX = 58% (not good at all, hampers future growth)XOM = 105% (enables future production growth)
Reliance on U.S. Economy:
COP = 73%CVX = 45%XOM = 31%(Should a slowdown occur in U.S. consumption COP more likely to take a hit than XOMor CVX.)
2006 & 2007 Earnings Growth:
COP, 2006 = 25% & 2007 = 13%(Recent Q2 results are momentarily better due to BR acquisition accountingmanipulations. We see oil remaining high but natural gas at 6.60 -7.70 for Q4)CVX, 2006 = 19% & 2007 = 1%XOM, 2006 = 18% & 2007 = 6%Russian Roulette:All those familiar with the Yukos travesty know that Vladimir Putin can not be trusted toabide by international standards of commerce. The entire dismantling of Yukos was dueto mafia style politics; essentially someone got on Putin’s wrong side. This is factuallyconfirmed from the current events. Yukos could have done exactly what the Russiangovernment is doing now; sell off assets and pay off the (alleged) tax bill and still be aviable business. This is the true litmus test proving that what Putin has done is nationalize private assets under the guise of capitalism only to find some new suckers that pray thatthe (elected) dictator won’t do the same again. If the prayers become the prey it servesthem right. Not to mention that the Russian government (Putin’s circle of ten) is pocketing all of the proceeds and leaving Yukos shareholders out to dry. We call thisdormant disease Putinitis. The question is when will the next outbreak occur? The marketcurrently assesses a high risk premium on Lukoil.
 At CrossProfit we emphasize fundamental analysis and delve into technical analysis onlyupon completion of rigorous fundamental analysis. The CrossProfit evaluation line is based on fundamentals.CrossProfit Evaluation Line: (buy below the line and sell above the line)COP EOL 06/07 = 69.80XOM EOL 03/07 = 75.80CVX EOL 10/06 = 65.30 For those that are unfamiliar with the term, EOL = end of line. The evaluation line is atwelve month forward looking line that specifies a risk/reward evaluation factoring inmarket volatility and determines whether or not an investment opportunity exists.Towards the ‘end of the line’ the line is usually less accurate as the evaluation was basedon data available a while ago. In plain English, the CVX evaluation line is the leastreliable because it ends in 10/06.Based on the above;COP has a 6-7% upsideCVX is currently slightly overvaluedXOM has a 8-9% upsideAll data excludes dividends. We expect XOM to raise its dividend or issue a specialdividend in Q2 2007.So what does all this mean?1) Higher margins benefiting COP refineries.2) Canadian/Libyan production cancels out each other.3) Paid a very high price for BR acquisition resulting in lower PE multiple.4) Increased natural gas capacity from acquisition stays profitable and contributes toearnings growth as long as the bottom doesn’t fall out on pricing.3) Positive reserves replacement.4) Putinitis.5) Pipeline investment in Venezuela but no new production or refinery projects.6) Yanbu not relevant for now.7) Prudhoe Bay is statistically not relevant (see below).Prudhoe Bay:Only one COP refinery relies on Alaskan oil for its supply and that refinery can besupplied from other sources. COP will take a hit on production profits from the Alaskanfiasco. However, with refinery margins up and refining and marketing contributing over 65% of revenue, COP still comes out ahead on a YOY (year over year) basis. Had theAlaskan problem occurred a few years ago it would be a different story.Conclusion:

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