NYSE: COP
CONOCO PHILLIPS
Current Price: $91.40
Target Price: $104.55
Investment Rationale:
ConocoPhillips is the third-largest integrated energy
company in the United States and the sixth-largest
non-government reserves holder in the world.
ConocoPhillips is well positioned to prosper in the
current economic environment. The company drives
almost all of its net sales from extracting and refining
crude oil and other energy supplies. Thus, its stock
price moves virtually in step with the price of crude
oil. The company holds a variety of strategic assets
and is well positioned in the global energy market.
The company pays a 2.00% dividend, which it has
increased every year since 2002.
Summary:
ConocoPhillips’s stock will outperform the market as
a whole, given the escalating demand for crude oil
and the rapidly increasing oil prices. Revenue growth
is projected at 3.3% per annum, an extremely
conservative estimate given the current prices of
commodities and oil. Worldwide demand for oil is
projected to increase by over 25% in the next 10
years, with the majority of that growth in India and
China.
Based on the sensitivity analysis constructed in this
report, there is very little downside risk to the
ConocoPhillips stock. The one dominant factor that
could override the entire analysis, however, is the
price of crude oil. Based on the regression output, the
COP stock could easily drop by 15 – 20% if the price
of crude falls to $75 / bbl. On the contrary, the stock
price should continue to escalate as the price of crude
clears $135 / bbl and beyond.
Recommendation: HOLD
Analyst Information:
Analyst:
John Evans
Fisher College of Business
The Ohio State University
Contact:
330.806.4309
evans_969@fisher.osu.edu
Fund:
OSU SIM (BUS-FIN 824)
Manager:
Royce West, CFA
Stock Information (21 May 2008):
Sector:
Industry:
Energy
Major Oil and Gas
Market Capitalization:
Shares Outstanding:
Average Volume (10 day):
$145.7 B
1.54 B
13.2 MM
52 Week High:
52 Week Low:
YTD Return:
Dividend Yield:
$95.07
$67.85
6.83%
$1.88 / 2.00%
The 14.4% upside is difficult to ignore, but the
uncertainty in the commodities market keeps COP on
HOLD.
Page 1 of 20
TABLE OF CONTENTS
Analyst Information
Stock Information
Investment Rationale
Summary
1
1
1
1
Company Profile
Business Structure
3
3
Stock Price Performance
Market Factors
Economic Factors
Political Factors
4
6
8
9
Industry and Sector Analysis
9
Company Analysis – SWOT
Financial Statements Analysis
Valuation Relative to the Energy Sector
Equity Valuation: Multiples
Equity valuation: Discounted Cash Flow (DCF) Method
11
12
12
13
13
Summary
References
15
15
Appendix
16
Page 2 of 20
Company Profile1
ConocoPhillips is a fully integrated, global energy company. Headquartered in Houston,
TX, ConocoPhilips is the third-largest integrated energy company in the United States,
the fifth-largest global refiner and the sixth-largest non-government reserves holder in the
world. ConocoPhillips employs approximately 32,800 employees in nearly 40 countries
around the globe in order to find, produce, refine, market and supply energy resources to
users across the planet.
The company currently has assets of in excess of $183 billion and its stock is listed on the
New York Stock Exchange under the symbol "COP."
ConocoPhillips is a successful blend of three major components. Conoco, Phillips
Petroleum Company, and Burlington Resources. Conoco and Phillips merged in 2002 and
then acquired Burlington Resources in 2006.
Conoco2 - Began in 1875 as the Continental Oil and Transportation Company. Conoco’s
founder, Isaac E. Blake, formed the company to capitalize on selling kerosene in bulk to
early western pioneers. Conoco underwent a series of identity transformations over the
subsequent millennium, highlighted by its acquisition by DuPont in 1981. The company
was later spun off in an IPO, retaining its roots as the Continental Oil and Transportation
Company.
Phillips Petroleum Company3 – Founded by brothers Frank and L.E. Phillips in 1903 and
incorporated four years later. Over the years, Phillips Petroleum Company has been the
industry leader in technological innovation, receiving its 10,000th patent in 1975.
Burlington Resources4 – Started in 1864 when President Abraham Lincoln granted
~47,000,000 acres and permission to build a transcontinental railroad to Northern Pacific
Railway Company, the predecessor to Burlington Northern Railroad Company. After
construction of the railroad was complete, Northern Pacific retained extensive land
holdings and mineral rights, which ultimately became part of Burlington Resources’
extensive acreage holdings. Burlington used these assets and key strategic planning to
digest many smaller companies forming the company that was ultimately acquired by
ConocoPhillips.
Business Structure
ConocoPhillips designates six primary business units within its annual report5. Those
units are described below:
Exploration and Production (E&P) – The E&P unit is responsible for the exploration,
production, transportation and marketing of crude oil, natural gas, and natural gas liquids
(NGL) worldwide. This group is responsible for developing assets and projects that
provide strong financial returns over long periods of time, which includes exploring for
new reserves. This group extracts bitumen from oil sands deposits in Canada and
Page 3 of 20
upgrades it into synthetic crude oil. In CY2007, E&P produced an average of 854,000
barrels per day (BD), 5.09 billion cubic feet per day of natural gas, and 155,000 BD of
NGL. The E&P group holds rights to search for and extract energy sources in 23
countries.
Refining and Marketing (R&M) – The R&M group refines crude oil and feedstocks into
petroleum products, markets those products, and transports them. As of the end of 2007,
R&M had composite US processing capacity of 2,037,000 BD with an additional 669,000
net BD abroad. This group sells fuels throughout the US and Europe, primarily under the
Phillips 66®, Conoco®, 76®, and JET® brands, in addition to lubricants, commercial
fuels and liquid petroleum gas.
LUKOIL Investment – ConocoPhillips holds a 20 percent ownership in LUKOIL, a large
Russian integrated oil and natural gas company headquartered in Moscow. In 2007,
LUKOIL had exploration, production, refining and marketing operations in
approximately 30 countries. ConocoPhillips’ estimated share of LUKOIL’s production
totaled 444,000 BD with an additional crude refining throughput of 214,000 BD.
Midstream –The Midstream group gathers natural gas, processes it to extract NGL, and
sells the residual gas to electrical utilities, industrial users, and other companies. At the
end of 2007, DCP Midstream owned approximately 58,000 miles of pipelines, 53
extraction plants, and 10 fractionation plants. This group holds a 50% interest in DCP
Midstream, LLC and other ConocoPhillips assets located primarily in North America.
Chemicals – This group, ChevronPhillips Chemical Company LLC (CPChem), is a 50%
joint venture with the Chevron Corporation. The company produces olefins and
polyolefins, other olefin products; aromatics, styrenics, and specialty products in both US
and international production facilities.
Emerging Businesses – This group develops new businesses and complementary
technologies. Examples include power generation; upstream and downstream
technologies and services; and alternative energy programs.
Stock Price Performance
One factor drives the price of ConocoPhillips stock more than any other: the price of oil.
As shown the figures below, the price of crude oil explains 84.19% of the variability and
pricing of ConocoPhillips stock. Thus, when oil prices spike, as they are right now,
ConocoPhillips share price follows suit.
Page 4 of 20
Crude oil prices from 1994 through 200811.
ConocoPhillips vs. Price of Crude
$120.00
$100.00
Price
$80.00
$60.00
$40.00
$20.00
$Jun-03
Jan-04
Aug-04
Feb-05
Sep-05
Mar-06
Oct-06
Apr-07
Nov-07
Jun-08
Dec-08
Date
Real $/barrel
COP
ConocoPhillips stock price and the rprice of crude since 2004.
Page 5 of 20
Regression Statistics
Multiple R 0.917605
R Square 0.841999
Adjusted R 0.83896
Standard E 7.004556
Observatio
54
ANOVA
df
Regression
Residual
Total
Intercept
X Variable
SS
MS
1 13596.12 13596.12
52 2551.318 49.06381
53 16147.44
ignificance F
F
277.111 1.75E-22
Coefficientstandard Erro t Stat
P-value Lower 95%Upper 95%Lower 95.0%
Upper 95.0%
1.954148 3.571919 0.547086 0.58666 -5.213431 9.121727 -5.213431 9.121727
0.968892 0.058203 16.64665 1.75E-22 0.852098 1.085685 0.852098 1.085685
Regression output – COP vs the price of crude.
As shown above, the price of ConocoPhillips stock is directly linked to the price of oil.
The following is an analysis of potential factors – market, economic, and political – that
could influence the underlying price of oil and thus the price of ConocoPhillips stock.
Market Factors
Market factors are long term in nature and impact the long term profitability of
ConocoPhillips and other firms in the oil industry.
1) Supply There are two components to the supply side of the equation: the total number of
available resources and the total number that can ultimately be recovered. Some experts
estimate that there are approximately six to eight trillion barrels each for conventional
and unconventional oil resources (shale oil, tar sands, extra heavy oil), inclusive of future
discoveries9. To date, only one out of a grand total of 12 to 16 trillion barrels of oil
resources has already been consumed. Stated differently, this means that there are
sufficient liquid crude supplies to sustain production rates at or near 100 million barrels
per day almost to the end of this century9.
For integrated oil and gas companies such as ConocoPhillips, this estimate would appear
to indicate that oil supplies are plentiful and would therefore support the long term
viability of the firm. What these figures do not factor, however, is the fraction of the total
resources that are ultimately recoverable. Currently, industry recovery rates average
about one in three barrels for conventional resources and considerably less for
unconventional resources9. Modern science and developing technologies should double
recovery efficiencies, which is significant, because every 10% gain in extraction
efficiency equates to an additional 1.2 to 1.6 trillion barrels of available resources – a 50year supply at the current consumption rates9.
Contrary to this positive perspective on oil supply is another, more negative outlook. This
viewpoint is often described as “peak oil”. The peak oil point is the widely accepted
tipping point, where 50% of the ultimately recoverable resources have been consumed9.
After the peak-oil-point has been reached, global production decline becomes imminent.
Page 6 of 20
Some experts believe that this point will be reached within the next 5-10 years (if it
hasn’t already been reached), unless the development and adoption of effective
alternatives accelerates 10.
Conclusion Æ Limited oil supplies would obviously drive oil prices higher in the short
term and thus boost the ConocoPhillips stock price. However, this situation would also
shift resources towards the development of alternative energy sources, a potential
detractor to the long term COP share value.
2) Capacity - Given the current state of investment and exploration, world production
capacity is limited. The only way to combat this limitation is to increase the number of
projects designed to search for and to harvest oil. Unfortunately for oil companies like
ConocoPhillips, these projects are becoming much more costly and difficult to complete.
In other words, the age of “easy oil” is disappearing. One estimate pegs the cost of adding
one barrel of daily production in Saudi Arabia (home of the most plentiful and accessible,
oil resources on the planet) at ~$4,000 throughout the 1990s. To add that same barrel of
daily production capacity today costs closer to $16,000 8.
One example of one of these costly projects is the Khurais project, which is a large oil
field currently in progress in Saudi Arabia (by Aramco, one of ConocoPhillips
competitors). This project will cost in excess of $15 billion and require innovative and
complex engineering solutions8. In addition, Aramco will have to build the infrastructure
to connect this giant field to its existing network. Projects such as Khurais are profitable
when oil prices are high, but can quickly turn to cash drains when prices fall. Even when
prices fall, these heavy capital expenditures and investments are required for the long
term success of a company.
Conclusion Æ Adding future processing capacity will cost more than it currently does. In
this elevated cost environment, successful completion of projects will become more
critical due to the overall cost of the project. Increased project costs and any failures of
these complex projects will be a detractor to the COP share price.
3) Demand – Demand for oil is constantly increasing, particularly in emerging markets.
Cambridge Energy Associates forecasts the global daily liquids demand to rise to 115
million barrels by 2017 versus 86 million at present9, an increase of over 25%.
More than any other countries, China and India represent the bulk of that increase.
Together, these two countries are home to over one third of the world’s population and
they are shifting the balance in the world energy market12. Today, China consumes only a
third as much oil as the United States, which burns a quarter of the world's oil each day.
By 2030, India and China together will import as much oil as the United States and Japan
do today12.
In addition to increased demand by individual countries and users, there are also many
more products that are now made from oil. Heating oil, airline fuels, plastics, and other
synthetic materials are driving both the demand and the price of oil.
Page 7 of 20
Conclusion Æ Increased demand will continue to push oil prices upward, given the
current production and capacity. This will drive the COP share price.
4) Use of Alternatives – Another market factor that will impact the price of oil is the
adoption of fuel alternatives. Many alternatives currently exist - biodiesel, bioalcohol,
batteries, fuel cells, hydrogen, vegetable oil and biomass are just a few - the production of
which would have widespread effects on the oil industry. For example, the production of
corn-based ethanol has increased demand for the feed stock, causing rising prices in
almost everything made from corn. In turn, this has reduced the demand for conventional
fuels, and thus lowered conventional fuel prices.
Conclusion Æ As mentioned above, alternative energy sources will decrease oil demand
and thus the COP share price. This assumes that COP does not develop or produce the
alternative energy source.
Economic Factors
Economic factors are short term in nature and impact the more immediate profitability of
ConocoPhillips and other firms in the oil industry.
1) A US recession – A recession in the US, which is a very likely possibility in the
current economic environment, would limit discretionary spending and overall
consumption by the US consumer. This would decrease overall demand for oil based
products and fuels and put downward pressure on oil prices. When oil prices fall, so do
the prices of stocks that are heavily correlated to the price of oil.
2) The strength of the US dollar –The dollar has been very weak against a basket of other
currencies for the past few years. Global oil prices are based in dollars, so when the dollar
is weak, the price of oil is more attractive to buyers and holders of other currencies. This
condition can help to fuel global demand for oil and put upward pressure on oil prices.
3) The US FOMC cuts rates – This condition is closely related to the potential for a
recession in the US. The FOMC has made eight consecutive cuts to the Federal Funds
Rate target. Ongoing, and successive cuts are designed to stave off a recession, but do
lead to an increase in inflation. When inflation increases, there is additional downward
pressure on the value of the dollar and thus upward pressure on oil prices.
4) Potential speculation in oil pricing – Oil prices have more than doubled since the
beginning of 2007 and there is data that suggests that speculation might be driving the
escalating cost of oil6. First, there have been billions of dollars of cash inflows into
commodity markets over the past few years. Second, the current oil market is
characterized by both large inventories and high prices, which is uncommon.
Further, filings from the Intercontinental Exchange (ICE), the leading global electronic
marketplace for energy futures, have shown that its exchange performs a price discovery
function with respect to oil. Couple this fact with the large cash inflows into the
Page 8 of 20
commodities markets and prices can significantly change without support from the
underlying market fundamentals.
Market insiders agree that current supply and demand levels should price oil near $55 a
barrel, well less than half the current market price, yet prices continue to escalate6.
Obviously, the current high prices are a driver to the stocks of integrated oil and gas firms,
but a potential collapse in prices is a significant potential risk.
Political Factors
1) Political instability – Political instability in the location of oil reserves has and will
continue to be a driving factor behind oil prices. Countries such as Nigeria, Venezuela,
Iran, Iraq, and Brazil are home to both large amounts of proven oil reserves and to
political instability. Each of these countries has recently experienced political unrest that
has impacted the oil supply in that country. These supply disruptions typically drive the
price of oil upward, sometimes significantly.
2) Nationalization of resources – In addition to political instability, nations such as
Venezuela have begun the nationalization of oil resources. With the current, high price of
oil, oil rich countries stand to gain immense economic profits by ending the privatization
of that country’s resources. Often, this process leaves the original asset holder little
recourse aside from a long, costly (and usually fruitless) legal battle with the government
or to abandon the oil assets entirely. In fact, ConocoPhillips took a $4B writedown in
2006 due to the loss of its oil assets in Venenzuela.
Conclusion Æ Political instability and the nationalization of oil reserves typically
provides upward price pressure in oil markets and significant downward price pressure
on the stock of the company losing the assets.
Industry and Sector Analysis
ConocoPhillips operates in the Major Oil and Gas Industry, which is part of the Energy
Sector. During times of rising interest rates, returns for the overall energy sector typically
decrease while integrated gas and oil industry does fairly well (average 1year relative
return of 15.28%). However, COP’s primary sources of income are exploration and
production and refining and marketing, which suffer significant declines (-26.6% and 13.3%, respectively) during these same times. During times of falling interest rates, the
overall energy sector does much better, averaging a 1.0% premium to the S&P50013.
Traditionally, oil and gas firms perform best during the recovery phase of the investment
cycle. In particular, all phases of the oil and gas industry have averaged better than 20%
returns during the time after the FOMC’s last rate cut and the first rate increase13.
The energy sector can also be characterized by significant highs and lows in overall
returns. Therefore, one can expect large ranges of expected values when analyzing the
Page 9 of 20
common valuation ratios (P/E, P/S, P/CF, P/BV). Currently, the overall energy sector has
valuations at or near the top of the expected ranges, indicating that the energy sector is
likely overvalued. A sampling of those valuations are shown below.
Valuations for the energy sector, both absolute and relative to the S&P500.
Relative to
SP500
Total Return
P/Forward E
P/S
P/B
P/EBITDA
P/CF
P/E/G ratio
ROE
High
Low
Mean
Current
1.74
1.76
1.04
1.18
1.64
1.02
1.87
1.57
0.68
0.46
0.53
0.58
0.61
0.55
0.58
0.46
0.92
0.64
0.68
0.80
0.80
0.74
1.12
1.08
1.72
0.72
1.03
1.16
0.88
0.83
0.84
1.46
Δ From
Mean
+86.9%
+12.5%
+51.5%
+45.0%
+10.0%
+12.2%
-25.0%
+35.2%
Opinion
Overvalued
Fair Value
Overvalued
Overvalued
Fair Value
Fair Value
Undervalued
Overvalued
Valuations for the energy sector relative to the S&P500.
As shown in the above table, the current valuation for the energy sector is best
summarized as overvalued. Therefore, the most likely outcome and outlook is that this
sector will revert to the mean, so individual stocks can be expected to decrease in
price/value.
Page 10 of 20
Company Analysis – SWOT Analysis
ConocoPhillips strengths are numerous. One of its major strengths is its extensive and
diversified asset base. This includes major legacy positions in the North Sea and growth
prospects in the Middle East, Asia Pacific, and the Caspian Sea. Additionally,
ConocoPhillips’ LUKOIL investment offers an additional array of opportunities.
Investment in the Russian Federation could be considered a risk due to the potential to
end the privatization of oil resources. However, ConocoPhillips appears to be well
positioned to avoid this fate in Russia. They have been praised by the Russian
Government for their business approach, a model in which they control only 20%
ownership of LUKOIL and provide full technical support, training, and information
exchange. LUKOIL operates in over 30 countries, many of which are politically unstable;
ConocoPhillips gains the upside of investing in these areas, where some governments are
more willing to partner with Russian firms than with companies from the West.
ConocoPhillips’ LUKOIL investment is arguably its biggest asset.
In fact, ConocoPhillips is well-suited to withstand resource nationalism because a
significant proportion of its assets are located in the United States, Canada, European
nations and other Organization of Economic Cooperation and Development (OECD)
member countries. Another strength is the company’s expanding capacity to process
heavy crude. This is the result of ongoing investment specifically targeted at processing
the heavy crude from the Canadian oil sands.
ConocoPhillips must also address some of its weaknesses. Some of its key weaknesses
include its susceptibility to the increasing costs and the increasing complexity of new
exploration and production projects. While these weaknesses are not necessarily unique
to ConocoPhillips, the company must initiate programs to combat these weaknesses.
Another weakness for ConocoPhillips is the identification and development of alternative
energy sources. The company is investing heavily in developing these technologies, but
they must find a way to develop these more quickly, otherwise they may be forced to
acquire these on the open market at a significantly higher price.
ConocoPhillips also has many opportunities that could enhance future growth and
profitability. First, the world population is growing along with the increased energy
demand in developing countries. The company must leverage its broad presence and asset
base to capitalize on these trends. Second, ConocoPhillips has increased its production
capacity for processing heavy crude. This will become a significant operating advantage
as output from the Canadian oil sands becomes a larger fraction of the world total.
However, ConocoPhillips must become a technical leader in processing this heavier
crude to profit from the initial investment and to offset depletion of more premium crude
reserves. Finally, ConocoPhillips has the opportunity to leverage its membership in the
U.S. Climate Action Partnership, an organization which supports the development of a
mandatory national framework to reduce greenhouse gas emissions. The company has
voluntarily joined this group in anticipation of future US regulations. As a result
ConocoPhillips is preparing carbon baselines and incorporating potential carbon costs
Page 11 of 20
into its current capital projects. Early preparation in this field could provide a competitive
advantage over other oil and gas majors in the coming years.
ConcoPhillips also faces a series of risks and threats. Threats such as energy supply
security and operating costs are directly controllable by the company, so management
must ensure that these potential risks are addressed. Other factors such as oil prices, tax
rates, the promotion of alternative energy sources, and energy legislation are out of
ConocoPhillips control. For these factors, the company must exercise influential power
where possible, and build contingency plans and structures to account for probable and
worst case scenarios.
Financial statements analysis A copy of the balance sheet, income statement, and cash flow statement from 2007 are
included in the appendix.
Income Statement – Gross profit is essentially flat in 2007 over the prior year and up
about one percent over 2003. SG&A is steadily decreasing, but is offset by the increase in
taxes to 48.9%. Operating and net income are down. The key driver to the decrease in
operating profits is the $4.0 B writedown of assets in Venezuela. This negatively
impacted net and operating income by over 25%. The key metrics on this statement are
net sales and cost of sales. Sales increase at a modest 3.17% in 2007, while the cost of
sales is up only 0.4%. Net sales should increase significantly in 2008 and beyond with the
rapid increase in oil prices. In 2007, ConocoPhillips consolidated, realized price for crude
oil was (only) $69.475.
Balance Sheet – There are no red flags or items of concern on the balance sheet. It is
worth noting that most of the increases in value occurred from 2005 to 2006, when
ConocoPhillips acquired Burlington Resources.
Cash Flow Statement – Cash from operations is up by 0.56% and 1.75% from 2005 to
2006 and from 2006 to 2007, respectively. Dividends increase in each successive year, as
has been the case since 2002. The company also announced a $10.0 B stock repurchase
program in 2007.
In conclusion, ConocoPhillips financial statements are clean with no real alarms or flags
for potential investors. The key factor for future sales growth is the price of oil, which is
currently double the realized price from 2007. ConocoPhillips is also doing a good job of
controlling costs which should boost operating profits in future years.
COP valuation relative to the energy sector
ConocoPhillips’ valuation relative to the energy sector is summarized in the table below.
The data represents the 1998 – 2007 time period. Like the rest of the sector,
ConocoPhillips stock price is directly correlated with the price of oil. Therefore, COP
Page 12 of 20
warrants valuations inline with the rest of the energy sector. All of the current ratios are
closely valued to the mean, except for PEG and ROE. These slight deviations may be a
byproduct of some of ConocoPhillips’ peripheral business ventures but are not
significantly different from those of the sector. Assuming that the stock valuation will
revert to the mean, COP is fairly valued.
Stock vs. Sector
Valuation
P/Forward E
P/S
P/B
P/EBITDA
P/CF
P/E/G ratio
ROE
High
Low
Mean
Current
1.06
0.71
0.89
1.14
1.10
1.67
1.63
0.48
0.41
0.36
0.38
0.45
0.46
0.53
0.71
0.52
0.58
0.65
0.66
0.90
0.98
0.67
0.52
0.49
0.67
0.61
0.77
0.75
Δ From
Mean
-5.6%
0.0%
-15.5%
+3.1%
-7.6%
-14.4%
-23.5%
Opinion
Fair Value
Fair Value
Undervalued
Fair Value
Fair Value
Undervalued
Undervalued
Equity valuation: multiples –
ConocoPhillips valuation is summarized via a multiples analysis in the table below. This
method is imprecise, yet still provides another benchmark estimation of the
ConocoPhillips stock price for comparison with the other models. The estimated stock
price from the multiples method is $88.91 per share, or ~2.7% overvalued from the May
23rd closing price of $91.40.
Absolute
Valuation
P/Forward E
P/S
P/B
P/EBITDA
P/CF
AVERAGE
High
Low
Mean
Current
29.9
1.12
3.3
17.7
18.3
5.8
0.37
0.7
2.2
4.0
10.2
0.64
1.6
3.9
5.9
7.9
0.74
1.5
4.1
5.6
Target
Multiple
10.2
0.64
1.6
3.9
5.9
Target x
Per Share
8.5
123.5
60.93
22.29
16.0
Target
Price
$86.70
$79.05
$97.49
$86.94
$94.40
$88.91
Equity valuation: Discounted Cash Flow (DCF) Method
ConocoPhillips valuation was also calculated via a discounted cash flow model. The
component worksheets for the final DCF are summarized and included in the appendix.
The terminal discount rate was set at 11.0% due to the cyclical nature of the energy
industry, while the terminal free cash flow rate was pegged at 4.0% as ConocoPhillips is
a relatively mature company.
Using the assumptions listed below, the model predicts an intrinsic value of $104.55 per
share, or 14.4% more than the $91.40 share price as of close of business on 5/25/08. Thus,
Page 13 of 20
the DCF model suggests that COP stock is undervalued and is subject to modest
upside gains.
The assumptions used in generating this model are:
Income Statement
• Cost of Sales – held constant at 65%
• SG&A – held constant at 10.5%, which is inline with the recent downward trend
• Production, exploration, operating expenses – minimal variation, values near 6.0%.
This is inline with recent 5 year average
• Depreciation – increases from 3.48% to 3.73%. In the DCF worksheet, these values
increase to a terminal value of 7.0%, which is equal to the long term capital
expenditure rate.
• Impairments – minimal expense of 0.25%. The $4B writedown of COP’s Venezuelan
assets in 2007 was assumed to be a unique circumstance.
• Other expenses – assumed minimal expense of 0.10%.
• Income tax provision – tax rate assumed constant at the long term rate of 45.0%.
• Share repurchases – 2.0% of the outstanding shares are repurchased each year. This
is in line with current, approved share repurchase programs
• Accounts receivable – equal to the 2006/2007 average (post Burlington Resources
acquisition)
• Inventories – equal to the long run average of 2.1%
• Accounts payable – equal to the 2006/2007 average (post Burlington Resources
acquisition)
• Sales growth – equal to the 2006/2007 average (post Burlington Resources
acquisition)
Segment Analysis
• Net Sales GrowthÆ E&P – these values were extracted from the annual statement
• Net Sales GrowthÆ R&M – decreases from 7.0% to 2.5% as oil prices are predicted
to fall in the next 12 - 36 months
• Net Sales GrowthÆ Midstream – assumed constant at 15.0%, with no acquisitions
• Net Sales GrowthÆ LUKOIL – this is net income growth of the LUKOIL investment.
Russia is a high growth market and high oil prices will fuel this asset.
• Net Sales GrowthÆ Chemicals – ongoing decrease in net sales, continues the 5 year
trend
• Net Sales GrowthÆ Emerging Businesses – constant growth of 12.0% due to the
development of alternative energy technologies
• Operating MarginsÆ E&P – assumed constant at 12.0%. Increase crude prices will
trim this margin over recent years
• Operating MarginsÆ R&M – assumed constant at 4.5%, equal to the short term
average
• Operating MarginsÆ Midstream - margins will decrease from the long term average
to 9.0% by 2010
• Operating MarginsÆ LUKOIL – no margins for this investment
Page 14 of 20
•
Operating MarginsÆ Emerging Businesses – increases from a money losing business
as the new technologies become economically viable
Cash Flow
• Changes in AR – assumed constant
• Changes in Liabilities – assumed constant
• Changes in Inventory – assumed constant
• Depreciation – see the assumption listed in under “income statement”
• Capital Expenditures – increases to a constant value of 7.0% as new E&P projects
become more costly and complex
Sensitivity Analysis
In addition to the standard DCF calculation, a sensitivity analysis shows the expected
range of COP stock values when varying the terminal discount rate from 9.0% to 13.0%
and the terminal free cash flow rate from 3.0% to 6.0%. This analysis bounds the
ConocoPhillips stock price between $75.68 and $217.74 per share. However, the more
probable valuation range is 10.0% to 12.0% for the terminal discount rate and 4.0% to
6.0% for the terminal free cash flow rate. This subset of the analysis yields a valuation
range of $90.36 to $161.56, which suggests almost zero downside risk against ~43.0%
upside gains. The following tables summarize the results.
Terminal Discount Rate
Terminal
FCF Rate
3.0%
4.0%
5.0%
6.0%
$
$
$
$
9.0%
133.95
150.71
175.85
217.74
$
$
$
$
10.0%
112.84
123.67
138.82
161.56
$
$
$
$
11.0%
97.20
104.55
114.35
128.07
$
$
$
$
12.0%
85.18
90.36
97.02
105.90
$
$
$
$
13.0%
75.68
79.44
84.14
90.18
Terminal Discount Rate
Terminal
FCF Rate
3.0%
4.0%
5.0%
6.0%
9.0%
-31.8%
-39.4%
-48.0%
-58.0%
10.0%
-19.0%
-26.1%
-34.2%
-43.4%
11.0%
-6.0%
-12.6%
-20.1%
-28.6%
12.0%
7.3%
1.2%
-5.8%
-13.7%
13.0%
20.8%
15.1%
8.6%
1.4%
Summary
In summary, ConocoPhillips is a HOLD with a price target of $104.55. This represents a
14.4% premium to the closing price on 5/23/08.
ConocoPhillips is well positioned to prosper in the current economic environment. The
company drives almost all of its net sales from extracting and refining crude oil and other
energy supplies. Thus, its stock price moves virtually in step with the price of crude oil.
Revenue growth is projected at 3.3% per annum, an extremely conservative estimate
given the current prices of commodities and oil. Worldwide demand for oil is projected to
increase by over 25% in the next 10 years, with the majority of that growth in India and
China.
Page 15 of 20
ConocoPhillips has a very critical asset in its 20% equity stake in the Russian oil major,
LUKOIL. This position provides equity share oil reserves and access to many developing
oil suppliers that ConocoPhillips would otherwise not be able to reach. The LUKOIL
investment and ConocoPhillips’ increasing capacity to process heavy crude are
competitive advantages for the firm, relative to its peers.
Based on the sensitivity analysis constructed in this report, there is very little downside
risk to the ConocoPhillips stock. The one dominant factor that could override the entire
analysis, however, is the price of crude oil. Based on the regression output, the COP
stock could easily drop by 15 – 20% if the price of crude falls to $75 / bbl. On the
contrary, the stock price should continue to escalate as the price of crude clears $135 / bbl
and beyond.
While the 14.4% upside predicted by the DCF is not insignificant, ConocoPhillips
still warrants a HOLD recommendation. The price target and model should be
revisited in three month intervals to assess the rapidly changing commodity markets,
along with the US and world economies, in general.
References
1) http://www.conocophillips.com/about/who_we_are/index.htm
2) http://www.conocophillips.com/about/who_we_are/history/conoco/index.htm
3) http://www.conocophillips.com/about/who_we_are/history/phillips/index.htm
4) http://www.conocophillips.com/about/who_we_are/history/burlington/index.htm
5) ConocoPhillips 2007 annual report
6)
http://money.cnn.com/2008/04/03/news/economy/senate_oil_prices/index.htm?section=
money_markets
7) http://www.senate.gov/%7Elevin/newsroom/release.cfm?id=257862
8) http://online.wsj.com/article/SB120881050953632313.html
9) http://online.wsj.com/article/SB120459389654809159.html
10) http://en.wikipedia.org/wiki/Alternative_fuel
11) http://en.wikipedia.org/wiki/Image:Oil_Prices_Medium_Term.png#file
12) http://www.iht.com/articles/2007/11/09/business/09oil.php?page=2
13) Course packet
Appendix
Page 16 of 20
12,752
45.0%
90
15,586
7,000
3.48%
(499)
-0.25%
14,067
7.00%
Taxes
Tax Rate
Minority Interest
Net Income
% Growth
Add Depreciation/Amort
% of Sales
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
$
1,105
0.55%
Interest - net
Interest % of Sales
Upside/(Downside) to DCF
Implied equity value/share
$
51.89%
138.82
91.40
1,645.9
Shares Outstanding
Current Price
448,398
85,620 37%
142,873 63%
228,493
3.51%
Terminal Value
NPV of free cash flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
8,020
29,534
14.70%
Operating Income
Operating Margin
Free Cash Flow
YOY growth
200,954
2008E
Revenue
% Growth
Year
DCF Valuation
5/26/2008
Ticker: COP
John Evans
8,955
12%
7,600
3.65%
(116)
-0.06%
14,573
7.00%
16,044
2.94%
13,127
45.0%
90
1,145
0.55%
30,406
14.61%
208,188
3.60%
2009E
Terminal
FCF Rate
Terminal
FCF Rate
9,315
4%
8,000
3.73%
(101)
-0.05%
15,014
7.00%
16,430
2.40%
13,443
45.0%
90
1,287
0.60%
31,249
14.57%
214,488
3.03%
2010E
12,199
27%
11,444
5.00%
(229)
-0.10%
16,021
7.00%
17,006
3.42%
13,840
45.0%
90
1,287
0.56%
32,043
14.00%
228,877
3.30%
2012E
$
$
$
$
9.0%
133.95
150.71
175.85
217.74
3.0%
4.0%
5.0%
6.0%
9.0%
-31.8%
-39.4%
-48.0%
-58.0%
Terminal Discount Rate
3.0%
4.0%
5.0%
6.0%
Terminal Discount Rate
9,574
3%
8,863
4.00%
(222)
-0.10%
15,510
7.00%
16,443
0.08%
13,380
45.0%
90
1,287
0.58%
31,019
14.00%
221,566
3.30%
2011E
Terminal Discount Rate =
Terminal FCF Growth =
$
$
$
$
10.0%
-19.0%
-26.1%
-34.2%
-43.4%
10.0%
112.84
123.67
138.82
161.56
14,750
21%
14,186
6.00%
(473)
-0.20%
16,550
7.00%
17,587
3.42%
14,316
45.0%
90
1,287
0.54%
33,100
14.00%
236,430
3.30%
$
$
$
$
11.0%
-6.0%
-12.6%
-20.1%
-28.6%
11.0%
97.20
104.55
114.35
128.07
17,455
18%
15,875
6.50%
488
0.20%
17,096
7.00%
18,188
3.42%
14,808
45.0%
90
1,287
0.53%
34,193
14.00%
244,233
3.30%
Forecast
2013E
2014E
10.0% start value
5.0% start value
$
$
$
$
12.0%
7.3%
1.2%
-5.8%
-13.7%
12.0%
85.18
90.36
97.02
105.90
18,304
5%
17,660
7.00%
(505)
-0.20%
17,660
7.00%
18,809
3.41%
15,315
45.0%
90
1,287
0.51%
35,321
14.00%
252,292
3.30%
2015E
$
$
$
$
13.0%
20.8%
15.1%
8.6%
1.4%
13.0%
75.68
79.44
84.14
90.18
19,971
9%
18,243
7.00%
521
0.20%
18,243
7.00%
19,450
3.41%
15,840
45.0%
90
1,287
0.49%
36,487
14.00%
260,618
3.30%
2016E
19,574
-2%
18,845
7.00%
(538)
-0.20%
18,845
7.00%
20,112
3.40%
16,382
45.0%
90
1,287
0.48%
37,691
14.00%
269,218
3.30%
2017E
Terminal
P/E
EV/EBITDA
Free Cash Yield
21,352
9%
19,467
7.00%
556
0.20%
19,467
7.00%
20,796
3.40%
16,941
45.0%
90
1,287
0.46%
38,934
14.00%
278,102
3.30%
2018E
Discounted Cash Flow Model
Page 17 of 20
CONOCOPHILLIPS 2007 Consolidated Balance Sheet5
Page 18 of 20
CONOCOPHILLIPS 2007 Consolidated Income Statement5
Page 19 of 20
CONOCOPHILLIPS 2007 Consolidated Statement of Cash Flows5
Page 20 of 20