Organization
Public Release Date
ConocoPhillips
May 2014
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IN THIS ISSUE
A Note From the Editor
2
Value Line Dividend Select Portfolios
4
This Month’s Recommendation
ConocoPhillips6
During the past few years, oil and gas exploration company ConocoPhillips
(NYSE: COP) has shed non-strategic, underperforming operations to
focus on more-promising businesses. We look for heavy investment, most
notably in North America, to pay off in solid sales, earnings, and cash-flow
growth. To 2017-2019, investors stand to gain from dividend hikes of about
3% a year, above-average yields of 3%-4%, and respectable share-price
appreciation, with limited risk.
Financial Statements
14
Other Notable Stock Selections
Atmos Energy Corp.
18
Natural gas utility Atmos Energy (NYSE: ATO) aims to lift its share net 6%8% a year. Ongoing spending on its core distribution operations in the
southern United States and likely reasonable regulatory treatment should
support the attainment of this goal. Favorable returns on equity ought to
ensure good annual dividend growth (3%-4%), helping to sustain a yield
of 3%, or better, over the long run.
Maxim Integrated Products
21
Maxim Integrated Products (NDQ: MXIM) is setting the scene for improved
sales and earnings. The maker of electronic devices is having success in
pursuing business in the world mobile computing, automotive, utility
infrastructure, and medical equipment markets. Investors likely will
benefit from a yield above 3%, yearly dividend growth of 8%-9%, decent
share-price gains, and stock buybacks through 2017-2019.
Footnotes24
A Note From the Editor
BY DavID M. Reimer, EDITORIAL ANALYST
So far this year, the broader domestic stock market has retained its strength well against significant macroeconomic and global political pressures, recovering from each brief pullback. As we have stated previously, in late January/early February there was a general economic setback among developing nations
that notably pushed down share prices overseas and in this country. By early March, the major market
indexes largely recovered but, near the middle of the month, the mounting political crisis in Ukraine
had a brief, measurably negative impact on the performance of stocks. As well, about one month later,
hedge funds, within a narrow window of time, shifted money away from high-flying social media, Internet search, and biotechnology equities toward blue chip tech companies. Too, interest in initial public
offerings became more subdued. A few companies looking to tap the market for funding even delayed
planned issues. As of this writing, stocks have returned to near-record levels. Bargain hunters have picked
up many of the beaten down high-tech issues. The Standard & Poor’s 500 Index is slightly up from
where it was at the start of this year, and is not far from its record high. Though currently in negative
territory, the Dow Jones Industrial Average is closing in on its 2014 breakeven level. The NASDAQ is a
good measure below its 14-year high, reached in early March, but has bounced off its low for the year.
True, the S&P 500 Volatility Index, also known as the VIX, has spiked a few times in 2014, but it has,
on most days, stayed somewhere in the low teens, a range that does not present much cause for concern.
Going forward, market volatility might well increase, especially if certain areas of the world, that is,
Eastern Europe, the Middle East, and Latin America, experience greater, or prolonged, political and
economic troubles. Tensions over the Ukraine continue to simmer. Also, though we don’t expect it, a
further slowdown of growth in China would likely worry investors. On a positive note, the recovery of
the U.S. economy in the wake of the severe 2007-2009 recession is progressing, albeit at a moderate
pace. Harsh winter weather had a negative impact on the operating performances of many domestic
companies, which is coming to light in the earnings season now under way. Recent regional and national
readings of manufacturing activity, though not particularly strong, do indicate an ongoing expansion.
The inclement winter created pent-up demand that ought to be satisfied in the current quarter and those
that follow. The same seems to be true regarding the retail and housing sectors. Since the economy is
holding up fairly well and inflation is gathering some momentum, the Federal Reserve likely will stick to
a plan to conclude its bond-buying program late this year or in early 2015. Employment is firming and
wages are improving incrementally. Consumers have considerably pared their debt obligations and have
more disposable income to spend on big ticket items. Easier lending terms have been a plus. Consumers
do, however, continue to be conservative about spending on everyday necessities. All this suggests steady
to slowly strengthening economic growth over the next several years.
Overseas, the economic situation, while not sanguine, is somewhat encouraging. Though economies in
Latin America remain under pressure, fears of a major meltdown have subsided. Europe has its financial
house in order after the recent crisis, but government and economic authorities, as they are well aware,
2
Value Line Dividend Select
May 2014
A Note From the Editor
need to take action to promote growth. Officials are weighing the viability of certain actions, including
something similar to the U.S. Federal Reserve’s bond-buying program. Russia is playing an effective
chess game with regard to Ukraine. That regional power, though apparently on the verge of falling into
a recession, is a significant supplier of natural gas to Europe (and, possibly in the near future, China)
and retains considerable economic leverage. An invasion of Ukraine cannot be ruled out. In the event of
such an occurrence, the United States may be hard pressed to win Europe’s backing for highly-stringent
sanctions, which would in all likelihood be a drag on the global economy. Elsewhere, officials in China
are working to ensure healthy, albeit more modest, long-term economic expansion founded more on
internal consumption. Assuming they are successful, developing and developed countries around the
globe should benefit.
We’re optimistic that the world economy will grow at a mid-single-digit annual rate over the next three
to five years. Most companies should become more confident about business prospects, and shift money
from stock buybacks and dividend hikes toward investment in growth areas, thus supporting broader
international growth. That said, large mature organizations, many of which are in our Dividend Select
portfolios, surely will remain mindful that they still need to reward loyal investors. A sizable, aging baby
boom population should continue to favor relatively safe, high-yielding equities.
Recent Portfolio Action
In the one-month period (ending April 25th), our Featured Portfolio turned in a strong performance
with a clear majority of stocks posting solid gains. Topping the list was consumer goods giant Unilever
(NYSE: UL), the ADRs (American Depository Receipts) of which advanced an impressive 10.5%, and
attained a new all-time high. There is much excitement surrounding the company’s pending purchase of
a controlling interest in Qinyuan Group, a water purification operation serving the vast China market.
In light of the elevated valuation, however, we are maintaining our Hold recommendation on this equity.
Not far behind Unilever was Consolidated Edison (NYSE: ED), turning in a strong one-month showing, with its share price rising 10.1%. The stock of the New York utility has benefited from investors
seeking high-quality issues. Our Buy recommendation on this stock stands. Investors may want to sell
their stakes in Johnson & Johnson (NYSE: JNJ), thereby locking in a hefty total return of 58% (or 20%
annualized) since our initial recommendation in July 2011.
Our Alternative Portfolio also performed well in the recent one-month term. Here, too, utilities proved
popular with investors. American Electric Power (NYSE: AEP) posted a gain of 9.2% and Public Service
Enterprise Group (NYSE: PEG) advanced 9.1%. Since AEP shares still have decent three- to five-year
total return prospects, we are maintaining our Hold recommendation. The stock of Public Service,
though, is trading at the upper end of our long-term price projections. Thus, we advise investors to shed
their stakes. Since our original report on the New Jersey-based utility in December of 2012, its stock has
produced a total return of 40% (28%, annualized). Separately, British American Tobacco (NYSE: BTI)
ADRs achieved an 8.7% price improvement in the 30-day period. Despite a tough market environment,
highlighted by stiff competition and declining demand for traditional smokes in developed nations, the
tobacco company is generating ample cash flow and rewarding investors with stock buybacks and an
May 2014
Value Line Dividend Select
3
A NOTE FROM THE EDITOR
attractive dividend. Emerging market cigarette demand is firm. In our view, those seeking income stand
to gain over the long run. We rate British American a Buy. We suggest investors divest their holdings in
DuPont (NYSE: DD). During the term since our initial report on the chemicals company in November
2012, the stock generated a total return of 60% (40%, annualized). Note that investors with taxable
accounts should consider their holding period for capital gains purposes, in combination with their risk
preferences.
Going forward, we look for good-quality, income-generating equities to perform well, in comparison
with the broader stock market indexes. Most conservative investors should be able to find a number of
equities within our Dividend Select portfolios that suit their individual outlook. ■
Dividend Select Featured Stock Portfolio † †
Recent
price
Name
Our
rec.
Curr.
yld (%)
2013
YTD total Ann. rtn. since
tot. rtn.
return
incep. (%)
Inception
date
AT&T (T)
$34.49 Hold
5.4
9.9
-0.6
12.3
2/10/2012
Bank of Montreal (BMO)
$68.68 Hold
4.5
†
15.7
4.2
23.4
6/7/2013
Baxter Int'l (BAX)
$72.32
Buy
2.7
7.3
5.4
15.1
10/5/2012
Coca-Cola (KO)
$41.01 Hold
3.0
17.2
Nil
12.2
1/17/2012
Consolidated Edison (ED)
$57.74
Buy
4.4
—
6.2
172
4/4/2014
Dow Chemical (DOW)
$48.50
Buy
3.0
13.1
10.0
74.0
12/6/2013
General Mills (GIS)
$52.29 Hold
3.1
27.5
5.6
17.9
8/12/2011
GlaxoSmithKline (GSK)
$55.76
Buy
4.6†
—
7.1
26.0
1/10/2014
$100.73 Hold
3.2
-0.1
4.7
7.9
10/11/2013
McDonald's (MCD)
Microchip Tech (MCHP)
$47.16
Buy
3.0
15.0
6.2
38.3
9/6/2013
Molson Coors (TAP)
$58.56
Buy
2.5
—
12.5
69.9
2/7/2014
Nestlé SA (NSRGY)
$75.96
Buy
3.2†
9.7
6.5
14.7
3/8/2013
Norfolk Southern (NSC)
$94.03 Hold
2.3
54.1
1.9
20.6
4/13/2012
PepsiCo (PEP)
$85.25
Buy
3.1
7.0
4.2
10.7
4/5/2013
Procter & Gamble (PG)
$81.41
Buy
3.2
0.5
0.7
1.7
8/9/2013
Roy'l Bank of Can. (RY)
$65.61 Hold
4.3†
10.4
-1.4
7.3
2/8/2013
Total S.A. (TOT)
$68.50
Buy
4.8†
4.1
13.2
45.3
11/8/2013
TransCanada (TRP)
$45.94
Buy
4.2†
—
3.3
24.7
3/7/2014
Unilever (UL)
$43.83 Hold
3.3†
9.2
7.3
18.7
3/9/2012
Waste Management (WM)
$43.04 Hold
3.5
36.8
-3.2
17.1
8/10/2012
2013 portfolio return
32.0
Year-to-date portfolio total return
4.1
Total portfolio annualized return since inception
20.7
† Excludes nonresident tax
† † As of April 25th, 2014
4
Value Line Dividend Select
May 2014
A NOTE FROM THE EDITOR
Dividend Select Alternative Stock Portfolio † †
Current
price
Our
rec.
A.J. Gallagher (AJG)
$44.48
Buy
3.2
7.6
-4.5
4.9
10/11/2013
AbbVie (ABBV)
$49.14
Buy
3.4
20.1
-6.2
18.5
10/11/2013
Amer. Elec. Pwr (AEP)
$53.38 Hold
3.8
14.4
15.3
17.1
12/16/2011
Avista (AVA)
$31.74
Buy
4.0
1.3
13.8
26.8
11/8/2013
BCE Inc. (BCE)
$43.93
Buy
5.0†
—
0.9
3.8
4/4/2014
$115.53
Buy
4.0
-5.0
7.5
4.3
5/10/2013
CSX Corp. (CSX)
$28.03
Buy
2.3
—
-2.4
-3.9
1/10/2014
Dr Pepper Snapple (DPS)
$53.58
Buy
3.1
5.2
10.0
14.6
6/7/2013
General Elec. (GE)
$26.60
Buy
3.3
37.9
-3.5
21.1
6/8/2012
Invesco (IVZ)
$34.88
Buy
2.6
—
1.0
3.3
3/7/2014
Kellogg (K)
$66.71 Hold
2.8
6.0
10.0
12.2
2/8/2013
Kohl's (KSS)
$54.68 Hold
2.9
9.0
-3.0
8.1
9/6/2013
Kraft Foods Group (KRFT)
$56.66
Buy
3.7
2.3
7.1
11.9
9/6/2013
Mercury General (MCY)
$47.17 Hold
5.2
15.0
-3.9
13.7
8/9/2013
Meridian Biosci. (VIVO)
$19.75
Buy
4.0
—
-6.1
-12.7
2/7/2014
Novartis (NVS)
$84.47 Hold
3.2†
7.3
5.1
14.2
5/10/2013
People's Utd Fncl (PBCT)
$14.38
Buy
4.6
—
-5.5
-9.1
1/10/2014
Piedmont Nat'l Gas (PNY)
$35.84
Buy
3.6
1.2
10.1
21.1
12/6/2013
PPL Corp. (PPL)
$33.55 Hold
4.4
10.5
14.2
14.5
5/4/2012
Qualcomm (QCOM)
$77.61
Buy
2.2
0.7
5.0
11.3
12/6/2013
Republic Services (RSG)
$34.40 Hold
3.1
-2.1
3.6
1.3
6/7/2013
Reynolds American (RAI)
$55.10 Hold
4.9
—
14.4
40.9
2/7/2014
Royal Dutch Shell (RDS-A)
$75.46 Hold
5.0
7.4
7.2
10.0
10/5/2012
Name
British Amer. Tobac. (BTI)
Curr.
2013
YTD total Ann. rtn. since
yld. (%) tot. rtn.
return
incep. (%)
†
†
Inception
date
Buy
3.2†
8.1
-1.2
10.9
11/8/2013
Sysco (SYY)
$36.04 Hold
3.2
17.9
1.4
8.3
6/3/2011
Taiwan Semicond. (TSM)
$19.91
Buy
2.5†
—
6.1
20.4
3/7/2014
TELUS Corp. (TU)
$34.43 Hold
4.4†
4.4
2.1
5.0
3/8/2013
Thomson Reuters (TRI)
$34.59 Hold
3.8†
17.2
-7.7
9.4
7/5/2013
Tupperware (TUP)
$84.61
Buy
3.3
—
3.0
13.4
4/4/2014
Verizon (VZ)
$45.94 Hold
4.6
18.8
-5.5
12.1
7/1/2011
Siemens AG (SI)
† Excludes nonresident tax
† † As of April 25th, 2014
$132.75
2013 portfolio total return
25.0
Year-to-date portfolio total return
2.5
Total portfolio annualized return since inception
12.2
May 2014
Value Line Dividend Select
5
This Month’s Recommendation
ConocoPhillips
Houston, Texas-based ConocoPhillips (NYSE: COP), with operations in 27 countries, is the largest
independent energy exploration and production (E&P) company in the world. At the end of 2013,
including equity investments, ConocoPhillips had sizable net proved reserves of 2,749 million barrels
of oil equivalent (MMBOE) of crude oil; 744 MMBOE of natural gas liquids; 3,398 MMBOE of
natural gas; and 2,030 MMBOE of bitumen (a liquid or semi-solid form of petroleum); equating to
a total of 8,921 MMBOE. The company traces its roots back to the Continental Oil and Transportation Co., which was headquartered in Ogden, Utah and founded in 1875. Over the years, operations
gained substantial scale, most notably by way of mergers and acquisitions. In 2002, Conoco Inc.
combined with Phillips Petroleum Co., creating the sixth largest entity within the broader integrated
petroleum industry. Some 10 years later, downstream operations (i.e., oil refining, fuel marketing, gas
gathering, and chemicals production) were separated from upstream activities (E&P) and spun off to
shareholders as a new publicly traded company called Phillips 66. More recently, management has
endeavored to shed underperforming and non-strategic assets to better focus on highly profitable and
promising core business venues.
Since downstream operations were spun off just two years ago, there is not quite enough of a trading
record for Value Line to assign a Timeliness rank to ConocoPhillips stock. (A rank will probably be
determined within the next few months.) Even so, in the wake of the Phillips 66 spinoff, Conoco
shares have performed in line with the broader market averages, providing investors with solid, relatively low-risk returns. Indeed, as of this writing, the total return (share-price appreciation and dividend payments) amounts to 48.5%. We note that in the first two months of this year, Conoco stock
diverged from the broader market, further backing off a high of $74.60 reached in late October 2013.
This was likely due to profit-taking on the part of investors. In recent weeks, though, the equity has
recovered.
We believe that management has the right plan in place to steadily build the company’s aggregate
average commodities production from 1,502 MBOED (thousand barrels of oil equivalent per day)
Dividend History & Projections
6
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Dividends
Declared
$1.91
$2.15
$2.64
$2.64
$2.73
$2.76
$2.84
$2.92
$3.00
$3.08
Dividend
Yield
4.2%
3.9%
3.7%
4.7%
4.2%
3.7%
3.6%
3.5%
3.4%
3.3%
Value Line Dividend Select
May 2014
ConocoPhillips
in 2013 to its goal of 1,900 MBOED within the next five years. Heavy capital outlays should pay
off in increased output, which ought to measurably strengthen yearly sales, earnings, and cash flow
growth, providing the means to reward loyal investors. During the past three years, asset divestitures
have helped to fund operations, as well as significant common stock buybacks and dividend hikes.
Going forward, additional share repurchases and dividend increases seem likely, funded by ongoing
operations. On a 12-month forward basis, the stock yields 3.7%, versus the Value Line median of
2.0%. We project average annual dividend advances of 3.0% to 2017-2019, which should support a
yield of 3%-4%. Over that timeframe, investors can also expect worthwhile share-price improvement.
ConocoPhillips has a stellar Financial Strength rating of A++ and its stock is ranked 1 (Highest) for
Safety. For information on the company’s direct share-purchase and dividend reinvestment plans, visit
www.conocophillips.com.
Value Line Ranks & Projections
Business Background
TimelinessTM (a)
—
ConocoPhillips has a long history of
oil and gas discovery, technological innovation, and asset acquisition. It all
started in 1875 when Isaac Elder Blake
established Continental Oil and Transportation to import kerosene, via railroad tank cars, to Utah from Colorado.
This fuel was highly sought after for
use in lanterns, as opposed to relying
on whale oil and candles for light. A
decade later, Standard Oil took control
of the company and expanded its marketing of petroleum products in the
Rocky Mountain region. Separately, in
the early 20th Century, brothers Frank
and L.E. Phillips struck oil in Oklahoma and quickly built up a sizable portfolio of successful exploration wells.
Around that time, the American auto
industry began to establish itself, and
the refining of oil into gasoline started to become an important business.
Notably, in 1913, the U.S. Supreme
Court, as part of its effort to break
up monopolies, ordered Standard Oil
to divest Continental. From its home
base in the West, Continental then
SafetyTM (B)
1
Recent Price
$74.40
2017-’19 Price Forecast
$85-$100
Footnotes are on page 24
Company Data
Industry
Petroleum (Producing)
Exchange
NYSE
Ticker Symbol
COP
Options
Yes
Financial Strength
A++
Actual E.P.S. FY ’13
$6.43
Estimated E.P.S. FY ’14
$6.35
Estimated E.P.S. FY ’15
$6.70
Current P/E Ratio
12.6
Relative P/E
0.67
(C)
Dividend Yield
3.7%
Actual Payout Ratio FY ‘13
42%
Shares Outstanding
1,239.8 million
Insider Holdings
Less than 1%
Market Cap
$92.2 billion (Large Cap)
Report As Of
May 9, 2014
Address
4600 North Dairy Ashford Rd.
Houston, TX 77079
Telephone
212-207-1996
Website
www.conocophillips.com
May 2014
Value Line Dividend Select
7
ConocoPhillips
launched construction of a chain of 1,000 service stations extending across a 15-state territory. Also
noteworthy, by the late 1920s, Phillips Petroleum Co. had set up 10,000 gasoline filling stations of
its own, nationwide, and was offering aviation and home propane fuel services. In 1929, Continental
Oil Co. (also known as Conoco) was formed upon the merger of Continental Oil and Transportation with Marland Oil, an Oklahoma-based business with considerable oil reserves around the globe
and a large domestic gasoline station network serving customers in 30 states. Conoco was becoming
a well-recognized brand name at that time. Through the 1930s, both Phillips and Conoco enlarged
their refining capacities and enhanced their retailing capabilities. Most visibly, Phillips acquired the
Independent Oil and Gas Co., a refining and retail fuel operation run by another family member, and
Continental built a lucrative pipeline to Chicago, developed a new brand of Conoco motor oil, which
became quite popular with consumers, and created highly effective gasoline marketing campaigns.
During the 1940s, Phillips and Conoco formulated improved, lightweight aviation fuels used in
military and commercial applications. As well, in that decade, Phillips set up a chemicals division.
Through the 1950s and 1960s, Phillips became more deeply involved in the burgeoning plastics industry and was one of the first companies to begin transporting liquefied natural gas (LNG). Over
that same period, Conoco ramped up its research & development operations and expanded its refinery
business. In the 1970s, Conoco extended operations overseas via asset acquisitions, particularly in
Europe. Too, the company was then stepping up its focus on the chemicals and plastics markets. That
ConocoPhillips Price Chart
8
Share Prices
2009
2010
2011
2012
2013
2014
High
57.4
68.6
81.8
78.3
74.6
74.9
Low
34.1
46.6
58.7
50.6
56.4
63.5
Value Line Dividend Select
May 2014
ConocoPhillips
drew the attention of DuPont, which purchased all of Conoco’s outstanding common shares for $7.4
billion in 1981. Sixteen years later, however, wanting to turn its attention more toward the “life sciences” (i.e., biotechnology) market, DuPont shed its interest in Conoco through a $4.4 billion initial
public offering. A financially fit Conoco was free to pursue promising opportunities in the world E&P
sector. In August 2002, Conoco and Phillips merged in an all-stock transaction, creating ConocoPhillips, a company with a total market capitalization of $35 billion. In the following years, the combined
company embarked on several new forays, including an oil sands development project in Canada,
an offshore oil endeavor in Vietnam, a partnership with Lukoil of Russia, a coal-bed methane and
LNG processing and sales venture, a water recycling research center, and renewable energy production plants. Furthermore, ConocoPhillips used its improved financial heft to purchase Burlington
Resources, another Houston-based oil and gas company, for $35.6 billion in 2006.
In 2011, the board of directors approved management’s plan to separate the company into two publicly traded entities, ConocoPhillips and Phillips 66, which was executed in April 2012. Management
was looking to unlock hidden stockholder value that had built up as a result of the merger’s success.
Indeed, the separation has increased the total market capitalization of the two stocks by some 105%,
to just over $140 billion. Under its new configuration as an E&P company, ConocoPhillips has
moved to divest nonstrategic operations and boost production within the core energy business, while
adding new assets with the potential for high returns on investment; the North American shale oil
industry has proved to be an especially lucrative endeavor. From 2011 to date, management has shed
interests in the Russian entities Lukoil and Naryanmarneftegaz and certain assets in Algeria, Australia,
Canada, Kazakhstan, the North Sea, Trinidad and Tobago, Vietnam, Montana, and North Dakota.
Currently, the sale of a Nigerian asset is pending. Last year, the company sold a sizable $10 billion
worth of assets. Going forward, management expects a more normal annual rate of asset sales of approximately 1% ($1 billion-$2 billion) of the total.
Segment Overview
ConocoPhillips has divided itself into six regional operating segments identified as: Lower 48 and
Latin America, Asia Pacific and Middle East, Canada, Alaska, Europe, and Other International. The
Lower 48 and Latin America segment, primarily consisting of assets in the 48 contiguous states in
the continental United States, the Gulf of Mexico, and Colombia, accounts for the biggest portion
of overall average daily net production. Last year, the U.S. Lower 48 represented the bulk of this
production, or 491 MBOED, made up of 243 MBOED of liquids (mostly crude oil and natural
gas) and 1,490 MMCFD (million cubic feet per day) of natural gas. This segment contributed 29%
of Conoco’s global liquids production and 38% of its gas output in 2013. It has 13.1 million acres
of onshore fields, 10.4 million of which is designated as “conventional” acreage and 2.7 million as
“unconventional.” Conventional E&P refers to the use of traditional drilling wells to tap into oil and
gas deposits, while unconventional E&P entails the high-tech extraction of oil and gas and other
commodities, including extra-heavy oil, natural bitumen (oil sands), and coal-bed liquids. Generally,
conventional acreage is easy to tap and involves low-cost processes. Unconventional acreage is more
challenging in that advanced, expensive technology is required to access commodities in hard-to-
May 2014
Value Line Dividend Select
9
ConocoPhillips
reach underground deposits. Some of the largest unconventional fields are located in northwestern
New Mexico and southwestern Colorado (the San Juan Basin); North Dakota and eastern Montana
(Bakken); West Texas and southeastern New Mexico (Permian); and South Texas (Eagle Ford).
In recent years, given ample oil deposits in shale formations and low natural gas prices, Conoco has
turned more of its attention toward investing in high-margined, liquids-rich unconventional extraction fields. As well, the company has increased its efforts, with good results, so far, to further develop
and optimize production at existing locations and establish new sites, particularly at its four most
significant fields. Crude oil production at the segment rose a strong 24% last year. Too, Conoco is
working to capitalize on meaningful deepwater discoveries in the Gulf of Mexico, more specifically,
within the Lower Tertiary at Coronado and Gila, and the Shenandoah and Tiber underwater areas.
In Colombia, Conoco is currently exploring unconventional fields in the Middle Magdalena Basin.
Elsewhere in Latin America, on a negative note, the company is pursuing compensation for assets that
were previously expropriated by the governments of Venezuela and Ecuador. In total, the segment
looks to boost its production some 365 MBOED (from 2012 levels) by 2017.
Conoco’s Asia Pacific and Middle East segment, with average production of 312 MBOED in 2013
(or 13% of company liquids output and 30% of natural gas generation), is its next largest operation.
Inside the segment, last year, 85 MBOED of production originated from Indonesia, 84 MBOED
from the Australia and Timor Sea region, 83 MBOED from Qatar, 54 MBOED from China, and 6
MBOED from Malaysia. In the South Natuna Sea off the coast of Indonesia, the segment runs operations across three oil fields and 16 natural gas fields. It also operates five oil fields and seven gas fields
in South Sumatra. The company is actively developing new exploration sites in Papua and central Kalimantan. In Australia, Conoco has a venture with Origin Energy and China Petrochemical that produces liquefied natural gas from coal-bed methane. That operation has begun building LNG export
facilities with the aim of capitalizing on a fast-growing global market. In the Timor Sea, the segment
is expanding its natural gas exploration and also runs LNG production and export facilities. A partnership with Qatar Petroleum and Mitsui develops gas fields and produces LNG in Qatar for global
export. In China, the segment, along with its partners, China National Offshore Oil Co. (CNOOC)
among them, principally produces oil from offshore wells in Bohai Bay and the South China Sea.
Studies are under way to determine the viability of shale gas exploration in the Sichuan Basin located
in the southwestern region of the country. In Malaysia, Conoco has interests in five deepwater production sharing contracts with well operator Royal Dutch Shell. Furthermore, the segment owns and
has interests in deepwater projects that are in development in Bangladesh and Brunei. The segment
expects its output to rise by about 25 MBOED over the period from 2012-2017.
The Canada segment is the third most significant producer of commodities for the company, turning
out 276 MBOED (17% of total liquids production and 20% of gas production) in 2013, including 775 MMCFD of gas, 109 MBD (million barrels per day) of bitumen, and 38 MBD of liquids.
Operations, here, mainly consist of natural gas fields in the western part of the country, from central
Alberta to northeastern British Columbia, and oil sands development in the Athabasca Region of
northeastern Alberta. In western Canada, Conoco has leasehold rights in 5.7 million acres and has
10
Value Line Dividend Select
May 2014
ConocoPhillips
stakes in 80 natural gas processing plants. Development is concentrated on the Deep Basin, Kaybob,
and Clearwater areas. With regard to oil sands extraction, the segment is participating with Total S.A.
in a project, located near Fort McMurray, which is slated for initial production in 2015; peak output
of 150 MBOED may well be reached by 2018. Also, it has a heavy-oil partnership with Cenovus
Energy to work the bitumen deposits within the Foster Creek, Christina Lake, and Narrows Lake
areas. This partnership is utilizing an effective thermal oil recovery technology called steam-assisted
gravity drainage. Within the next five years, production capacity in these areas may well approach 750
MBOED. Conoco has 900,000 acres of land with substantial oil sands deposits. Additionally, the
Canada segment has a 55% interest in the Amauligak discovery, which is in a shallow-water area of
the Beaufort Sea, and is considering various options for its development. Most important, the segment
is pursuing liquid-rich deposits, via unconventional exploration, in Alberta, British Columbia, and
the Northwest Territories; the Montney, Muskwa, Duvernay, and Canol locations are getting much
attention. Management has targeted 105 MBOED in additional Canada-segment production over
the 2012-2017 term.
Conoco’s Alaska segment (23% of liquids output and 1% of gas output) produced a combined net
average of 200 MBOED in crude oil, natural gas liquids, natural gas, and LNG last year. It is the
largest producer of oil and gas in the state with major operations in the North Slope, Prudhoe Bay,
and Kuparuk areas. The segment has exploration leases covering 500,000 undeveloped acres in the
National Petroleum Reserve–Alaska and another 300,000 acres in the Chukchi Sea. Thus, there is
ample opportunity to continue to expand energy exploration and production. A recent relaxation
of progressive tax rules in the state has created more incentive for investment. Also noteworthy, the
company is working with Exxon Mobil, TransCanada, and British Petroleum on a long-term plan to
considerably expand the state’s LNG export infrastructure. Alaska production is estimated to increase
by 35 MBOED from 2012 to 2017.
In 2013, operations in Europe’s North Sea turned out 189 MBOED (14% of total liquids production
and 11% of gas production), with 119 MBOED coming from the Norway sector and the remainder
from the United Kingdom sector. Assets in the Norway sector of the sea extract and ship oil to Norway
and the United Kingdom and natural gas to Norway and Germany. Those in the U.K. sector produce
oil and gas generally for local delivery. Conoco has full and partial ownership interests in several existing wells and new ones that are in the planning stage in the North Sea, auguring well for future production. Four major projects are under way and should help to restore combined production growth
for operations in Norway and the United Kingdom. The company is also actively exploring promising
sites in Poland and Greenland. Europe’s production ought to rise by about 40 MBOED in the 20122017 period.
Lastly, Conoco’s Other International segment produced 34 MBOED of liquids (4% of the total) in
2013. Some 30 MBOED of output stems from Libya, where the company has a stake in the Waha
Concession that explores and produces oil and gas within a 13 million acre area in the Sirte Basin.
The Libyan National Oil Corp., Hess Corp., and Marathon Oil Corp. participate with Conoco in the
concession. Oil production there, however, has been suspended since mid-2013 due to the shutdown
May 2014
Value Line Dividend Select
11
ConocoPhillips
of the Es Sider export terminal, a result of ongoing worker and political strife. Meanwhile, new development wells continue to drill for additional reserves. Elsewhere, through a venture with Polar Lights
Co., the segment is developing fields in the Timan-Pechora Basin in northern Russia. Other energy assets are in development in Angola, Azerbaijan, and Senegal. We note that the company is particularly
excited about exploring some very large blocks of acreage off the coast of Angola. Management expects
Other International-segment production to advance by 10 MBOED from 2012 to 2017.
Business Prospects
ConocoPhillips is unique in the E&P industry in that it is twice the size of its closest competitor and
offers investors an uncharacteristically low level of risk. Substantial scale and financial heft enhance
the company’s technological capabilities, provide the ability to take on massive, multibillion-dollar
projects, and lend much flexibility to pursue a broad spectrum of E&P endeavors. That said, management is careful to always keep in mind its aim of optimizing both operating performance and
stockholder value via appropriate asset allocation. Currently, capital spending, running in the range of
$16 billion-$17 billion a year, is at a high level. From 2014 to 2017, some 45% of these outlays will
be dedicated to developmental programs (e.g., oil sands), 30% will go toward major projects (LNG),
15% will be concentrated on long-term exploration (Angola), and 10% is earmarked for maintenance
of existing assets. (Note that exploration spending is divided 50/50 between conventional and unconventional activities.) The company believes that these ratios of investment will support its production
growth target. Conoco’s debt-to-total capital ratio at the end of 2013 was a modest 29% and compared favorably with those of a majority of its E&P industry peers.
Most visibly, about 25% of annual spending is now devoted to the LNG export initiative in Australia,
mentioned above, and the oil sands endeavor with Total S.A. in Canada. These two projects should
begin to ramp up production next year. Importantly, as related start-up investments trail off, Conoco
will have more funds available to enlarge its promising unconventional exploration efforts. Major
projects and developmental programs ought to go a long way toward replenishing reserves, as those
from established assets, most notably in Alaska, Norway, and the United Kingdom, become depleted
with age. Impressively, in 2013, the company achieved a reserve replacement ratio of 179% for ongoing assets. (The ratio was 147%, net of asset divestitures.) Reserve additions of 1.1 BBOE (billions
of barrels of oil equivalent) largely came from the Eagle Ford and Bakken areas in the Lower 48, oils
sands sites in Canada, and the Australia LNG project. Some 75% of these new reserves consisted of
high-value, liquids-priced commodities, including LNG. The Australia project, oil sands activities
in Canada, unconventional development in the Lower 48, large projects in Europe, and deepwater
exploration in Malaysia should be the prime drivers of growth over the next three to five years. An
emphasis on oil-based production and LNG likely will boost profitability and cash flow. A higher
proportion of business in low-tax jurisdictions will be an extra plus.
After the spinoff of Phillips 66, management specified the goal of increasing overall production by
3%-5% a year, emphasizing commodities that would promote a similar rate of operating margin
expansion. This would potentially enable the company to improve its cash flow by 6%-10%, annu-
12
Value Line Dividend Select
May 2014
ConocoPhillips
ally, and provide the means to reward investors with an attractive yield, supported by solid dividend
growth, and incremental share buybacks. We note that from 2012 to 2013, Conoco’s total production
from continuing operations was generally flat (rising by just 30 MBOED) and commodities price
levels held fairly steady. Even so, the company’s cash-flow margin (excluding special items, such as
leasehold impairment charges and dry hole cost outlays) improved from $25.64 per BOE (barrel of oil
equivalent) to $28.55 BOE, thanks to a more favorable mix of commodities. Additional improvement
appears in store for the long term. Now that the company has put major asset dispositions behind
itself, year-to-year sales and share-net comparisons ought to stabilize by the end of this year and turn
positive.
Conoco’s dividend yield is not only competitive with those offered by its smaller E&P peers, but
also those of the largest Europe-based integrated petroleum companies, the distributions of which
are subject to nonresident withholding taxes, and of the domestic oil production majors. In 2012,
ConocoPhillips began trading as a new company with a very appealing 5% dividend yield. The income level has moved lower, on a yield basis, but that was due to solid share-price appreciation.
Management intends to maintain an above-average yield by regularly hiking the payout. Last year,
total dividend payments amounted to 22% of gross cash flow, which was a reasonable ratio. As recent
capital investments begin to generate results, we believe that Conoco can attain its production, operating margin, and cash flow goals over the next several years. Cash flow gains should be sufficient to
increase the dividend by 3% a year and sustain an above-average yield. Though the global price of oil,
at times, can cause some near-term volatility in its share price (due to changes in reserve valuations),
Conoco stock has closely tracked the performance of the broader domestic stock market indexes for
most of the company’s history as an E&P operation. Importantly, increasing supplies of oil and gas
from reliable sources, growing conservation efforts, and an expanding renewables industry are helping
to reduce volatility in world energy prices. A shift in the business mix, favoring the developed world,
implies less operating and political uncertainty ahead. In our view, this equity is an appealing low-risk
income vehicle for conservative investors over the pull to 2017-2019. ■
May 2014
Value Line Dividend Select
13
FINANCIAL STATEMENTS — ConocoPhillips
Income Statement Data (In millions, excluding per share amounts)
2013
2014
2015
2016
2017
2018
$54,413
$56,600
$58,625
$61,100
$63,825
$67,300
Equity in Earnings Of Affiliates
2,219
2,500
2,750
3,250
3,500
4,000
Gain on Disposals
1,242
500
200
200
200
200
374
400
425
450
475
500
$58,248
$60,000
$62,000
$65,000
$68,000
$72,000
22,643
23,000
23,500
24,000
24,500
25,000
7,238
7,400
7,600
7,800
8,000
8,200
854
875
900
925
950
975
Exploration Expenses
1,232
1,250
1,275
1,300
1,325
1,350
Non-Income Taxes
2,884
2,950
3,000
3,050
3,100
3,150
Operating Income
$23,397
$24,525
$25,725
$27,925
$30,125
$33,325
7,434
7,750
8,200
8,600
9,050
9,500
Interest Expense
612
615
618
622
625
630
Other Expenses
905
875
800
750
700
650
$14,446
$15,285
$16,107
$17,953
$19,750
$22,545
6,409
7,375
7,795
8,740
9,700
11,175
44.4%
48.2%
48.4%
48.7%
49.1%
49.6%
59
63
74
91
109
135
$7,978
$7,847
$8,238
$9,122
$9,941
$11,235
1,239.8
1,235.0
1,230.0
1,225.0
1,220.0
1,215.0
$6.70
$7.45
$8.15
$9.25
Sales & Other Oper. Revs.
Other Income
Revenues & Other Income
Purchased Commodities
Production & Oper. Expenses
Selling Gen'l & Admin. Exp.
Depreciation
Pretax Income
Income Taxes
Effective Tax Rate
Net Inc. Non-Controlling Ints.
Net Income
Diluted Shares
Diluted Earnings per Share
$6.43
$6.35
Percentage Analysis
2013
2014
2015
2016
2017
2018
Operating Margin
40.2%
40.9%
41.5%
43.0%
44.3%
46.3%
Pretax Margin
24.8%
25.5%
26.0%
27.6%
29.0%
31.3%
Net Margin
13.7%
13.1%
13.3%
14.0%
14.6%
15.6%
14
Value Line Dividend Select
May 2014
FINANCIAL STATEMENTS — ConocoPhillips
Avg. Annual Rates of Growth
(2013 to 2018)
Revenues: 4.5%
Operating Income: 7.5%
Pretax Income: 6.0%
Earnings per share: 7.5%
Flow of Funds Data (In millions)
Cash Flow
2013
2014
2015
2016
2017
2018
$15,412
$15,597
$16,438
$17,722
$18,991
$20,735
717
1711
2365
1210
990
—
—
—
—
—
—
—
—
—
—
Debt Financing
—
Pf’d Equity Financing
—
Com. Equity Financing
Other
Total Funds In
Capital Spending
Other Investments
Dividends Paid
Debt Retired
20
1,733
1,582
1,522
1,503
1,494
1,470
$17,165
$17,896
$19,671
$21,590
$21,695
$23,195
15,537
16,500
15,500
14,500
13,500
13,000
—
—
—
—
—
—
3,334
3,400
3,500
3,575
3,660
3,745
946
590
1,576
2,200
1,075
875
Pf’d Equity Retired
—
Com. Equity Retired
—
Total Funds Out
Yearend Working Cap’l
—
—
—
—
—
350
370
390
410
425
$19,817
$20,840
$20,946
$20,665
$18,645
$18,045
$3,894
$950
($325)
$600
$3,650
$8,800
All numbers, except percentages and per-share data, are in millions. Numbers in bold italics are Value Line estimates; all estimates except
percentages and per-share figures are rounded to the nearest whole number. Footnotes are on page 24.
May 2014
Value Line Dividend Select
15
FINANCIAL STATEMENTS — ConocoPhillips
Historical Balance Sheet Data (In millions)
2011
2012
12/31/13
Cash & Equivalents
$6,361
$4,366
$6,518
Receivables
14,648
9,182
8,487
Inventories
4,631
965
1,194
Other
4,578
9,476
2,824
$30,218
$23,989
$19,023
Net Property, Plant
84,180
67,263
72,827
Investments & LT Recs.
32,108
23,489
23,907
6,724
2,403
2,300
$153,230
$117,144
$118,057
$17,973
$10,013
$9,314
Debt Due
1,013
955
589
Taxes Payable
4,220
3,366
2,713
Other
4,862
3,109
2,513
$28,068
$17,443
$15,129
Long Term Debt
21,610
20,770
21,073
Other Liabilities
38,328
30,944
29,765
Stockholders’ Equity
65,224
47,987
52,090
$153,230
$117,144
$118,057
Total Current Assets
Other
Total Assets
Payables
Total Current Liabilities
Total
Capitalization & Returns on Capital (In millions)
2013
2014
2015
2016
2017
2018
Long Term Debt
$21,073
$21,200
$21,335
$21,500
$21,635
$21,750
Stockholders’ Equity
$52,090
$53,500
$55,500
$60,000
$65,000
$72,500
Return on Total Capital
11.3%
10.5%
10.7%
11.2%
11.5%
11.9%
Return on Equity
15.3%
14.7%
14.9%
15.2%
15.3%
15.5%
16
Value Line Dividend Select
May 2014
FINANCIAL STATEMENTS — ConocoPhillips
Quarterly Revenues (In millions)
Mar. 31
Jun. 30
Sep. 30
Dec. 31
Full Yr.
2011
56,530
65,627
62,784
59,872
$244,813
2012
16,083
14,842
14,713
16,366
$62,004
2013
14,651
14,142
15,470
13,985
$58,248
2014
14,900
14,950
15,000
15,150
$60,000
2015
15,400
15,450
15,500
15,650
$62,000
Quarterly Revenue Growth
Mar. 31
Jun. 30
Sep. 30
Dec. 31
Full Yr.
2012
-71.5%
-77.4%
-76.6%
-72.7%
-74.7%
2013
-8.9%
-4.7%
5.1%
-14.5%
-6.1%
2014
1.7%
5.7%
-3.0%
8.3%
3.0%
2015
3.4%
3.3%
3.3%
3.3%
3.3%
Quarterly EPS(D)
Mar. 31
Jun. 30
Sep. 30
Dec. 31
Full Yr.
2011
1.82
2.41
2.52
2.02
$8.76
2012
1.67
1.35
1.40
1.48
$5.91
2013
1.63
1.66
1.96
1.20
$6.43
2014
1.55
1.55
1.60
1.65
$6.35
2015
1.62
1.63
1.70
1.75
$6.70
Quarterly EPS Growth
Mar. 31
Jun. 30
Sep. 30
Dec. 31
Full Yr.
2012
-8.2%
-44.0%
-44.4%
-26.7%
-32.5%
2013
-2.4%
23.0%
40.0%
-18.9%
8.8%
2014
-4.9%
-6.6%
-18.4%
37.5%
-1.2%
2015
4.5%
5.2%
6.3%
6.1%
5.5%
Quarterly Dividends Paid
Mar. 31
Jun. 30
Sep. 30
Dec. 31
Full Yr.
2010
0.50
0.55
0.55
0.55
$2.15
2011
0.66
0.66
0.66
0.66
$2.64
2012
0.66
0.66
0.66
0.66
$2.64
2013
0.66
0.66
0.69
0.69
$2.70
2014
0.69
All numbers, except percentages and per-share data, are in millions. Numbers in bold italics are Value Line estimates; all estimates except
percentages and per-share figures are rounded to the nearest whole number. EPS might not add to total due to change in shares outstanding.
May 2014
Value Line Dividend Select
17
Other Notable Stock Selections
Atmos Energy Corp.
Atmos Energy Corp.’s predecessor company was Amarillo Gas Co., a Texas Panhandle coal gas producer
founded by brothers Frank and J.C. Storm in 1906. In 1924, Amarillo Gas merged with Amarillo Oil,
which had just previously discovered the largest natural gas field in the world at that time, forming
Southwestern Development Co. The company quickly expanded its gas production and pipeline assets.
In 1932, Sinclair Consolidated Oil Corp. gained control of Southwestern. Later, in 1954, Southwestern
became a part of Pioneer Natural Gas Co. That business changed its name to Pioneer Corp. in 1975
to better reflect diverse energy operations. In 1983, Pioneer spun off Energas Co., as an independent
utility, to its shareholders. Energas purchased Trans Louisiana Gas in 1986 and Kentucky Gas in 1987.
The following year, the company adopted the Atmos Energy moniker. Thereafter, additional merger and
acquisition deals were completed, including those of Greeley Gas’s Colorado and Kansas operations,
United Cities Gas, Associated Natural Gas—Missouri, Woodward Marketing, Louisiana Gas Service,
LGS Natural Gas, Mississippi Valley Gas, and TXU Gas’s utility and pipeline assets in Texas. During the
past two fiscal years (years end September 30th), management decided to better focus and consolidate
operations, divesting assets in Georgia, Missouri, Illinois, and Iowa.
Today, Dallas-based Atmos Energy is one of the largest gas utilities in the United States, with a focus
on the South. It transports and distributes gas to three million customers, across eight states, via regulated operations. As well, the company has a non-regulated gas services subsidiary doing business in
the Midwest and Southeast. Atmos has a good track record of maintaining its network and delivering
reliable service. This has led to favorable rate treatment
within the company’s territory. To 2017-2019, as investValue Line Ranks & Projections
ment in distribution expands, we project steady revenue,
Timeliness(A)
3
earnings, and cash-flow advances. Since its spinoff from
Safety(B)
2
Pioneer, Atmos has paid 121 consecutive quarterly diviRecent Price
$51.27
dends. The equity yields 3.0%, versus the Value Line median of 2.0%. Decent average annual dividend increases
2017-2019 Price Forecast
$45-$60
of 3%-4% seem likely over the long run. Given a Safety
Footnotes are on page 24
Dividend History & Projections
18
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Dividends
Declared
$1.32
$1.34
$1.36
$1.38
$1.40
$1.48
$1.52
$1.58
$1.64
$1.70
Dividend
Yield
5.3%
4.7%
4.2%
4.1%
3.5%
3.2%
3.2%
3.2%
3.2%
3.2%
Value Line Dividend Select
May 2014
Atmos Energy Corp.
Rank of 2 (Above Average), Atmos stock is suitable for conservative investors. (For information concerning the company’s direct stock-purchase plan, go to www.atmosenergy.com.)
An Expansive Service Territory
Atmos owns six natural gas distribution divisions, which contributed 65% of net income in fiscal 2013.
Revenues are weighted more toward the stable residential ratepayer class, making up 65% of the total.
Commercial businesses represent 29% of annual receipts, while the industrial class accounts for 4%;
public authority and other customers contribute the remainder. The sizable Mid-Tex division, subject
to Texas regulatory oversight, is made up of two segments, known as Mid-Tex Cities and Mid-Tex—
Dallas, with a combined rate base of $1.7 billion. (Note that regulators establish an authorized rate of
return on a specified rate base, which is determined according to the value of assets providing service.)
Mid-Tex Cities serves 1.3 million and Mid-Tex—Dallas has 225,000 accounts. The next biggest distribution division, Kentucky/Mid-States, provides gas service to 325,000 across Kentucky, Tennessee, and
Virginia. It has a rate base of roughly $460 million. Atmos’ Louisiana division has more than 340,000
connected meters in the state it is named after, and its Trans LA and LGS segments have a combined rate
base of just over $400 million. The West Texas division, with nearly 295,000 meter hookups, covers the
metropolitan areas of Amarillo, Lubbock, and Midland; its rate base approximates $272 million. The
Mississippi division has customer accounts exceeding 255,000 and a rate base approaching $290 million.
Lastly, Colorado-Kansas serves almost 100,000 ratepayers in Colorado, where the rate base amounts to
$86 million, and more than 136,000 in Kansas, via a rate base of $160 million.
The Atmos Pipeline—Texas division consists of regulated gas transmission and storage operations. With
an asset base of nearly $1 billion, it generated 30% of Atmos’ net income last fiscal year. This division
runs the largest intrastate pipeline in Texas and has five underground storage reservoirs. Assets are located
in the major gas producing areas of the state. Atmos Pipeline delivers gas to the Mid-Tex division and
third parties. The division files at least one full rate case with regulators every five years. There is, however,
a regulatory program in place through 2017 that provides for annual adjustments. These adjustments are
based on the performance of the division’s non-regulated operations. Any revenue gains, net of a benchmark, are shared between the company and ratepayers on a 25%/75% basis.
We note that in any given year, Atmos will have distribution rate cases under review by various respective
state regulators. Over all, rate treatment has been reasonable. Mid-Tex, Louisiana, and Mississippi have
annual tariff adjustment mechanisms, which help to cover the cost of service between rate filings, thus
limiting uncertainty. Also, the Mississippi division and the Kentucky and Tennessee segments of Kentucky/Mid-States have performance-based rate programs. Such programs provide incentives that allow
the utilities to keep (and share, with ratepayers, a portion of ) gas purchase cost savings. As well, gas cost
adjustment mechanisms across the entire territory protect margins against volatile commodity prices.
Most important, the rates of return on common equity allowed by state authorities have been adequate,
running in the mid-9%-to-low-10% range. Ahead, we expect this range to creep higher, given ongoing
system investments and assuming that the cost of borrowing rises. The allowed rate of return for Atmos
Pipeline—Texas has been 11.8%, and it might also trend higher for the same reasons.
May 2014
Value Line Dividend Select
19
Atmos Energy Corp.
Generally, regulators have taken care to ensure that the company earns sufficient returns on investment,
thus promoting system reliability and safety. Over the years, management has made good progress in
reducing regulatory lag (i.e., delays in earning a return on investments). Too, management has secured
approval in many jurisdictions to utilize revenue-decoupling and weather-normalization rate designs,
which help to reduce seasonal earnings volatility in a given year. The decoupling design implements base
rates that are higher and consumption rates that are lower than those of traditional ratemaking. Under
weather normalization, customers’ bills may increase when demand is low and decline when demand
is high; these offsetting rates keep the utilities within their allowed returns. Atmos’ utilities experience
peak usage (for heating) during the winter. Furthermore, Atmos Pipeline, Mid-Tex, West Texas, Colorado-Kansas, and the Kentucky and Virginia segments of Kentucky/Mid-States have infrastructure rate
mechanisms that facilitate the timely recovery of outlays related to system upgrades.
Separately, non-regulated operations generated 5% of the company’s net income in fiscal 2013. The
Atmos Energy Holdings subsidiary buys, sells, and delivers natural gas in the competitive sector of the
energy industry. It serves some 1,000 customers in the Midwest and Southeast. The subsidiary provides
storage and transportation services to municipalities, industrial companies, local gas distributors, and
Atmos’ regulated Louisiana and Kentucky utility businesses.
Business Outlook
Following a solid first-quarter 2014 operating performance, as of this writing, Atmos was preparing to
release results for the seasonally-significant second quarter on, or around, May 7th. We look for the company to beat the Wall Street consensus share-net estimate of $1.25 for the quarter, given below-normal
temperatures in the service territory. The company appears on track to meet its fiscal 2014 earnings
guidance of $2.66-$2.76 per diluted share. Indeed, the actual full-year result could come in close to the
upper level of this range. This would be a respectable showing, considering that a $390 million secondary
offering of 9.2 million shares of stock was completed last February. In fiscal 2013, Atmos earned $2.50
a share; the stock float at the end of that year was 90.64 million.
To 2017-2019, management projects that share net will advance 6%-8% annually, rising to $3.45-$3.65.
We believe that such gains are attainable. The South’s economy is benefiting from a strong energy exploration sector, a reviving industrial market, and population migrations from other parts of the country. This
fiscal year, Atmos’ capital outlays should total $830 million-$850 million. From fiscal 2015 to fiscal 2018,
the company plans to spend $850 million-$950 million a year to maintain and expand its gas delivery
network to meet growing customer needs. Regulators likely will allow fair returns. The rate base may well
increase by $3 billion, to more than $7 billion, over the pull to 2018. In addition to strong cash flow, the
recent stock issuance provides economical funding. Favorable credit ratings ought to allow the company
to supplement its financing requirements with low-coupon debt. Through fiscal 2019, about $1.2 billion
of long-term debt, out of $2.45 billion, falls due; the remainder matures more than 10 years out. Management is careful to maintain a sound capital structure with a debt weighting of 50%-55%. We expect
Atmos to sustain a return on equity of 9%, or better, over the next three to five years. Cash flow likely will
be sufficient to increase the dividend 3%-4% annually, supporting a yield of 3%, or higher. We would
not be surprised to see the share price attain new heights, which would be an added plus for investors. ■
20
Value Line Dividend Select
May 2014
Other Notable Stock Selections
Maxim Integrated Products
Though not one of the largest, Maxim Integrated Products is a significant player in the global semiconductor industry. The San Jose, California-based company is primarily focused on designing, manufacturing,
and marketing linear (also known as analog) and mixed-signal (analog/digital) electronic devices. Maxim
also produces digital integrated-circuit products. Furthermore, it offers circuit design tools. Major market
segments served include consumer (38% of business), industrial (31%), computing (17%), and communications (14%). Three main manufacturing plants are located in the United States, and there are two significant test facilities in the Philippines and Taiwan. The company also contracts with third-party producers
and circuit testing outfits. Foreign sales represent some 88% of the total. Last fiscal year (ended June 29,
2013), sales tallied $2.44 billion and net income amounted to $530 million, or $1.77 a share, excluding
special items, which were historical records.
Since its founding in 1983, Maxim has proved to be an effective competitor, thanks to proficient in-house
design, high-quality manufacturing processes, and broad market diversification, supported by strategic acquisitions. The company first turned a profit in 1987 and, notwithstanding the pressures from periodic economic downturns, has stayed in the black ever since. A regular quarterly dividend was instituted in 2003.
The dividend was increased each year, with the exception of 2010. In 2009 and 2010, the payout ratio (all
dividends to net profits) exceeded 100%, as earnings fell in the wake of the severe 2007-2009 recession.
Earnings and the payout ratio quickly strengthened, however, and dividend hikes resumed in 2011. From
now to 2017-2019, we project solid mid-to-high single-digit sales growth. Likely better operating leverage
should allow both per-share earnings and cash flow to advance at a yearly rate of around 10%, or greater.
Such gains ought to be enough to raise the dividend at an
Value Line Ranks & Projections
average annual rate of 8% to 9%. A yield in the 3% range
Timeliness(a)
3
should be maintained, going forward. Additional, successSafety(B)
3
ful acquisitions might prove our projections conservative.
Recent Price
$31.55
2017-2019 Price Forecast
$35-$55
Footnotes are on page 24
We note that Maxim is a cyclical company and its shares
generally track the performance of the broader stock market (beta=1.00). As denoted by the equity’s Safety Rank
Dividend History & Projections
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Dividends
Declared
$0.80
$0.80
$0.84
$0.88
$0.96
$1.08
$1.17
$1.26
$1.35
$1.44
Dividend
Yield
5.3%
4.3%
3.7%
3.4%
3.3%
3.4%
3.4%
3.3%
3.3%
3.3%
May 2014
Value Line Dividend Select
21
Maxim Integrated Products
of 3, market risk, here, is about average. In the coming three to five years, the global economy likely will
continue to expand at a modest pace. This should be sufficient for Maxim to achieve a respectable operating performance. Share-price appreciation prospects appear attractive. (Dividend reinvestment and direct
share-purchase plans are available via computershare; visit maxim-ic.com for the details.)
Building a Competitive Business
As noted above, Maxim was established in 1983. Jack Gifford, co-founder of Advanced Micro Devices,
was instrumental in forming the company, as were several other leading scientists and inventors. In 1985,
the MAX600 power converter (alternating current to direct current) was one of Maxim’s first proprietary
products to win significant industry recognition. The company enhanced its technical ability to produce
integrated circuits in 1989 by acquiring a wafer fabrication (fab) plant in Sunnyvale, California. Among
the many business purchases made through the years, some of the more important are: Textronix’s Semiconductor Division (wafer fab and high-speed production processes); Dallas Semiconductor (wafer fab and
digital design); Vitesse Storage (enhanced computer interface connections for disk and optical data storage
drives); Mobilygen (video data compression); Innova Card (financial transaction security products); Zilog
Secure Trans (wireless microcontrollers used in point-of-sale and automated teller machines); Teridian (systems on a chip for utility smart meters); Phyworks (optical transceivers used in high-speed broadband
communications networks); SensorDynamics (sensors and micro-electromechanical devices); and Volterra
Semiconductor (low-voltage enterprise, cloud computing, communications, and networking products).
These acquisitions helped to boost manufacturing capacity and capabilities, expand the device lineup, and
broaden international market coverage.
Today, Maxim is a well-established company with about half of its sales stemming from advanced integrated products. For the communications industry, Maxim makes products used in base stations, network
& datacom devices, and various other telecom equipment. Also, in the computing sector, the company’s
offerings are found in data storage machines, financial terminals, notebook computers, servers, desktops,
and peripherals. In the consumer area, Maxim items reside in cell phones, digital cameras, handheld computers, home entertainment consoles, and appliances. Elsewhere, in the industrial market, the company’s
products are utilized in automatic test equipment, cars and trucks, control & automation machines, electronic instrumentation, medical devices, military & aerospace equipment, security systems, and utility networks. More than half of Maxim’s fabrication takes place at its three plants located in California, Oregon,
and Texas. Third-party foundries, such as Seiko Epson, Powerchip Technology, and Maxchip Electronics,
produce about 47% of the company’s mixed-signal products.
Maxim vies for customers against the likes of Analog Devices, Semtech, Texas Instruments, Samsung, and
Qualcomm. The companies compete on new products, time to market, product performance and features,
quality and reliability, and customized design and applications. Independent distributors account for 31%
of Maxim’s annual sales; Avnet Electronics, with a 14% share of the total, is the largest. Samsung, representing 20% of sales, is Maxim’s biggest customer. No single product makes up more than 10% of the total.
A research & development budget averaging 22% of annual sales helps to ensure a steady flow of new,
meaningful products and, thereby, maintain the company’s competitiveness.
22
Value Line Dividend Select
May 2014
Maxim Integrated Products
Operating Trends
The first half of fiscal 2014 proved somewhat challenging for Maxim. Sales from continuing operations
declined due to lower demand from the smartphone, notebook, and home entertainment markets. Solid
uptake of automotive, tablet & e-reader, and data & networking products picked up some of the slack, and
the October addition of Volterra lent support to the top line. In the six-month period, sales totaled $1.2
billion, versus $1.23 billion in the comparable fiscal 2013 term. While the first-quarter sales comparison
was negative, the second-quarter match-up was positive, thanks to the acquisition. Costs related to the integration of Volterra had an unfavorable impact on profitability, as did lower capacity utilization. Share net
declined, year over year, in both quarters. In the recent three-month period ending in March, sales came
in at $606 million, which was in the middle of management’s guidance and on a par with the year-earlier
result; share net was $0.43. Sales from the mobile device and automotive sectors improved nicely. Volterra
provided solid support. The gross margin, excluding special items, is running in the low-60% range and
should move higher in the coming quarters, thanks to an improving mix and rising cost savings. For the
final period of fiscal 2014, we estimate sales of $650 million and share earnings of $0.47; in the fiscal 2013
fourth quarter, Maxim earned $0.44 a share, on sales of $608 million. Full-year sales should tally $2.46
billion and share net $1.67 (exclusive of acquisition, restructuring, and asset impairment charges).
We expect stronger top- and bottom-line momentum in fiscal 2015. The company is making good progress
in melding Volterra’s assets with its own. Volterra is providing meaningful time-to-market advantages in
the enterprise and communications sectors. Maxim will leverage its global distribution to sell more Volterra
products. Also, management has aggressively pursued new automotive, consumer, and communications
business. In particular, Maxim has strived to put more components into smartphones. These efforts soon
should begin to pay off. In fiscal 2015, sales may well rise more than 9%, to $2.7 billion, and earnings
improve some 20%, to $2.00 a share. Longer term, product innovation, most visibly in the increasingly
complex mobile device, automotive, utility, and medical segments, and expansion of the customer base
ought to keep operating momentum favorable.
Finances
While it’s common for companies in the semiconductor industry to finance operations via cash flow and
equity issuances, several do occasionally tap the debt market. In June 2010, that’s just what Maxim did. The
company took advantage of a low-interest rate environment, issuing $300 million of 3.45% senior unsecured notes. Those notes were retired in 2013, after $500 million in 3.375% unsecure notes, due in 2023,
were sold to the public. During the second quarter of fiscal 2014, management issued another $500 million
in debt, with a 2.5% coupon, to fund operations and stock buybacks. In the fourth quarter of 2013, the
board of directors authorized up to $1 billion of share repurchases, without any expiration date, following
$641 million in buybacks (23 million shares) completed under a 2011 authorization. As of March 29th,
the debt-to-total capital ratio stood at 29%, a historical high for the company. This is a manageable level,
but we believe that Maxim will limit its borrowing over the next several years, as cash flow builds. Annual
capital spending, at 5%-7% of sales, is relatively modest. Cash and cash-equivalent reserves recently stood
at more than $1.2 billion. On balance, we believe that this stock is a worthwhile holding, with moderate
risk exposure, for the pull to 2017-2019. ■
May 2014
Value Line Dividend Select
23
FOOTNOTES
((A) The Timeliness Rank is Value Line’s assessment of a stock’s probable relative market performance in the 6-12 months ahead. It is computer
generated, and uses input items including the company’s multi-year price and earnings history, recent price and earnings momentum, and
earnings surprises. All data are known and actual. Stocks ranked 1 (Highest) and 2 (Above Average) are deemed likely to outpace the yearahead market.
(B) The Safety Rank is a measure of potential risk associated with individual common stocks. It is computed by averaging two other Value
Line indexes--the Price Stability Index and the Financial Strength Rating. Safety Ranks range from 1 (Highest) to 5 (Lowest). Conservative
investors may wish to purchase equities ranked 1 (Highest) or 2 (Above Average) for Safety.
(C) Relative P/E is the company’s current P/E divided by the market P/E.
(D) Diluted earnings. First-quarter 2014 earnings report: May 1st; second-quarter earnings report: July 30th.
24
Value Line Dividend Select
May 2014
Notes
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