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Leigh Baldwin & Co.

112 Albany Street, Cazenovia, NY 13035 | Phone: (315) 655-2964 Toll Free: 1-800-659-8044

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Stock of the Week

Conoco Phillips

December 16th 2015

Conoco Phillips
NYSE Symbol: COP
Industry: Oil
Price as of 12/13: $49.58


                The fundamentals for energy and oil in particular have gone from bad to worse. With oil well before $40 a barrel, we're starting to see some cracks in the industry.Besides small and capital intensive oil drillers going out of business, were also seeing issues with the MLP sector. Bellwether, Kinder Morgan cut their dividend 75% to preserve their credit rating. With their recent weakness, the MLP stocks are priced more like utilities with no short term growth. If you want exposure to the energy space and an attractive dividend, its best to go right to the biggest well capitalized companies and stocks like Exxon Mobil, Chevron, and Conoco Phillips. All three will do whatever it takes to preserve their dividend. The fundamentals may not improve much in the next year, but with yields of 3.93% or better the stocks provide good income while you wait for the fundamentals to improve.

ConocoPhillips has the  best dividend yield of 6.15%, but the most risk. The company has gone from generating over $5 a share in earnings or over $5 billion to negative earnings in 2015. Next year the company is expected to return to profitability, but that still won't pay for the $2.96 a share dividend or $3 billion worth. Protecting the dividend remains Conoco's top priority. Management flexed its capital spending in 2016 to protect its payout and balance sheet. Targets were slashed with an estimated 20% reduction from 2014 levels. Conoco still expects to grow volumes by 1-3% in 2016 (ex-divestments), in large part due to ramp-up of major projects completed in 2015. At $50 a barrel of oil, Conoco will outspend cash flow by 10% after dividends, taking leverage to 2.5x net debt/cash flow. Management believe there is further capacity to dial-down spend into 2017 which, combined with growth coming through, sees dividend as fully covered at$60 oil. For 2016 capex, Conoco is projecting a 6% drop in operating expenses, which would save $1 billion cumulatively.

                Chevron is the next highest yield at 4.95%. Chevron's chief executive, John Watson, last week declared that preserving the common's payout was his "No. 1 priority." That has meant workforce reductions, capex cuts, elimination of share repurchases, asset sales, and additional debt. Chevron, the second-largest energy, will cut capital spending in 2016 by 24% to $26.6 billion, keeping a promise it made in October to dial back future spending to weather a global rout in oil markets that has pushed crude prices below $40 a barrel. The Citigroup analyst has maintained a $110 price target. Chevron's cash flow from operations generated in 2015 and 2016 will only partially cover the company's capital expenditures, not to mention dividend obligations presently at $8 billion. Watson laid out plans to return to cash flow neutrality by 2017 that include spending cuts, asset sales and additional borrowing. In October, Chevron announced it would reduce its workforce by 10% and cut future spending. It has eliminated share repurchases. The quarterly dividend, which Chevron has lifted annually through recession and periods of price declines, remained unchanged this year at $1.07 a share. Unlike Conoco, Chevron does have a PE which is high at 24 times next year's earnings, but at least they are making money at these depressed levels.

             The story for Exxon is even better than Chevron. Exxon has the lowest yield of the three at 3.93%, but also provides the most security with the best valuation. Currently the stock trades for 20 times reduced earnings. Exxon is similar to JP Morgan in the financial crisis when they were able to take advantage of the financial stress at other banks to gobble up assets on the cheap. If anyone is going to benefit from this oil glut it will be Exxon over the next several years providing financial support to weaker, financially stressed oil companies. The biggest oil company may just get even bigger in the coming years.