Stock of the Week
NYSE Symbol: COP
Price as of 1/15: $45.12
The markets are off to a good start in the new year with the major averages in the green as earnings season starts. Money rotation continues to persist as investors look for stocks and sectors that will benefit from the reopening of the economy. Case in point, energy is the top sector year to date up 12% with the financials in second up just 4.9%. The price of brent crude spiked 40% in the last two and a half months back above $50 a barrel at levels not seen since the pandemic started back in March. During the pandemic, oil companies had to cut costs dramatically to survive the downturn. The well capitalized oil companies were able to take advantage of the downturn including this week's featured stock, Conoco Phillips. A few months ago, Conoco announced the $9.7 billion acquisition of Concho Resources, acquiring oil rich territory in the Permian Basin. The deal closed last week, providing Conoco with a catalyst to growth earnings and sales in the coming years as demand for oil rebounds. In the meantime, shareholders can enjoy a 3.5% dividend waiting for the fundamentals to improve.
The combination of ConocoPhillips with Concho Resources expands and diversifies the company over 16 countries along with more access to the oil rich lands in the Permian Basin. Many investors are excited about the cost reductions the merger will generate, producing profits and strong cash at lower oil prices. Initially, Conoco expected the combined companies to generate $7.5 billion to $7.8 billion in cash flow from operations when oil was at $40 a barrel when the deal was originally announced. Oil at $40 a barrel allows the combined company to fund their capital needs to maintain their current production levels while also providing the 3.5% dividend with room to spare. With oil back above $50 a barrel, the combined company anticipates an additional $3 billion in cash to help restart their growth engine.
Pent-up demand for air travel could drive a 'V' shaped recovery in oil demand. Jet fuel is only 8% of demand but represented 40-50% of the decline during the pandemic. China, which already reopened their economy, has seen oil demand rise 5.8% year over year. Some oil analysts are suggesting an undersupply in oil if demand jumps dramatically. The number of rigs drilling for oil in the U.S. are still down 60% from pre-pandemic levels. This year, the industry is expected to reinvest just 70 to 80% of its cash flow from operations to preserve cash. Even as many customers push for an alternative to oil, the world still needs oil, with peak oil demand still at least a decade away.
A number of analysts have upgraded Conoco recently due to the merger with Concho along with rising prices and the pending reopening of the economy. Analysts have price targets in the range of $56 to $59 a share, representing 20% to 30% upside not including the 3.5% dividend. In the short term, stocks and the markets may remain volatile, but longer-term Conoco is well positioned to benefit from the resumption of global growth and air travel.
Commentary and opinions presented to this site are for informational purposes only and should not be considered as a solicitation to buy or sell any security. Please contact your financial professional for specific guidance on investments. The author of this article does own or has a vested interest in this security but is required to hold the position for at least 10 days and cannot write about a stock in the period of 2 market days before to 2 market days after purchasing or selling the stock.