After Conoco Phillips (NYSE: COP) enjoying a strong end to 2021, somehow it looked like higher returns for shareholders were ahead, as my previous article pointed out earlier in 2022. Fortunately, they did not disappoint with large variable dividends increasing their cash yields, which, if continued at their most recent quarterly rate, would show a high yield of 6.75%. While shareholders are certainly benefiting from this cash windfall as well as the sharp rise in their share price, it seems time to take profits off the table given the economic risks on the horizon, as shown in this follow-up analysis. which also covers their subsequently released results for the second quarter of 2022.
Executive summary and ratings
Since many readers are likely short on time, the table below provides a very brief summary and ratings for the main criteria assessed. This google doc provides a list of all my equivalent ratings as well as more information about my rating system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.
*Instead of simply assessing dividend coverage through earnings per share cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their situation financial.
The recovery they enjoyed in 2021 accelerated in the first half of 2022, as one would expect given that oil and gas prices hit levels not seen in about a decade after the invasion. Russian from Ukraine. This saw their operating cash flow hit a whopping $12.982 billion for the first half of 2022, more than double its previous result of $6.331 billion in the first half of 2021. In fact, if the removal of its working capital of $1.381 billion, their underlying income of $14.363 billion is close to their annual income of $16.996 billion for 2021, although it is only half the span.
Despite this building up of working capital and the increase in their capital expenditure which effectively doubled year-on-year to $5.129 billion in the first half of 2022 from $2.465 billion in the first half of 2021 , they still generated a huge free cash flow of $7.853 billion. In addition to easily funding their $1.852 billion dividend payouts, it also easily funded their $3.725 billion share buybacks, resulting in shareholders earning very impressive returns of $5.577 billion for just six months.
While everyone knows that soaring oil and gas prices are generously filling shareholders’ pockets with cash, in my view the biggest question going forward is actually what happens when conditions operating conditions soften. The current global energy shortage is providing support and thus reducing short-term downside risks, but at the same time I still think it would be prudent for investors to remember that the energy sector is notoriously volatile and therefore someday, like it or not, these booming operating conditions will ease, even if they avoid a severe downturn.
This consideration is particularly relevant at present in light of the growing recession risks on the horizon, which have already sent oil prices back below $100 a barrel and could see further weakness and also hurt sentiment. investors to their industry and drive down their share price. Despite their variable dividends providing a tangible cash return to shareholders, around two-thirds of their returns to shareholders in the first half of 2022 came from share buybacks which rise and fall in parallel with their free cash flow. Given that their share price would obviously also follow in tandem, this makes their margin of return for shareholders without these booming oil and gas prices particularly important to ensure that shareholders are not left dry when the tide comes. proverbial will retire.
To assess this consideration, I prefer to compare their current valuation to their free cash flow under normal operating conditions. In my eyes, their 2021 results provide a suitable baseline since its strong end was mirrored by a weak start, thus averaging accordingly with free cash flow of $11.672 billion. If that’s compared to their current market cap of around $140 billion, he sees a high but still single-digit free cash flow yield of just over 8%. While that’s not necessarily bad or exorbitant, it’s also not particularly cheap and so in the medium to long term, their stocks don’t seem to offer desirable value without those booming oil and gas prices.
Despite increasing their shareholder returns in the first half of 2022, their immense free cash flow still caused their net debt to plunge to $8.79 billion, a massive drop of 39.21 % from its previous level of $14.46 billion at the end of 2021. After seeing this decrease of $5.67 billion, their net debt is only an intangible $21 million above its previous level at the end of 2020 and therefore effectively saw them repay their borrowings to fund their 2021 acquisitions of Concho Resources and Shell’s (SHEL) shale assets. Granted, $2.914 billion of that decline came from net divestments of relatively small acquisitions, including their shares in Cenovus Energy (CVE), but regardless, it still provides a lasting benefit.
With the repayment of their loans in 2021, they are now in a much stronger position to handle whatever the future holds for their industry. Unsurprisingly, this saw their respective net debt to EBITDA and net debt to operating cash flow fall even lower to 0.24 and 0.31 than their already very low previous respective results of 0.73 and 0, 85 at the end of 2021.
These results have already ended 2021 below the 1.00 threshold for the very low territory, but if they had to face another severe downturn before repaying their additional loans, their leverage would have exploded. To give an example, if we compare their net debt of $14.46 billion from the end of 2021 to their financial performance affected by the downturn in 2020, this creates a net debt to EBITDA ratio of 3.01. and a net debt to operating cash flow ratio of 3.71, the latter being in the high range between 3.51 and 5.00.
While these results would not necessarily have jeopardized their solvency, they would nonetheless have hampered their shareholders’ returns and likely suppressed their stock price, as higher leverage equals higher risks and therefore translates by a lower valuation. Whereas now that their net debt has essentially returned to its previous level since the end of 2020, even if this same scenario were to occur now, their net debt to EBITDA and net debt to operating cash flow would obviously only back to their previous results of 2.25 and 1.83 at the end of 2020. Besides the former which is only in the moderate territory of 2.01 and 3.50 and thus reduces the risks of a hypothetical severe downturn , this lasting benefit also reduces any requirement for deleveraging in the future.
After seeing their immense free cash flow in the first half of 2022, it was no surprise that their already strong liquidity improved further with their respective current and cash ratios increasing to 1.54 and 0.67, compared to their previous respective results of 1.34 and 0.46. Although this may go up and down in the future, their ability to generate free cash flow and their large operational size should guarantee them always easy access to the debt markets if they choose to refinance instead of repay the debts. future debt maturities, even if central banks continue to tighten monetary policy.
They produced strong fundamental improvements in the first half of 2022, such as the repayment of their loans from 2021, although it nevertheless seems time to take profits off the table after their strong share price rally. Even though no one can see the future, economic risks loom on the horizon, with fears of a recession only growing as the Federal Reserve raises interest rates to tame inflation, thus increasing the likelihood of an easing of operating conditions. At least their stock price is not exorbitant and therefore I only believe it is now appropriate to downgrade my buy rating to a hold rating.
Notes: Unless otherwise stated, all figures in this article are taken from ConocoPhillips’ SEC Filingsall calculated figures were performed by the author.