ExxonMobil Energy Forecast

Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In light of how discounted energy stocks are right now, I thought it would be fitting to highlight two of the largest producers in the field: BP and Conoco. One company--do we need to say who?--has been conflict-ridden by regulators and powerful businessmen yet opening a new chapter of its life where it can focus on high returns. The other company has been de-risking operations through partner agreements and a change in capital allocation. Through these two companies, I illustrate several reasons why you should also be bullish on this sector.

Why You Should Buy BP (NYSE: BP)

Despite resolving the Macondo oil spill in a $4.5 billion settlement (equivalent to one-twentieth of the September quarter revenue), the market continues to ignore BP's potential. Further, Rosneft's reported $28 billion buyout of the AAR group of Russian billionaires and their 50% stake in TNK-BP ends a major political challenge for the British producer. BP had a profitable, but difficult, relationship with AAR, and now that the company has a 20% stake in Rosneft, which will effectively own all of TNK-BP, they can indirectly operate without the governance strife. These two positive catalysts have, however, not driven a meaningful positive stock reaction from the market.

One other major positive catalyst could emerge from the United States lifting its ban against BP for government contracts. After settling with the Justice Department on the Macondo matter and putting out aggressive PR blitzes on the firm's "social responsibility," BP may see the strife end sooner. And at 1.1x book value versus the 1.5x industry average, shares look undervalued, especially in light of the 17.6% return on invested capital. Although 9 of 14 reporting analysts believe the stock is a "buy" or better--a large minority, 35% say it is just a "hold."

The company is likely to file for approval to restart exploration in the Canadian Arctic with Imperial Oil and Exxon Mobil as soon as next summer. This area has effectively ~$9 trillion worth of recoverable oil and a major catalyst. In terms of strategy, the company will focus more on higher-margin deepwater E&P in Azerbaijan, Angola, the North Sea, and the Gulf of Mexico. Ironically, this is just the same kind of strategy that analysts, like Oppenheimer, have been pushing for: higher-returns with smaller scale. Oppenheimer has further argued that the major producers are too spread out, which has led to sluggish growth and limited value creation. BP's sale of $5.6 billion worth of deepwater assets in the Gulf of Mexico--$37 billion has been sold since 2010--is yet another instance of management cutting back on size. 

Why You Should Buy ConocoPhillips (NYSE: COP)

Conoco is another major oil & gas company to consider invest in. It trades at 1.5x book value and offers a 4.5% dividend yield. Analysts forecast 5.3% annual EPS growth over the next 5 years. I foresee multiples expanding and, combined with the dividend yield and earnings expanding, investors should expect an annual average return north of 10%. In mid-2012, Oppenheimer dropped the price target from $90 to $65 but still rated the stock as "outperform". I share this outlook: the stock, although not incredibly valued, is a safe oil & gas pick with steady growth and income support. You can call it "Exxon Lite."

The firm recently announced its 2013 capex budget, which amounts to $15.8 billion--more or less in-line with what is expected this year. Around 60% of the budget will go towards North American operations, and the remainder will be allocated primarily to Europe and Asia. Conoco has been shifting its focus: In late November, it announced an arrangement to sell the 8.4% stake in the Kashagan oilfield of the Caspian Sea for around $5 billion. In light of the project's operational setbacks, the partners may reject it, and they reserve the right to do just that within 60 days. Elsewhere, Conoco's operations have done well. In the third quarter, Eagle Ford production peaked at a record 86K boe/d and averaged 76K boe/d--this rate is expected to increase 16% sequentially to 100K boe/d. Production as a whole was more or less flat in the same quarter last year at ~1.5M boe/d.

With a 14.4% return on invested capital, a cheap valuation, and a streamlined de-risked business, Conoco provides a compelling investment. Although it is expected to grow less than the 5.7% rate of the overall integrated oil & gas sector, its dividend yield and lower volatility still more than offsets for implied outperformance.

Mathman6577 has no positions in the stocks mentioned above. The Motley Fool owns shares of General Electric Company and ExxonMobil. Motley Fool newsletter services recommend Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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