3 Reasons to Buy this Oil and Gas Company

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

Natural gas prices have been steadily rising over the last year, and ConocoPhillips (NYSE: COP) witnessed a 6% improvement in its cash margins in the last quarter as a result. The company produces around 40% natural gas, while petroleum liquids account for the rest. This allows ConocoPhillips to perform in line with the rising gas prices. Here are three reasons why ConocoPhillips appears to be a solid investment option.

Beneficiaries

Since rising gas prices are an industry-wide advantage, all major oil and gas producers with significant natural gas production stand to benefit here. Anadarko Petroleum (NYSE: APC) and Eni (NYSE: E) perfectly fit the criteria. Eni produces around 51% natural gas, while petroleum liquids account for the rest. On the other hand, Anadarko is the world’s largest natural gas producer by volume, and produces only a fraction of petroleum liquids.

Both Anadarko and Eni are jointly developing the world’s second largest liquid natural gas (LNG) export terminal in Africa, with an estimated development cost of $50 billion. Once the facility is fully operational, Anadarko and Eni would be catering to rising energy demands in Asian and African countries. This would further position both companies towards natural gas, thus allowing them to profit with rising gas prices.

However, I personally prefer ConocoPhillips over its peers. It is the largest natural gas producer in North America, and recently received the regulatory approval to expand its Freeport LNG export terminal. It’s a well known fact that LNG exports from the continent have been bottlenecked due to the lack of liquefaction facilities. Once the expansion work is complete, Freeport LNG terminal would have the capacity to export around 13.2 million tons of natural gas annually.

This would create a strain on the domestic natural gas supply and further push up its prices. This way ConocoPhillips can enjoy higher profits on its domestic gas supply while its exports would capture the international pricing differential.

Aggressive expansions

Besides that, ConocoPhillips would also be spending $15.8 billion on North American capital projects in 2013 alone. Around $6.32 billion has been earmarked for the expansion of existing assets, while around $5.5 billion would be used for Norweigian and Malaysian projects. The remaining budget has been allocated for exploration and drilling related activities.

On the expansion side, ConocoPhillips is heavily investing in the hydrocarbon rich Niobrara region. By the end of 2013, the company plans to drill 32 wells in the region, out of which it has already drilled three wells in the first quarter.

Even Anadarko Petroleum is investing heavily in Niobrara with an investment budget of $1 billion per year. It has an inventory of around 4000 wells, and plans to drill around 300 wells during 2013. But the management of ConocoPhillips announced that Niobrara wells have high crude yields, which hints towards high margin crude production. This would result in balanced growth, instead of leveraging a single sector.

Investors’ delight

Since 2011, ConocoPhillips has been distributing quarterly dividends of $0.66 per share or an annual payout of $3.22 billion. This equates to a lucrative annual yield of 4.28% with a modest payout ratio of 43% Besides that, the company has also repurchased 4.4% of its shares outstanding over the last year, for an estimated $5.15 billion.

Share buybacks not only highlight the board’s faith and confidence in the company’s future, but also reduce its dividend burden. Such repurchases leave room for dividend hikes in the future.

During its annual shareholders meeting, one of the shareholders suggested that ConocoPhillips terminate its future share buyback plans and spends its entire distributable cash on dividends. Its management stated that having a balanced approach is a better option, which suggests that ConocoPhillips would most likely continue with its share repurchases.

As a result of this balanced approach, ConocoPhillips has returned around $8.4 billion to its shareholders in the form of share buybacks and dividends over the last year. This value distribution has been a major contributor to its impressive 2012 fiscal year EPS growth rate of 15.19%.

Conclusion

With rising gas prices and lower tax rates, the management of ConocoPhillips is expecting a margin expansion of 300-500 basis points. This coupled with the mentioned reasons calls for significant upside in its share price. According to analyst consensus, its annual EPS is estimated to grow by 9.69% over the next year. However, analysts at Barclays are particularly bullish on ConocoPhillips with a price target of $80 per share -- a 30% premium.

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Piyush Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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