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ConocoPhillips (NYSE: COP) has worked hard to distinguish itself from other oil companies over the past few years by shifting its focus from growing production to increasing shareholder value. That led it on a path to shed high-cost assets so that it could slim down to a company that could thrive at lower oil prices.
This strategy has worked remarkably well. That's why shares are up more than 50% over the past year compared to about a 15% gain for the average oil stock as measured by the Vanguard Energy ETF. However, despite that dramatic outperformance, CFO Don Wallette stated on the company's most recent quarterly conference call that "we think our stock is well undervalued and has a lot of upside to it." He gave two reasons why the company thinks its stock is a buy.
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Cheap cash flow
One of the factors ConocoPhillips' CFO looks at when valuing the company's stock is its ability to expand its cash flow margins in an environment like the one it's in today. In the CFO's view, cash flow can expand rapidly at current oil prices. However, the market isn't giving the company any credit for this growth potential:
| Oil stock | Price-to-cash flow from operations ratio |
|---|---|
| Pioneer Natural Resources (NYSE: PXD) | 15.2 times |
| EOG Resources (NYSE: EOG) | 14 times |
| Concho Resources (NYSE: CXO) | 13 times |
| ExxonMobil (NYSE: XOM) | 11.5 times |
| Chevron (NYSE: CVX) | 11.4 times |
| ConocoPhillips | 11 times |
| Anadarko Petroleum (NYSE: APC) | 8.6 times |
| Devon Energy (NYSE: DVN) | 7.3 times |
Data source: Ycharts.
As that table shows, ConocoPhillips' stock trades near the bottom of the barrel compared to peers on a cash flow basis even after its massive run-up over the past year. Typically low growth stocks are the ones that sell for a below average multiple. However, that's not the case with ConocoPhillips.
The company spent the past several years repositioning so that it could run its business on $50 oil going forward. At that price point, the oil giant can generate enough cash to invest $5.5 billion per year in developing new wells, which should grow production at a 5% compound annual growth rate and cash flow at a 10% rate. Further, there would be enough money left over so that the company could return about 30% of its cash flow to investors via dividends and buybacks, with it targeting $1.5 billion in stock repurchases per year through 2020.
However, with crude currently in the $70s, ConocoPhillips is outperforming its plan and generating more cash than expected. Because of that, the company has already allocated another $500 million to its buyback in 2018 and could boost it even further if oil continues flying high. Those cash flow fueled repurchases should help raise ConocoPhillips' valuation closer to the top of the peer group where it belongs.