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ConocoPhillips Shows Bigger Isn't Better, as Big Oil, Exxon Lag

Antoine Gara

NEW YORK (TheStreet) -- The best Big Oil stock may be the one planning to become smaller.
Investors looking to find stock profits in the gargantuan but slow-growing earnings of Big Oil companies have been disappointed in 2012, but as May approaches, there's reason to focus on the upcoming split of ConocoPhillips COP over the earnings results of ExxonMobil XOM , which again disappointed investors.
As industry giants like ExxonMobil, Chevron CVX , BP BP and Royal Dutch Shell RDS.A lag rising markets, an ambitious breakup strategy by ConocoPhillip may be a strong target for those in search of a needle-moving investment within a Big Oil group of stocks that don't seem to budge.

After ExxonMobil reported that its first quarter profit dropped 11% to $9.45 billion, or $2 a share on Thursday -- missing Wall Street consensus of $2.09 -- it's hard for investors to be encouraged. Slowing energy production that is cutting into earnings and a share price not keeping pace with rising markets can make a profit that rivals the GDP of nations seem inconsequential. Even a 21% dividend raise by dividend laggard Exxon Mobil -- announced a day before the weak earnings -- wasn't enough to keep shares from selling off. ConocoPhillip's split into two separate oil exploration and refining companies, on the other hand, may be a worthwhile investment for Big Oil-inclined investors.
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According to Oppenheimer energy analyst Fadel Gheit, the move "will create two strong companies, including the largest E&P company in terms of production, proved reserves and market value, and the second-largest refiner in the US." Gheit estimates that after the split and previously announced asset divestiture programs, both companies will have stronger balance sheets and higher dividend yields than their new non-integrated oil industry peers.
" A successful implementation of the divestiture program and the use of proceeds to reduce debt and supplement operating cash flow in funding profitable growth could provide the needed catalyst to boost stock performance further."
On May 1, ConocoPhillips will spin its downstream unit that includes a chemicals and refining and marketing business into a new publicly traded stock, Phillips 66, ticker symbol "PSX." ConocoPhillips shareholders will get a share of PSX for every two shares of their existing shares, while retaining their interest in the company's upstream oil exploration business, which is among the largest in the U.S.
"COP will continue its 'shrink to grow' strategy by selling non-core assets and investing in high-return projects, while PSX will reduce its refining focus by selling assets and shifting capex to high-return petrochemicals and midstream projects," adds Gheit.
The move may be a welcome relief after high oil prices have done little to improve the sector's stock performance. The company's shares are off over 1% year-to-date, underperforming a 10% gain for the Standard & Poor's 500 Index. In the past 12 months, the stocks of ConocoPhillips, ExxonMobil and Chevron have all shed ground, while the S&P has gained over 3%, recovering from a second half lull.

After the split, ConocoPhillips will be the largest independent exploration and production company in the U.S., with 56% of its 1.6 million barrels of oil equivalent a day in liquids and more than half of its oil and gas coming from North America. That oil and gas portfolio includes large Eagle Ford, Permian and Bakken liquids-rich shale assets and a significant stake in Canadian oil sands projects like Foster Creek-Christina Lake. Internationally, the company also has liquid natural gas production assets in Australia, oil investments in the North Sea and deepwater oil wells offshore of Malaysia.
After the split, ConocoPhillips is expected to have a market cap of $69 billion -- roughly the size of Occidental Petroleum OXY -- but it will possess double the oil and gas reserves, notes Gheit of Oppenheimer, who highlights the company's projected 4.9% dividend yield, $5 billion in first-half 2012 share repurchases and balance sheet leverage.
Meanwhile, the company's stated plan to divest slow-growing assets, a potential successful multi-billion arbitration claim on its seized Venezuelan energy assets and the lower valuation given to its oil reserves could be an added catalyst, in coming years, adds Gheit.
Phil Weiss, Argus Research analyst, said in a recent report, "COP is presenting itself as a new class of investment, largely due to its plans to provide sector-leading distributions and annual margin improvement, while also growing production at a more measured pace than peers. We reiterate our view that the upcoming spinoff will help to further unlock the shares underlying value."
The spun off refining and chemicals division Phillips 66 may also prove to be a winning oil-sector play. " The company will have substantial interests in the Chemicals and Midstream businesses, which are higher return than the core Refining & Marketing business," noted Jefferies analyst Iain Reid in an April research note. At a recent conference, Greg Garland, the CEO of Phillips 66, said he plans to grow those businesses using 50% of the company's expected capital expenditure, up from levels of 16%. While Reid expects that the newly split companies will continue to trade in line with peers, "we see good potential for the downstream company to improve this position over time."
The unit is the second largest refiner in the U.S., when counting its petrochemicals joint venture with Chevron and its midstream joint venture with Spectra Energy. Of Phillips 66's $5.9 billion in earnings in the last three years, the company's refining & marketing unit accounted for 66% of profit, while chemicals accounted for 20% and midstream 14%, notes Gheit of Oppenheimer.
"Its large and balanced assets portfolio, with more than 80% of the capital employed in the US, provides attractive investment opportunities and a superior risk-return profile, in our view," adds Gheit.
Summing up the analyst bullishness on the ConocoPhillips split in the simplest terms: bigger isn't necessarily better when it comes to the recently stalled Big Oil stock sector.
For more on oil and gas M&A, see 5 energy deals not to be forgotten in 2012 and Chesapeake Energy's flurry of asset sales.
-- Written by Antoine Gara in New York