(By Mani) ConocoPhillips
) may cut its dividend as free cash flow is being pressured amid cyclical oil price pullback. The company is also directing much of the proceeds from asset sales towards capital program rather than its usual strategy of buying back shares.
Houston, Texas-based ConocoPhillips experienced a material sequential decline of 24 percent in clean discretionary cash flow from operations, generating just $2.73 billion in the second quarter with organic, free cash flow deficit post-dividend of $2.3 billion.
The exploration and production companies (E&Ps) such as ConocoPhillips are valued on cash flow rather than earnings multiples as earnings comparisons may be impacted by two different accounting methods, historical writedowns, and varying levels of deferred taxes.
"Based on EV/DACF, COP is currently trading at the second highest multiple in the sector and 3 turns above its close peers. COP is the second most expensive E&P in our universe on EV/DACF, despite the lowest long term growth rate and negative FCF outlook," UBS analyst William Featherston wrote in a note to clients.
Under current NYMEX prices, the company is estimated to generate free cash flow deficits of $7.6 billion and $4.9 billion in 2012 and 2013, respectively, after taking into account the large dividend of $3.3 billion to $3.4 billion per annum. This is especially worrisome given the 24 percent sequential decline in clean discretionary cash flow in the second quarter.
The analyst sees the company needs a breakeven West Texas Intermediate (WTI) price of more than $125 a barrel in 2013-2014 to fund capex and the dividend without the need of financing or asset sales.
As such, should oil prices fall precipitously, investors would grow concerned that the company's dividend would be at risk of being cut, placing downward pressure on its shares. ConocoPhillips recently declared a quarterly dividend of 66 cents per share, payable Sept. 4, 2012, to stockholders of record at the close of business on July 23, 2012.
"Even under the UBS Brent price deck of $108/Bbl, $100/Bbl and $97/Bbl in 2012-2014, we estimate COP will deplete all of its ~$6 billion cash balance (including restricted cash) by the end of 2013 and will need to take on additional debt by 2014 without help of incremental asset sales… putting its dividend or growth target at risk should oil prices soften," Featherston said.
Moreover, ConocoPhillips is unlikely to restate its share buyback program over the medium term without higher oil prices or an increase in its asset sale program. The company completed about $1.5 billion of asset sales in the first half of 2012 and reiterated its asset sale target of $8 billion to $10 billion by mid-2013. Given the size of the cash flow deficits, timeliness of future asset dispositions is becoming increasingly important for the company.
The company now expects to allocate future proceeds from asset disposition ($6.5 billion to $8.5 billion remaining in 2012-2013) to fund its capital program instead of share repurchases. This is a marked departure from its strategy of redirecting divestiture proceeds to a large share repurchase program since 2010.
ConocoPhillips raised its 2012 capex outlook by $1 billion to $16 billion, but it maintained long-term capex guidance at $15 billion per annum.
While COP bought back $5 billion shares in the first half of 2012, it disclosed that the share buyback program has been stopped due to weakening commodity prices.
"As COP has re-directed future asset sale proceeds to fund its capital program instead of share buybacks, we see the company having very limited ability to restart buybacks in the foreseeable future unless oil prices rally materially or asset sale target is increased," Featherston noted.