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Why Conoco Still Gets No Respect


Although it has vaulted into Big Oil's ranks through acquisitions, ConocoPhillips (COP) is having trouble earning its seat at the table. Among the handful of supermajors, Conoco's $183 billion in revenues rank behind only those of ExxonMobil (XOM), BP (BP), Royal Dutch Shell (RDS.A), and Chevron (CVX), and they exceed those of Total (TOT). But its shares trade at 5.8 times forward earnings. That's cheap; Exxon trades at 10.7 times forward earnings, BP at 10, and Chevron Corp. at 8.1. For the year, Conoco shares are up 1.7%. That compares with 3% for BP, 15% for Chevron, and a 21% gain for Exxon.

So what's the company's crime? Acting like high energy prices are here to stay, it seems. Last December, Conoco raised eyebrows with its $35.6 billion cash-and-stock acquisition of Burlington Resources Inc. (COP), a large natural-gas producer. The deal was made expecting natural gas prices in the range of $8 per thousand cubic feet, though they're closer to $5 now. "They have been very aggressive with respect to their assumptions on commodity prices," says Mark Gilman, an analyst at Benchmark Co. "Management seems to be operating on assumptions that we believe are not only inaccurate but...potentially damaging."

Gilman's price target for Conoco stock is 47 a share, below its recent 58 and well below those of most other Wall Street analysts, many of whom expect the stock to rise past 70. Still, the Conoco discount is undeniable, and perhaps surprising for a company that has returned 116% to investors over the past three years--helping it land at No. 31 on the BusinessWeek 50 list of top corporate performers.

Conoco's low relative valuation has even attracted the eye of Warren E. Buffett, who disclosed a substantial investment earlier this year. But oil-company investors on the whole have been harder to impress. That's in part because they're not necessarily as focused on growth. After all, stocks in this sector will be heavily swung by just one factor: the price of oil. If it goes up, that's good for everyone. If it goes down, that's not good, but it's better for the ultraconservative companies--Exxon, for example--that have low expectations for the underlying commodity prices.

LOW PRICE, HIGH HOPES

Conoco gets dinged, as well, for its overall financial picture, which isn't as balanced as its bigger peers. The Houston-based company is the No. 2 refiner in the U.S., and as such moves much more on the vagaries of gasoline prices. Conoco doesn't have the roster of exploration projects that some of the other majors do, so A.G. Edwards & Sons Inc. (AGE) analyst Bruce Lanni figures it will have to rely on more acquisitions and joint ventures to meet its 3% yearly production growth targets.

The laggard p-e ratio could make brokering big deals tougher in the future. Conoco's market value is $95 billion, which could only be considered slight in the world of oil supermajors, where Exxon's value tops $396 billion. But slight it is, especially with Conoco's debt at $29 billion following the Burlington purchase. Although the company is cheap, it's not seen as vulnerable to a takeover, thanks to its heft and regulatory restrictions.

The company says it expects the valuation gap to close over time. On a recent analyst call, Chief Executive James J. Mulva admitted that Conoco's earlier forecast for natural gas was off. He promised "more constrained" capital spending, and to bring debt down near $20 billion in the next couple of years. And if energy prices stay high, share buybacks may be in the offing.

A lot of things will happen in this industry if energy prices stay high. A continued seller's market for exploration and production assets could eventually vindicate Conoco's strategy. Then it'll be treated just like any other old supermajor. "We saw the same thing with Total," says Tina Vital, an equity analyst at Standard & Poor's (MHP). "Until the market got used to it, it traded at a discount."

By Brian Hindo


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