Why the ConocoPhillips Stock Buyback Means Money in Your Pocket
This morning, ConocoPhillips (NYSE:COP) announced that it was upping its quarterly dividend to 66 cents (a 20% increase) and authorizing another $10 billion in stock buybacks. This latest buyback is on top of a similar $5 billion move last year (of which the company has repurchased about $4 billion to date).
The announcement has certainly improved the short-term value of the shares (up about 2.5% today). But its significance goes well beyond any immediate impact on market price.
What we have here is a combination of the “traditional” intended reasons for a stock buyback and an indicator of where the oil market is moving – at least according to the major players in it.
We also have signals of two developments that mean significant profits are headed our way…
Before I explain, let’s explore those traditional reasons behind such a move.
The Six Traditional Benefits of A Stock Buyback
First, a stock buyback provides for a company’s earnings to be divided out among fewer remaining shares in the market. That means higher earnings per share (EPS), resulting in an almost inevitably higher price per share.
Second, to a company like ConocoPhillips – with substantial cash flow (revenues were $53.2 billion in the fourth quarter alone) – an important consideration is the return on excess cash. And stock buybacks provide a greater return (in enhancing the value of treasury stock) than a company can get simply leaving that cash in short-term money market accounts.
Third, the presence of excess cash exposes a company to takeover bids.
COP’s fourth-quarter profits came in at $2.04 billion. While that certainly covers the new 66-cent-per-share dividend, quarterly profits actually came in at more than twice that – $1.39 a share. That has led some analysts to believe that COP may announce a further dividend rise in March.
The company also ended 2010 with $10.4 billion in cash and short-term investments on hand, while reducing its debt-to-capital ratio from 31% to 25% year-on-year.
All of these elements, if left unattended, provide too much cash hanging out there to be ignored in an accelerating M&A cycle.
Fourth, a buyback allows the company to pass on extra cash to stockholders without increasing the dividend. If a pullback in revenue is anticipated (and COP had just such an event in the second quarter of 2010), the move can improve overall company financials.
Fifth, the buyback will usually increase the return on equity (ROE).
Obviously the more undervalued the stock is at the time of the buyback, the greater the increase. That is actually what the company is telling the market when it engineers a buyback – namely, that it believes its stock is undervalued. And generally, that translates into another pump in price.
Sixth – and most apparently, given the lowered number of shares outstanding, the buyback will boost aggregate demand for the stock.
The COP move calls to mind several other buybacks in the oil sector, especially the 2007 decision by Exxon Mobil Corp. (NYSE:XOM) to commit fully 80% of quarterly profits ($32 billion out of $40 billion) to repurchasing its own shares.
However, it also provides us with a clear signal of what is to come…
High Prices, Higher Profits
There will certainly be additional buybacks coming. But individual investors in the oil sector will be making profits whether their shares are subject to repurchase or not.
That’s because the COP move is telegraphing two company conclusions. First, the value of shares will be higher in the future than they are now.
Second, the sector itself will be experiencing accelerated oil pricing increases. The XOM buyback in 2007, for example, preceded a significant run-up in crude oil prices and led to record profits for Exxon Mobil.
However, this second aspect does not automatically mean the big boys will be emphasizing oil extraction. In fact, we are witnessing a progressive increase in the percentage of that market controlled by non-traded national oil companies (NOCs); the Saudi Aramcos of the world.
COP is currently shifting the focus of its extensive restructuring plan to refining and distribution. It is moving downstream to compete with most of the other majors already emphasizing that sector.
And this is perhaps the single most important observation to take from the COP announcement.
The money made by oil majors will be coming more from intensifying their efforts in value-added production and distribution.
Gasoline and diesel, after all, provide greater profits than crude oil.
We should expect, therefore, to see the increasing movements in M&A among oil companies emphasizing the downstream sector. That just happens also to open up small and medium-sized players with well-focused and -managed approaches to fields below the threshold of NOCs or the remaining interests of majors in production.
Both of these developments will be making money for you.