Buy ConocoPhillips (COP)?

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The energy sector is reshaping rapidly as the participants try to replace depleting reserves. We are seeing divestitures, spin-offs and shedding of non-core assets to streamline the core businesses, as well as focus on high-growth segments. ConocoPhillips (NYSE:COP) is one of the most important players in the sector, and last year spun off its downstream business into Phillips 66 (NYSE:PSX), an independent entity. As a result, the company has become more focused and lean, which will result in enhanced value creation for its shareholders, in my opinion.

A look at the quarterly performance

For the quarter, the company reported adjusted earnings of $1.75 billion, consistent with analyst estimates but down 2% year-over-year. The main reasons for earnings decline were higher depreciation, amortization and depletion expenses and lower prices. Production is a concern for the company, as the quarterly production stood at 1,596 million barrels of oil equivalents. More worrying news is that the company is expecting the production levels to be lower in the next quarter.

ConocoPhillips (NYSE:COP)Credit: ConocoPhillips (NYSE:COP)

An important strategy is the sale of non-core assets – during the last quarter, it sold assets worth $1.1 billion. Further sales are expected during the year in Algeria, Kashagan and Nigeria. At the moment, proceeds from any sales are being directed towards new drilling and exploration activities. As I mentioned above, the companies are trying to add to their depleting reserves through new discoveries.

For the purpose of executing new exploration activities, the company has planned $15 billion in capital expenditures every year for the next three years. Cash flows are under a little stress at the moment, and assets sales will be needed to meet the capital expenditures. Currently, ConocoPhillips (NYSE:COP) is focusing on politically stable regions with consistent regulatory environments, i.e. North America and Australia. In the long term, the strategy will allow the company to maintain its production levels and generate substantial cash flows.

Replacing depleting reserves and future growth

Moving on to new investments, the company has decided to invest more than $1 billion in the U.S. and Colombian shale plays. ConocoPhillips (NYSE:COP) already has a strong portfolio of assets in these shale plays (Eagle Ford and Bakken), which are expected to contribute heavily towards the future production targets.

Furthermore, the company has a substantial share (30%) in recently discovered reserves in the Gulf of Mexico. At the moment, ConocoPhillips holds 1.9 million acres in the Gulf of Mexico area. In addition, the projects in Australia, Malaysia and Christina lake oil sands in Canada are also on track. Over the next three years, substantial reserves will be added to the current portfolio and the production levels will improve. The confidence in the success of these projects gives ConocoPhillips (NYSE:COP) the belief that it will be able to meet its long-term growth target of 3-5%.

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