Why You Shouldn't Sell ConocoPhillips

Independent oil and gas giant ConocoPhillips has been on an impressive run. This year, shares have jumped almost 27%. Since the company's separation from its refining arm in May 2012, shares have gone from $53 to $73, not including a solid 5% dividend.

In light of such a tidy gain, one might be tempted to sell and call it a day, especially since grade-A peers ExxonMobil and Chevron are relatively flat on the year.

Source: YCharts.

But ConocoPhillips has a bright future, and its stock is still worth holding. Major oil companies are often bought for dividends and dividend growth, and ConocoPhillips's cash flow will continue to grow faster than the other two through 2017. Think of ConocoPhillips as a B-student compared to Chevron's and Exxon's A. Conoco is in the process of improving that grade, which is the reason for the stock's steady climb. That process is not over, and as an investment, ConocoPhillips is still the best choice of the three.

The A-students
A couple things make ExxonMobil and Chevron A-students. Return on invested capital was strong at 25.4% and 21.5% respectively in 2012, compared to Conoco's 10.11%. Also, margins are high: $20 and $23.70 per barrel respectively. Basically, these two companies are very efficient, disciplined machines. But you probably already knew that.

While efficiency is important, it is only half the equation for energy companies; growth is the other side. For example, mature fields tend to be the most profitable because they don't require much capital, but production will be on the decline. Production growth, on the other hand, tends to need plenty of capital, especially at the initial phase of a field's development.

Chevron has done the best at balancing these two factors. It earns high returns, and its production is expected to grow between 4% and 5%. Contrast that to ExxonMobil's estimated 2% to 3% production growth. Overall output in the U.S. is ramping up with the shale oil discoveries, and both Chevron and ExxonMobil have mostly stayed on the sidelines. Of the three, ConocoPhillips has been the best at harnessing the long-term potential of shale oil.

The improving pupil
ConocoPhillips' production will grow between 3%-5% to 2017, a rate similar to Chevron, but without the inflated margin. But here's what sets ConocoPhillips apart: Unlike Chevron and ExxonMobil, its margins are improving. Management is disposing of assets in places with opaque business environments and focusing mostly on stable OECD countries. When we add 3% to 5% production growth to margin expansions of the same amount, we get 6% to 10% growth in cash flow. This is something the big two can't match. This trend should hold until 2017, and it will add to ConocoPhillips' already impressive, industry-leading dividend yield.

Tomorrow's prospects for oil and gas are often determined by today's exploration efforts. ConocoPhillips has some exciting shale plays and Gulf of Mexico prospects. Already, the Gulf has yielded a 1 billion barrel discovery in the Shenandoah block. ConocoPhillips is also exploring the Permian basin of West Texas. Finally, it is putting a lot of work into exploring for shale oil in the Duvernay up in the Yukon Territory. Of the big three U.S. energy companies, ConocoPhillips is poised to take advantage of shale oil production.

Foolish conclusion
A steady turnaround in margins and solid production growth are the reasons for ConocoPhillips' stock performance this year. Cash flow should continue growing at this impressive rate through 2017.

Shale oil production is the primary driver of growth in oil capacity over the last few years. No major player has done as well as ConocoPhillips in taking advantage of this trend. If you are optimistic about the growing capacity and output of oil and gas, ConocoPhillips is the best choice of the big three U.S. energy plays.

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The article Why You Shouldn't Sell ConocoPhillips originally appeared on Fool.com.

Casey Hoerth is long ConocoPhillips for various family accounts. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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