Organization ConocoPhillips Public Release Date - Value … · ConocoPhillips 6 During the past few years, oil and gas exploration company ConocoPhillips (NYSE: COP) has shed non-strategic,

Organization ConocoPhillips

Public Release Date May 2014

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IN THIS ISSUE

A Note From the Editor 2

Value Line Dividend Select Portfolios 4

This Month’s Recommendation

ConocoPhillips 6

During the past few years, oil and gas exploration company ConocoPhillips

(NYSE: COP) has shed non-strategic, underperforming operations to

focus on more-promising businesses. We look for heavy investment, most

notably in North America, to pay off in solid sales, earnings, and cash-flow

growth. To 2017-2019, investors stand to gain from dividend hikes of about

3% a year, above-average yields of 3%-4%, and respectable share-price

appreciation, with limited risk.

Financial Statements 14

Other Notable Stock Selections

Atmos Energy Corp. 18

Natural gas utility Atmos Energy (NYSE: ATO) aims to lift its share net 6%-

8% a year. Ongoing spending on its core distribution operations in the

southern United States and likely reasonable regulatory treatment should

support the attainment of this goal. Favorable returns on equity ought to

ensure good annual dividend growth (3%-4%), helping to sustain a yield

of 3%, or better, over the long run.

Maxim Integrated Products 21

Maxim Integrated Products (NDQ: MXIM) is setting the scene for improved

sales and earnings. The maker of electronic devices is having success in

pursuing business in the world mobile computing, automotive, utility

infrastructure, and medical equipment markets. Investors likely will

benefit from a yield above 3%, yearly dividend growth of 8%-9%, decent

share-price gains, and stock buybacks through 2017-2019.

Footnotes 24

2 Value Line Dividend Select May 2014

So far this year, the broader domestic stock market has retained its strength well against significant mac-roeconomic and global political pressures, recovering from each brief pullback. As we have stated previ-ously, in late January/early February there was a general economic setback among developing nations that notably pushed down share prices overseas and in this country. By early March, the major market indexes largely recovered but, near the middle of the month, the mounting political crisis in Ukraine had a brief, measurably negative impact on the performance of stocks. As well, about one month later, hedge funds, within a narrow window of time, shifted money away from high-flying social media, Inter-net search, and biotechnology equities toward blue chip tech companies. Too, interest in initial public offerings became more subdued. A few companies looking to tap the market for funding even delayed planned issues. As of this writing, stocks have returned to near-record levels. Bargain hunters have picked up many of the beaten down high-tech issues. The Standard & Poor’s 500 Index is slightly up from where it was at the start of this year, and is not far from its record high. Though currently in negative territory, the Dow Jones Industrial Average is closing in on its 2014 breakeven level. The NASDAQ is a good measure below its 14-year high, reached in early March, but has bounced off its low for the year. True, the S&P 500 Volatility Index, also known as the VIX, has spiked a few times in 2014, but it has, on most days, stayed somewhere in the low teens, a range that does not present much cause for concern.

Going forward, market volatility might well increase, especially if certain areas of the world, that is, Eastern Europe, the Middle East, and Latin America, experience greater, or prolonged, political and economic troubles. Tensions over the Ukraine continue to simmer. Also, though we don’t expect it, a further slowdown of growth in China would likely worry investors. On a positive note, the recovery of the U.S. economy in the wake of the severe 2007-2009 recession is progressing, albeit at a moderate pace. Harsh winter weather had a negative impact on the operating performances of many domestic companies, which is coming to light in the earnings season now under way. Recent regional and national readings of manufacturing activity, though not particularly strong, do indicate an ongoing expansion. The inclement winter created pent-up demand that ought to be satisfied in the current quarter and those that follow. The same seems to be true regarding the retail and housing sectors. Since the economy is holding up fairly well and inflation is gathering some momentum, the Federal Reserve likely will stick to a plan to conclude its bond-buying program late this year or in early 2015. Employment is firming and wages are improving incrementally. Consumers have considerably pared their debt obligations and have more disposable income to spend on big ticket items. Easier lending terms have been a plus. Consumers do, however, continue to be conservative about spending on everyday necessities. All this suggests steady to slowly strengthening economic growth over the next several years.

Overseas, the economic situation, while not sanguine, is somewhat encouraging. Though economies in Latin America remain under pressure, fears of a major meltdown have subsided. Europe has its financial house in order after the recent crisis, but government and economic authorities, as they are well aware,

A Note From the EditorBY DAVID M. REIMER, EDITORIAL ANALYST

May 2014 Value Line Dividend Select 3

A NOTE FROM THE EDITOR

need to take action to promote growth. Officials are weighing the viability of certain actions, including something similar to the U.S. Federal Reserve’s bond-buying program. Russia is playing an effective chess game with regard to Ukraine. That regional power, though apparently on the verge of falling into a recession, is a significant supplier of natural gas to Europe (and, possibly in the near future, China) and retains considerable economic leverage. An invasion of Ukraine cannot be ruled out. In the event of such an occurrence, the United States may be hard pressed to win Europe’s backing for highly-stringent sanctions, which would in all likelihood be a drag on the global economy. Elsewhere, officials in China are working to ensure healthy, albeit more modest, long-term economic expansion founded more on internal consumption. Assuming they are successful, developing and developed countries around the globe should benefit.

We’re optimistic that the world economy will grow at a mid-single-digit annual rate over the next three to five years. Most companies should become more confident about business prospects, and shift money from stock buybacks and dividend hikes toward investment in growth areas, thus supporting broader international growth. That said, large mature organizations, many of which are in our Dividend Select portfolios, surely will remain mindful that they still need to reward loyal investors. A sizable, aging baby boom population should continue to favor relatively safe, high-yielding equities.

Recent Portfolio ActionIn the one-month period (ending April 25th), our Featured Portfolio turned in a strong performance with a clear majority of stocks posting solid gains. Topping the list was consumer goods giant Unilever (NYSE: UL), the ADRs (American Depository Receipts) of which advanced an impressive 10.5%, and attained a new all-time high. There is much excitement surrounding the company’s pending purchase of a controlling interest in Qinyuan Group, a water purification operation serving the vast China market. In light of the elevated valuation, however, we are maintaining our Hold recommendation on this equity. Not far behind Unilever was Consolidated Edison (NYSE: ED), turning in a strong one-month show-ing, with its share price rising 10.1%. The stock of the New York utility has benefited from investors seeking high-quality issues. Our Buy recommendation on this stock stands. Investors may want to sell their stakes in Johnson & Johnson (NYSE: JNJ), thereby locking in a hefty total return of 58% (or 20% annualized) since our initial recommendation in July 2011.

Our Alternative Portfolio also performed well in the recent one-month term. Here, too, utilities proved popular with investors. American Electric Power (NYSE: AEP) posted a gain of 9.2% and Public Service Enterprise Group (NYSE: PEG) advanced 9.1%. Since AEP shares still have decent three- to five-year total return prospects, we are maintaining our Hold recommendation. The stock of Public Service, though, is trading at the upper end of our long-term price projections. Thus, we advise investors to shed their stakes. Since our original report on the New Jersey-based utility in December of 2012, its stock has produced a total return of 40% (28%, annualized). Separately, British American Tobacco (NYSE: BTI) ADRs achieved an 8.7% price improvement in the 30-day period. Despite a tough market environment, highlighted by stiff competition and declining demand for traditional smokes in developed nations, the tobacco company is generating ample cash flow and rewarding investors with stock buybacks and an



attractive dividend. Emerging market cigarette demand is firm. In our view, those seeking income stand to gain over the long run. We rate British American a Buy. We suggest investors divest their holdings in DuPont (NYSE: DD). During the term since our initial report on the chemicals company in November 2012, the stock generated a total return of 60% (40%, annualized). Note that investors with taxable accounts should consider their holding period for capital gains purposes, in combination with their risk preferences.

Going forward, we look for good-quality, income-generating equities to perform well, in comparison with the broader stock market indexes. Most conservative investors should be able to find a number of equities within our Dividend Select portfolios that suit their individual outlook. ■

Dividend Select Featured Stock Portfolio † †

NameRecent price

Our rec.

Curr. yld (%)

2013 tot. rtn.

YTD total return

Ann. rtn. since incep. (%)

Inception date

AT&T (T) $34.49 Hold 5.4 9.9 -0.6 12.3 2/10/2012

Bank of Montreal (BMO) $68.68 Hold 4.5† 15.7 4.2 23.4 6/7/2013

Baxter Int'l (BAX) $72.32 Buy 2.7 7.3 5.4 15.1 10/5/2012

Coca-Cola (KO) $41.01 Hold 3.0 17.2 Nil 12.2 1/17/2012

Consolidated Edison (ED) $57.74 Buy 4.4 — 6.2 172 4/4/2014

Dow Chemical (DOW) $48.50 Buy 3.0 13.1 10.0 74.0 12/6/2013

General Mills (GIS) $52.29 Hold 3.1 27.5 5.6 17.9 8/12/2011

GlaxoSmithKline (GSK) $55.76 Buy 4.6† — 7.1 26.0 1/10/2014

McDonald's (MCD) $100.73 Hold 3.2 -0.1 4.7 7.9 10/11/2013

Microchip Tech (MCHP) $47.16 Buy 3.0 15.0 6.2 38.3 9/6/2013

Molson Coors (TAP) $58.56 Buy 2.5 — 12.5 69.9 2/7/2014

Nestlé SA (NSRGY) $75.96 Buy 3.2† 9.7 6.5 14.7 3/8/2013

Norfolk Southern (NSC) $94.03 Hold 2.3 54.1 1.9 20.6 4/13/2012

PepsiCo (PEP) $85.25 Buy 3.1 7.0 4.2 10.7 4/5/2013

Procter & Gamble (PG) $81.41 Buy 3.2 0.5 0.7 1.7 8/9/2013

Roy'l Bank of Can. (RY) $65.61 Hold 4.3† 10.4 -1.4 7.3 2/8/2013

Total S.A. (TOT) $68.50 Buy 4.8† 4.1 13.2 45.3 11/8/2013

TransCanada (TRP) $45.94 Buy 4.2† — 3.3 24.7 3/7/2014

Unilever (UL) $43.83 Hold 3.3† 9.2 7.3 18.7 3/9/2012

Waste Management (WM) $43.04 Hold 3.5 36.8 -3.2 17.1 8/10/2012

2013 portfolio return

Year-to-date portfolio total return

Total portfolio annualized return since inception

32.0

4.1

20.7

† Excludes nonresident tax † † As of April 25th, 2014



Dividend Select Alternative Stock Portfolio † †

NameCurrent

priceOur rec.

Curr. yld. (%)

2013 tot. rtn.

YTD total return

Ann. rtn. since incep. (%)

Inception date

A.J. Gallagher (AJG) $44.48 Buy 3.2 7.6 -4.5 4.9 10/11/2013

AbbVie (ABBV) $49.14 Buy 3.4 20.1 -6.2 18.5 10/11/2013

Amer. Elec. Pwr (AEP) $53.38 Hold 3.8 14.4 15.3 17.1 12/16/2011

Avista (AVA) $31.74 Buy 4.0 1.3 13.8 26.8 11/8/2013

BCE Inc. (BCE) $43.93 Buy 5.0† — 0.9 3.8 4/4/2014

British Amer. Tobac. (BTI) $115.53 Buy 4.0† -5.0 7.5 4.3 5/10/2013

CSX Corp. (CSX) $28.03 Buy 2.3 — -2.4 -3.9 1/10/2014

Dr Pepper Snapple (DPS) $53.58 Buy 3.1 5.2 10.0 14.6 6/7/2013

General Elec. (GE) $26.60 Buy 3.3 37.9 -3.5 21.1 6/8/2012

Invesco (IVZ) $34.88 Buy 2.6 — 1.0 3.3 3/7/2014

Kellogg (K) $66.71 Hold 2.8 6.0 10.0 12.2 2/8/2013

Kohl's (KSS) $54.68 Hold 2.9 9.0 -3.0 8.1 9/6/2013

Kraft Foods Group (KRFT) $56.66 Buy 3.7 2.3 7.1 11.9 9/6/2013

Mercury General (MCY) $47.17 Hold 5.2 15.0 -3.9 13.7 8/9/2013

Meridian Biosci. (VIVO) $19.75 Buy 4.0 — -6.1 -12.7 2/7/2014

Novartis (NVS) $84.47 Hold 3.2† 7.3 5.1 14.2 5/10/2013

People's Utd Fncl (PBCT) $14.38 Buy 4.6 — -5.5 -9.1 1/10/2014

Piedmont Nat'l Gas (PNY) $35.84 Buy 3.6 1.2 10.1 21.1 12/6/2013

PPL Corp. (PPL) $33.55 Hold 4.4 10.5 14.2 14.5 5/4/2012

Qualcomm (QCOM) $77.61 Buy 2.2 0.7 5.0 11.3 12/6/2013

Republic Services (RSG) $34.40 Hold 3.1 -2.1 3.6 1.3 6/7/2013

Reynolds American (RAI) $55.10 Hold 4.9 — 14.4 40.9 2/7/2014

Royal Dutch Shell (RDS-A) $75.46 Hold 5.0† 7.4 7.2 10.0 10/5/2012

Siemens AG (SI) $132.75 Buy 3.2† 8.1 -1.2 10.9 11/8/2013

Sysco (SYY) $36.04 Hold 3.2 17.9 1.4 8.3 6/3/2011

Taiwan Semicond. (TSM) $19.91 Buy 2.5† — 6.1 20.4 3/7/2014

TELUS Corp. (TU) $34.43 Hold 4.4† 4.4 2.1 5.0 3/8/2013

Thomson Reuters (TRI) $34.59 Hold 3.8† 17.2 -7.7 9.4 7/5/2013

Tupperware (TUP) $84.61 Buy 3.3 — 3.0 13.4 4/4/2014

Verizon (VZ) $45.94 Hold 4.6 18.8 -5.5 12.1 7/1/2011

2013 portfolio total return

Year-to-date portfolio total return

Total portfolio annualized return since inception

25.0

2.5

12.2

† Excludes nonresident tax † † As of April 25th, 2014


Houston, Texas-based ConocoPhillips (NYSE: COP), with operations in 27 countries, is the largest independent energy exploration and production (E&P) company in the world. At the end of 2013, including equity investments, ConocoPhillips had sizable net proved reserves of 2,749 million barrels of oil equivalent (MMBOE) of crude oil; 744 MMBOE of natural gas liquids; 3,398 MMBOE of natural gas; and 2,030 MMBOE of bitumen (a liquid or semi-solid form of petroleum); equating to a total of 8,921 MMBOE. The company traces its roots back to the Continental Oil and Transporta-tion Co., which was headquartered in Ogden, Utah and founded in 1875. Over the years, operations gained substantial scale, most notably by way of mergers and acquisitions. In 2002, Conoco Inc. combined with Phillips Petroleum Co., creating the sixth largest entity within the broader integrated petroleum industry. Some 10 years later, downstream operations (i.e., oil refining, fuel marketing, gas gathering, and chemicals production) were separated from upstream activities (E&P) and spun off to shareholders as a new publicly traded company called Phillips 66. More recently, management has endeavored to shed underperforming and non-strategic assets to better focus on highly profitable and promising core business venues.

Since downstream operations were spun off just two years ago, there is not quite enough of a trading record for Value Line to assign a Timeliness rank to ConocoPhillips stock. (A rank will probably be determined within the next few months.) Even so, in the wake of the Phillips 66 spinoff, Conoco shares have performed in line with the broader market averages, providing investors with solid, rela-tively low-risk returns. Indeed, as of this writing, the total return (share-price appreciation and divi-dend payments) amounts to 48.5%. We note that in the first two months of this year, Conoco stock diverged from the broader market, further backing off a high of $74.60 reached in late October 2013. This was likely due to profit-taking on the part of investors. In recent weeks, though, the equity has recovered.

We believe that management has the right plan in place to steadily build the company’s aggregate average commodities production from 1,502 MBOED (thousand barrels of oil equivalent per day)

This Month’s Recommendation

ConocoPhillips

Dividend History & Projections

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Dividends Declared

$1.91 $2.15 $2.64 $2.64 $2.73 $2.76 $2.84 $2.92 $3.00 $3.08

Dividend Yield

4.2% 3.9% 3.7% 4.7% 4.2% 3.7% 3.6% 3.5% 3.4% 3.3%


CONOCOPHILLIPS

in 2013 to its goal of 1,900 MBOED within the next five years. Heavy capital outlays should pay off in increased output, which ought to measurably strengthen yearly sales, earnings, and cash flow growth, providing the means to reward loyal investors. During the past three years, asset divestitures have helped to fund operations, as well as significant common stock buybacks and dividend hikes. Going forward, additional share repurchases and dividend increases seem likely, funded by ongoing operations. On a 12-month forward basis, the stock yields 3.7%, versus the Value Line median of 2.0%. We project average annual dividend advances of 3.0% to 2017-2019, which should support a yield of 3%-4%. Over that timeframe, investors can also expect worthwhile share-price improvement. ConocoPhillips has a stellar Financial Strength rating of A++ and its stock is ranked 1 (Highest) for Safety. For information on the company’s direct share-purchase and dividend reinvestment plans, visit www.conocophillips.com.

Business BackgroundConocoPhillips has a long history of oil and gas discovery, technological in-novation, and asset acquisition. It all started in 1875 when Isaac Elder Blake established Continental Oil and Trans-portation to import kerosene, via rail-road tank cars, to Utah from Colorado. This fuel was highly sought after for use in lanterns, as opposed to relying on whale oil and candles for light. A decade later, Standard Oil took control of the company and expanded its mar-keting of petroleum products in the Rocky Mountain region. Separately, in the early 20th Century, brothers Frank and L.E. Phillips struck oil in Oklaho-ma and quickly built up a sizable port-folio of successful exploration wells. Around that time, the American auto industry began to establish itself, and the refining of oil into gasoline start-ed to become an important business. Notably, in 1913, the U.S. Supreme Court, as part of its effort to break up monopolies, ordered Standard Oil to divest Continental. From its home base in the West, Continental then

Value Line Ranks & Projections

TimelinessTM (A) —

SafetyTM (B) 1

Recent Price $74.40

2017-’19 Price Forecast $85-$100

Footnotes are on page 24

Company Data

Industry Petroleum (Producing)

Exchange NYSE

Ticker Symbol COP

Options Yes

Financial Strength A++

Actual E.P.S. FY ’13 $6.43

Estimated E.P.S. FY ’14 $6.35

Estimated E.P.S. FY ’15 $6.70

Current P/E Ratio 12.6

Relative P/E (C) 0.67

Dividend Yield 3.7%

Actual Payout Ratio FY ‘13 42%

Shares Outstanding 1,239.8 million

Insider Holdings Less than 1%

Market Cap $92.2 billion (Large Cap)

Report As Of May 9, 2014

Address4600 North Dairy Ashford Rd. Houston, TX 77079

Telephone 212-207-1996

Website www.conocophillips.com


CONOCOPHILLIPS

launched construction of a chain of 1,000 service stations extending across a 15-state territory. Also noteworthy, by the late 1920s, Phillips Petroleum Co. had set up 10,000 gasoline filling stations of its own, nationwide, and was offering aviation and home propane fuel services. In 1929, Continental Oil Co. (also known as Conoco) was formed upon the merger of Continental Oil and Transporta-tion with Marland Oil, an Oklahoma-based business with considerable oil reserves around the globe and a large domestic gasoline station network serving customers in 30 states. Conoco was becoming a well-recognized brand name at that time. Through the 1930s, both Phillips and Conoco enlarged their refining capacities and enhanced their retailing capabilities. Most visibly, Phillips acquired the Independent Oil and Gas Co., a refining and retail fuel operation run by another family member, and Continental built a lucrative pipeline to Chicago, developed a new brand of Conoco motor oil, which became quite popular with consumers, and created highly effective gasoline marketing campaigns.

During the 1940s, Phillips and Conoco formulated improved, lightweight aviation fuels used in military and commercial applications. As well, in that decade, Phillips set up a chemicals division. Through the 1950s and 1960s, Phillips became more deeply involved in the burgeoning plastics in-dustry and was one of the first companies to begin transporting liquefied natural gas (LNG). Over that same period, Conoco ramped up its research & development operations and expanded its refinery business. In the 1970s, Conoco extended operations overseas via asset acquisitions, particularly in Europe. Too, the company was then stepping up its focus on the chemicals and plastics markets. That

ConocoPhillips Price Chart

Share Prices 2009 2010 2011 2012 2013 2014

High 57.4 68.6 81.8 78.3 74.6 74.9

Low 34.1 46.6 58.7 50.6 56.4 63.5


CONOCOPHILLIPS

drew the attention of DuPont, which purchased all of Conoco’s outstanding common shares for $7.4 billion in 1981. Sixteen years later, however, wanting to turn its attention more toward the “life sci-ences” (i.e., biotechnology) market, DuPont shed its interest in Conoco through a $4.4 billion initial public offering. A financially fit Conoco was free to pursue promising opportunities in the world E&P sector. In August 2002, Conoco and Phillips merged in an all-stock transaction, creating ConocoPhil-lips, a company with a total market capitalization of $35 billion. In the following years, the combined company embarked on several new forays, including an oil sands development project in Canada, an offshore oil endeavor in Vietnam, a partnership with Lukoil of Russia, a coal-bed methane and LNG processing and sales venture, a water recycling research center, and renewable energy produc-tion plants. Furthermore, ConocoPhillips used its improved financial heft to purchase Burlington Resources, another Houston-based oil and gas company, for $35.6 billion in 2006.

In 2011, the board of directors approved management’s plan to separate the company into two pub-licly traded entities, ConocoPhillips and Phillips 66, which was executed in April 2012. Management was looking to unlock hidden stockholder value that had built up as a result of the merger’s success. Indeed, the separation has increased the total market capitalization of the two stocks by some 105%, to just over $140 billion. Under its new configuration as an E&P company, ConocoPhillips has moved to divest nonstrategic operations and boost production within the core energy business, while adding new assets with the potential for high returns on investment; the North American shale oil industry has proved to be an especially lucrative endeavor. From 2011 to date, management has shed interests in the Russian entities Lukoil and Naryanmarneftegaz and certain assets in Algeria, Australia, Canada, Kazakhstan, the North Sea, Trinidad and Tobago, Vietnam, Montana, and North Dakota. Currently, the sale of a Nigerian asset is pending. Last year, the company sold a sizable $10 billion worth of assets. Going forward, management expects a more normal annual rate of asset sales of ap-proximately 1% ($1 billion-$2 billion) of the total.

Segment OverviewConocoPhillips has divided itself into six regional operating segments identified as: Lower 48 and Latin America, Asia Pacific and Middle East, Canada, Alaska, Europe, and Other International. The Lower 48 and Latin America segment, primarily consisting of assets in the 48 contiguous states in the continental United States, the Gulf of Mexico, and Colombia, accounts for the biggest portion of overall average daily net production. Last year, the U.S. Lower 48 represented the bulk of this production, or 491 MBOED, made up of 243 MBOED of liquids (mostly crude oil and natural gas) and 1,490 MMCFD (million cubic feet per day) of natural gas. This segment contributed 29% of Conoco’s global liquids production and 38% of its gas output in 2013. It has 13.1 million acres of onshore fields, 10.4 million of which is designated as “conventional” acreage and 2.7 million as “unconventional.” Conventional E&P refers to the use of traditional drilling wells to tap into oil and gas deposits, while unconventional E&P entails the high-tech extraction of oil and gas and other commodities, including extra-heavy oil, natural bitumen (oil sands), and coal-bed liquids. Generally, conventional acreage is easy to tap and involves low-cost processes. Unconventional acreage is more challenging in that advanced, expensive technology is required to access commodities in hard-to-


CONOCOPHILLIPS

reach underground deposits. Some of the largest unconventional fields are located in northwestern New Mexico and southwestern Colorado (the San Juan Basin); North Dakota and eastern Montana (Bakken); West Texas and southeastern New Mexico (Permian); and South Texas (Eagle Ford).

In recent years, given ample oil deposits in shale formations and low natural gas prices, Conoco has turned more of its attention toward investing in high-margined, liquids-rich unconventional extrac-tion fields. As well, the company has increased its efforts, with good results, so far, to further develop and optimize production at existing locations and establish new sites, particularly at its four most significant fields. Crude oil production at the segment rose a strong 24% last year. Too, Conoco is working to capitalize on meaningful deepwater discoveries in the Gulf of Mexico, more specifically, within the Lower Tertiary at Coronado and Gila, and the Shenandoah and Tiber underwater areas. In Colombia, Conoco is currently exploring unconventional fields in the Middle Magdalena Basin. Elsewhere in Latin America, on a negative note, the company is pursuing compensation for assets that were previously expropriated by the governments of Venezuela and Ecuador. In total, the segment looks to boost its production some 365 MBOED (from 2012 levels) by 2017.

Conoco’s Asia Pacific and Middle East segment, with average production of 312 MBOED in 2013 (or 13% of company liquids output and 30% of natural gas generation), is its next largest operation. Inside the segment, last year, 85 MBOED of production originated from Indonesia, 84 MBOED from the Australia and Timor Sea region, 83 MBOED from Qatar, 54 MBOED from China, and 6 MBOED from Malaysia. In the South Natuna Sea off the coast of Indonesia, the segment runs opera-tions across three oil fields and 16 natural gas fields. It also operates five oil fields and seven gas fields in South Sumatra. The company is actively developing new exploration sites in Papua and central Ka-limantan. In Australia, Conoco has a venture with Origin Energy and China Petrochemical that pro-duces liquefied natural gas from coal-bed methane. That operation has begun building LNG export facilities with the aim of capitalizing on a fast-growing global market. In the Timor Sea, the segment is expanding its natural gas exploration and also runs LNG production and export facilities. A part-nership with Qatar Petroleum and Mitsui develops gas fields and produces LNG in Qatar for global export. In China, the segment, along with its partners, China National Offshore Oil Co. (CNOOC) among them, principally produces oil from offshore wells in Bohai Bay and the South China Sea. Studies are under way to determine the viability of shale gas exploration in the Sichuan Basin located in the southwestern region of the country. In Malaysia, Conoco has interests in five deepwater pro-duction sharing contracts with well operator Royal Dutch Shell. Furthermore, the segment owns and has interests in deepwater projects that are in development in Bangladesh and Brunei. The segment expects its output to rise by about 25 MBOED over the period from 2012-2017.

The Canada segment is the third most significant producer of commodities for the company, turning out 276 MBOED (17% of total liquids production and 20% of gas production) in 2013, includ-ing 775 MMCFD of gas, 109 MBD (million barrels per day) of bitumen, and 38 MBD of liquids. Operations, here, mainly consist of natural gas fields in the western part of the country, from central Alberta to northeastern British Columbia, and oil sands development in the Athabasca Region of northeastern Alberta. In western Canada, Conoco has leasehold rights in 5.7 million acres and has


CONOCOPHILLIPS

stakes in 80 natural gas processing plants. Development is concentrated on the Deep Basin, Kaybob, and Clearwater areas. With regard to oil sands extraction, the segment is participating with Total S.A. in a project, located near Fort McMurray, which is slated for initial production in 2015; peak output of 150 MBOED may well be reached by 2018. Also, it has a heavy-oil partnership with Cenovus Energy to work the bitumen deposits within the Foster Creek, Christina Lake, and Narrows Lake areas. This partnership is utilizing an effective thermal oil recovery technology called steam-assisted gravity drainage. Within the next five years, production capacity in these areas may well approach 750 MBOED. Conoco has 900,000 acres of land with substantial oil sands deposits. Additionally, the Canada segment has a 55% interest in the Amauligak discovery, which is in a shallow-water area of the Beaufort Sea, and is considering various options for its development. Most important, the segment is pursuing liquid-rich deposits, via unconventional exploration, in Alberta, British Columbia, and the Northwest Territories; the Montney, Muskwa, Duvernay, and Canol locations are getting much attention. Management has targeted 105 MBOED in additional Canada-segment production over the 2012-2017 term.

Conoco’s Alaska segment (23% of liquids output and 1% of gas output) produced a combined net average of 200 MBOED in crude oil, natural gas liquids, natural gas, and LNG last year. It is the largest producer of oil and gas in the state with major operations in the North Slope, Prudhoe Bay, and Kuparuk areas. The segment has exploration leases covering 500,000 undeveloped acres in the National Petroleum Reserve–Alaska and another 300,000 acres in the Chukchi Sea. Thus, there is ample opportunity to continue to expand energy exploration and production. A recent relaxation of progressive tax rules in the state has created more incentive for investment. Also noteworthy, the company is working with Exxon Mobil, TransCanada, and British Petroleum on a long-term plan to considerably expand the state’s LNG export infrastructure. Alaska production is estimated to increase by 35 MBOED from 2012 to 2017.

In 2013, operations in Europe’s North Sea turned out 189 MBOED (14% of total liquids production and 11% of gas production), with 119 MBOED coming from the Norway sector and the remainder from the United Kingdom sector. Assets in the Norway sector of the sea extract and ship oil to Norway and the United Kingdom and natural gas to Norway and Germany. Those in the U.K. sector produce oil and gas generally for local delivery. Conoco has full and partial ownership interests in several exist-ing wells and new ones that are in the planning stage in the North Sea, auguring well for future pro-duction. Four major projects are under way and should help to restore combined production growth for operations in Norway and the United Kingdom. The company is also actively exploring promising sites in Poland and Greenland. Europe’s production ought to rise by about 40 MBOED in the 2012-2017 period.

Lastly, Conoco’s Other International segment produced 34 MBOED of liquids (4% of the total) in 2013. Some 30 MBOED of output stems from Libya, where the company has a stake in the Waha Concession that explores and produces oil and gas within a 13 million acre area in the Sirte Basin. The Libyan National Oil Corp., Hess Corp., and Marathon Oil Corp. participate with Conoco in the concession. Oil production there, however, has been suspended since mid-2013 due to the shutdown


CONOCOPHILLIPS

of the Es Sider export terminal, a result of ongoing worker and political strife. Meanwhile, new devel-opment wells continue to drill for additional reserves. Elsewhere, through a venture with Polar Lights Co., the segment is developing fields in the Timan-Pechora Basin in northern Russia. Other energy as-sets are in development in Angola, Azerbaijan, and Senegal. We note that the company is particularly excited about exploring some very large blocks of acreage off the coast of Angola. Management expects Other International-segment production to advance by 10 MBOED from 2012 to 2017.

Business ProspectsConocoPhillips is unique in the E&P industry in that it is twice the size of its closest competitor and offers investors an uncharacteristically low level of risk. Substantial scale and financial heft enhance the company’s technological capabilities, provide the ability to take on massive, multibillion-dollar projects, and lend much flexibility to pursue a broad spectrum of E&P endeavors. That said, man-agement is careful to always keep in mind its aim of optimizing both operating performance and stockholder value via appropriate asset allocation. Currently, capital spending, running in the range of $16 billion-$17 billion a year, is at a high level. From 2014 to 2017, some 45% of these outlays will be dedicated to developmental programs (e.g., oil sands), 30% will go toward major projects (LNG), 15% will be concentrated on long-term exploration (Angola), and 10% is earmarked for maintenance of existing assets. (Note that exploration spending is divided 50/50 between conventional and uncon-ventional activities.) The company believes that these ratios of investment will support its production growth target. Conoco’s debt-to-total capital ratio at the end of 2013 was a modest 29% and com-pared favorably with those of a majority of its E&P industry peers.

Most visibly, about 25% of annual spending is now devoted to the LNG export initiative in Australia, mentioned above, and the oil sands endeavor with Total S.A. in Canada. These two projects should begin to ramp up production next year. Importantly, as related start-up investments trail off, Conoco will have more funds available to enlarge its promising unconventional exploration efforts. Major projects and developmental programs ought to go a long way toward replenishing reserves, as those from established assets, most notably in Alaska, Norway, and the United Kingdom, become depleted with age. Impressively, in 2013, the company achieved a reserve replacement ratio of 179% for ongo-ing assets. (The ratio was 147%, net of asset divestitures.) Reserve additions of 1.1 BBOE (billions of barrels of oil equivalent) largely came from the Eagle Ford and Bakken areas in the Lower 48, oils sands sites in Canada, and the Australia LNG project. Some 75% of these new reserves consisted of high-value, liquids-priced commodities, including LNG. The Australia project, oil sands activities in Canada, unconventional development in the Lower 48, large projects in Europe, and deepwater exploration in Malaysia should be the prime drivers of growth over the next three to five years. An emphasis on oil-based production and LNG likely will boost profitability and cash flow. A higher proportion of business in low-tax jurisdictions will be an extra plus.

After the spinoff of Phillips 66, management specified the goal of increasing overall production by 3%-5% a year, emphasizing commodities that would promote a similar rate of operating margin expansion. This would potentially enable the company to improve its cash flow by 6%-10%, annu-


CONOCOPHILLIPS

ally, and provide the means to reward investors with an attractive yield, supported by solid dividend growth, and incremental share buybacks. We note that from 2012 to 2013, Conoco’s total production from continuing operations was generally flat (rising by just 30 MBOED) and commodities price levels held fairly steady. Even so, the company’s cash-flow margin (excluding special items, such as leasehold impairment charges and dry hole cost outlays) improved from $25.64 per BOE (barrel of oil equivalent) to $28.55 BOE, thanks to a more favorable mix of commodities. Additional improvement appears in store for the long term. Now that the company has put major asset dispositions behind itself, year-to-year sales and share-net comparisons ought to stabilize by the end of this year and turn positive.

Conoco’s dividend yield is not only competitive with those offered by its smaller E&P peers, but also those of the largest Europe-based integrated petroleum companies, the distributions of which are subject to nonresident withholding taxes, and of the domestic oil production majors. In 2012, ConocoPhillips began trading as a new company with a very appealing 5% dividend yield. The in-come level has moved lower, on a yield basis, but that was due to solid share-price appreciation. Management intends to maintain an above-average yield by regularly hiking the payout. Last year, total dividend payments amounted to 22% of gross cash flow, which was a reasonable ratio. As recent capital investments begin to generate results, we believe that Conoco can attain its production, oper-ating margin, and cash flow goals over the next several years. Cash flow gains should be sufficient to increase the dividend by 3% a year and sustain an above-average yield. Though the global price of oil, at times, can cause some near-term volatility in its share price (due to changes in reserve valuations), Conoco stock has closely tracked the performance of the broader domestic stock market indexes for most of the company’s history as an E&P operation. Importantly, increasing supplies of oil and gas from reliable sources, growing conservation efforts, and an expanding renewables industry are helping to reduce volatility in world energy prices. A shift in the business mix, favoring the developed world, implies less operating and political uncertainty ahead. In our view, this equity is an appealing low-risk income vehicle for conservative investors over the pull to 2017-2019. ■


Income Statement Data (In millions, excluding per share amounts)

2013 2014 2015 2016 2017 2018

Sales & Other Oper. Revs. $54,413 $56,600 $58,625 $61,100 $63,825 $67,300

Equity in Earnings Of Affiliates 2,219 2,500 2,750 3,250 3,500 4,000

Gain on Disposals 1,242 500 200 200 200 200

Other Income 374 400 425 450 475 500

Revenues & Other Income $58,248 $60,000 $62,000 $65,000 $68,000 $72,000

Purchased Commodities 22,643 23,000 23,500 24,000 24,500 25,000

Production & Oper. Expenses 7,238 7,400 7,600 7,800 8,000 8,200

Selling Gen'l & Admin. Exp. 854 875 900 925 950 975

Exploration Expenses 1,232 1,250 1,275 1,300 1,325 1,350

Non-Income Taxes 2,884 2,950 3,000 3,050 3,100 3,150

Operating Income $23,397 $24,525 $25,725 $27,925 $30,125 $33,325

Depreciation 7,434 7,750 8,200 8,600 9,050 9,500

Interest Expense 612 615 618 622 625 630

Other Expenses 905 875 800 750 700 650

Pretax Income $14,446 $15,285 $16,107 $17,953 $19,750 $22,545

Income Taxes 6,409 7,375 7,795 8,740 9,700 11,175

Effective Tax Rate 44.4% 48.2% 48.4% 48.7% 49.1% 49.6%

Net Inc. Non-Controlling Ints. 59 63 74 91 109 135

Net Income $7,978 $7,847 $8,238 $9,122 $9,941 $11,235

Diluted Shares 1,239.8 1,235.0 1,230.0 1,225.0 1,220.0 1,215.0

Diluted Earnings per Share $6.43 $6.35 $6.70 $7.45 $8.15 $9.25

Percentage Analysis

2013 2014 2015 2016 2017 2018

Operating Margin 40.2% 40.9% 41.5% 43.0% 44.3% 46.3%

Pretax Margin 24.8% 25.5% 26.0% 27.6% 29.0% 31.3%

Net Margin 13.7% 13.1% 13.3% 14.0% 14.6% 15.6%

FINANCIAL STATEMENTS — CONOCOPHILLIPS



Flow of Funds Data (In millions)

2013 2014 2015 2016 2017 2018

Cash Flow $15,412 $15,597 $16,438 $17,722 $18,991 $20,735

Debt Financing — 717 1711 2365 1210 990

Pf’d Equity Financing — — — — — —

Com. Equity Financing 20 — — — — —

Other 1,733 1,582 1,522 1,503 1,494 1,470

Total Funds In $17,165 $17,896 $19,671 $21,590 $21,695 $23,195

Capital Spending 15,537 16,500 15,500 14,500 13,500 13,000

Other Investments — — — — — —

Dividends Paid 3,334 3,400 3,500 3,575 3,660 3,745

Debt Retired 946 590 1,576 2,200 1,075 875

Pf’d Equity Retired — — — — — —

Com. Equity Retired — 350 370 390 410 425

Total Funds Out $19,817 $20,840 $20,946 $20,665 $18,645 $18,045

Yearend Working Cap’l $3,894 $950 ($325) $600 $3,650 $8,800

Avg. Annual Rates of Growth(2013 to 2018)

Revenues: 4.5%

Operating Income: 7.5%

Pretax Income: 6.0%

Earnings per share: 7.5%

All numbers, except percentages and per-share data, are in millions. Numbers in bold italics are Value Line estimates; all estimates except percentages and per-share figures are rounded to the nearest whole number. Footnotes are on page 24.



Historical Balance Sheet Data (In millions)

2011 2012 12/31/13

Cash & Equivalents $6,361 $4,366 $6,518

Receivables 14,648 9,182 8,487

Inventories 4,631 965 1,194

Other 4,578 9,476 2,824

Total Current Assets $30,218 $23,989 $19,023

Net Property, Plant 84,180 67,263 72,827

Investments & LT Recs. 32,108 23,489 23,907

Other 6,724 2,403 2,300

Total Assets $153,230 $117,144 $118,057

Payables $17,973 $10,013 $9,314

Debt Due 1,013 955 589

Taxes Payable 4,220 3,366 2,713

Other 4,862 3,109 2,513

Total Current Liabilities $28,068 $17,443 $15,129

Long Term Debt 21,610 20,770 21,073

Other Liabilities 38,328 30,944 29,765

Stockholders’ Equity 65,224 47,987 52,090

Total $153,230 $117,144 $118,057

Capitalization & Returns on Capital (In millions)

2013 2014 2015 2016 2017 2018

Long Term Debt $21,073 $21,200 $21,335 $21,500 $21,635 $21,750

Stockholders’ Equity $52,090 $53,500 $55,500 $60,000 $65,000 $72,500

Return on Total Capital 11.3% 10.5% 10.7% 11.2% 11.5% 11.9%

Return on Equity 15.3% 14.7% 14.9% 15.2% 15.3% 15.5%


Quarterly Revenues (In millions)

Mar. 31 Jun. 30 Sep. 30 Dec. 31 Full Yr.

2011 56,530 65,627 62,784 59,872 $244,813

2012 16,083 14,842 14,713 16,366 $62,004

2013 14,651 14,142 15,470 13,985 $58,248

2014 14,900 14,950 15,000 15,150 $60,000

2015 15,400 15,450 15,500 15,650 $62,000

Quarterly Revenue Growth


2012 -71.5% -77.4% -76.6% -72.7% -74.7%

2013 -8.9% -4.7% 5.1% -14.5% -6.1%

2014 1.7% 5.7% -3.0% 8.3% 3.0%

2015 3.4% 3.3% 3.3% 3.3% 3.3%

Quarterly EPS(D)


2011 1.82 2.41 2.52 2.02 $8.76

2012 1.67 1.35 1.40 1.48 $5.91

2013 1.63 1.66 1.96 1.20 $6.43

2014 1.55 1.55 1.60 1.65 $6.35

2015 1.62 1.63 1.70 1.75 $6.70

Quarterly EPS Growth


2012 -8.2% -44.0% -44.4% -26.7% -32.5%

2013 -2.4% 23.0% 40.0% -18.9% 8.8%

2014 -4.9% -6.6% -18.4% 37.5% -1.2%

2015 4.5% 5.2% 6.3% 6.1% 5.5%

Quarterly Dividends Paid


2010 0.50 0.55 0.55 0.55 $2.15

2011 0.66 0.66 0.66 0.66 $2.64

2012 0.66 0.66 0.66 0.66 $2.64

2013 0.66 0.66 0.69 0.69 $2.70

2014 0.69


All numbers, except percentages and per-share data, are in millions. Numbers in bold italics are Value Line estimates; all estimates except percentages and per-share figures are rounded to the nearest whole number. EPS might not add to total due to change in shares outstanding.



Timeliness(A) 3

Safety(B) 2

Recent Price $51.27

2017-2019 Price Forecast $45-$60

Atmos Energy Corp.’s predecessor company was Amarillo Gas Co., a Texas Panhandle coal gas producer founded by brothers Frank and J.C. Storm in 1906. In 1924, Amarillo Gas merged with Amarillo Oil, which had just previously discovered the largest natural gas field in the world at that time, forming Southwestern Development Co. The company quickly expanded its gas production and pipeline assets. In 1932, Sinclair Consolidated Oil Corp. gained control of Southwestern. Later, in 1954, Southwestern became a part of Pioneer Natural Gas Co. That business changed its name to Pioneer Corp. in 1975 to better reflect diverse energy operations. In 1983, Pioneer spun off Energas Co., as an independent utility, to its shareholders. Energas purchased Trans Louisiana Gas in 1986 and Kentucky Gas in 1987. The following year, the company adopted the Atmos Energy moniker. Thereafter, additional merger and acquisition deals were completed, including those of Greeley Gas’s Colorado and Kansas operations, United Cities Gas, Associated Natural Gas—Missouri, Woodward Marketing, Louisiana Gas Service, LGS Natural Gas, Mississippi Valley Gas, and TXU Gas’s utility and pipeline assets in Texas. During the past two fiscal years (years end September 30th), management decided to better focus and consolidate operations, divesting assets in Georgia, Missouri, Illinois, and Iowa.

Today, Dallas-based Atmos Energy is one of the largest gas utilities in the United States, with a focus on the South. It transports and distributes gas to three million customers, across eight states, via regu-lated operations. As well, the company has a non-regulated gas services subsidiary doing business in the Midwest and Southeast. Atmos has a good track record of maintaining its network and delivering

reliable service. This has led to favorable rate treatment within the company’s territory. To 2017-2019, as invest-ment in distribution expands, we project steady revenue, earnings, and cash-flow advances. Since its spinoff from Pioneer, Atmos has paid 121 consecutive quarterly divi-dends. The equity yields 3.0%, versus the Value Line me-dian of 2.0%. Decent average annual dividend increases of 3%-4% seem likely over the long run. Given a Safety


Atmos Energy Corp.


2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Dividends Declared

$1.32 $1.34 $1.36 $1.38 $1.40 $1.48 $1.52 $1.58 $1.64 $1.70

Dividend Yield

5.3% 4.7% 4.2% 4.1% 3.5% 3.2% 3.2% 3.2% 3.2% 3.2%



ATMOS ENERGY CORP.

Rank of 2 (Above Average), Atmos stock is suitable for conservative investors. (For information concern-ing the company’s direct stock-purchase plan, go to www.atmosenergy.com.)

An Expansive Service TerritoryAtmos owns six natural gas distribution divisions, which contributed 65% of net income in fiscal 2013. Revenues are weighted more toward the stable residential ratepayer class, making up 65% of the total. Commercial businesses represent 29% of annual receipts, while the industrial class accounts for 4%; public authority and other customers contribute the remainder. The sizable Mid-Tex division, subject to Texas regulatory oversight, is made up of two segments, known as Mid-Tex Cities and Mid-Tex—Dallas, with a combined rate base of $1.7 billion. (Note that regulators establish an authorized rate of return on a specified rate base, which is determined according to the value of assets providing service.) Mid-Tex Cities serves 1.3 million and Mid-Tex—Dallas has 225,000 accounts. The next biggest distri-bution division, Kentucky/Mid-States, provides gas service to 325,000 across Kentucky, Tennessee, and Virginia. It has a rate base of roughly $460 million. Atmos’ Louisiana division has more than 340,000 connected meters in the state it is named after, and its Trans LA and LGS segments have a combined rate base of just over $400 million. The West Texas division, with nearly 295,000 meter hookups, covers the metropolitan areas of Amarillo, Lubbock, and Midland; its rate base approximates $272 million. The Mississippi division has customer accounts exceeding 255,000 and a rate base approaching $290 million. Lastly, Colorado-Kansas serves almost 100,000 ratepayers in Colorado, where the rate base amounts to $86 million, and more than 136,000 in Kansas, via a rate base of $160 million.

The Atmos Pipeline—Texas division consists of regulated gas transmission and storage operations. With an asset base of nearly $1 billion, it generated 30% of Atmos’ net income last fiscal year. This division runs the largest intrastate pipeline in Texas and has five underground storage reservoirs. Assets are located in the major gas producing areas of the state. Atmos Pipeline delivers gas to the Mid-Tex division and third parties. The division files at least one full rate case with regulators every five years. There is, however, a regulatory program in place through 2017 that provides for annual adjustments. These adjustments are based on the performance of the division’s non-regulated operations. Any revenue gains, net of a bench-mark, are shared between the company and ratepayers on a 25%/75% basis.

We note that in any given year, Atmos will have distribution rate cases under review by various respective state regulators. Over all, rate treatment has been reasonable. Mid-Tex, Louisiana, and Mississippi have annual tariff adjustment mechanisms, which help to cover the cost of service between rate filings, thus limiting uncertainty. Also, the Mississippi division and the Kentucky and Tennessee segments of Ken-tucky/Mid-States have performance-based rate programs. Such programs provide incentives that allow the utilities to keep (and share, with ratepayers, a portion of ) gas purchase cost savings. As well, gas cost adjustment mechanisms across the entire territory protect margins against volatile commodity prices. Most important, the rates of return on common equity allowed by state authorities have been adequate, running in the mid-9%-to-low-10% range. Ahead, we expect this range to creep higher, given ongoing system investments and assuming that the cost of borrowing rises. The allowed rate of return for Atmos Pipeline—Texas has been 11.8%, and it might also trend higher for the same reasons.


ATMOS ENERGY CORP.

Generally, regulators have taken care to ensure that the company earns sufficient returns on investment, thus promoting system reliability and safety. Over the years, management has made good progress in reducing regulatory lag (i.e., delays in earning a return on investments). Too, management has secured approval in many jurisdictions to utilize revenue-decoupling and weather-normalization rate designs, which help to reduce seasonal earnings volatility in a given year. The decoupling design implements base rates that are higher and consumption rates that are lower than those of traditional ratemaking. Under weather normalization, customers’ bills may increase when demand is low and decline when demand is high; these offsetting rates keep the utilities within their allowed returns. Atmos’ utilities experience peak usage (for heating) during the winter. Furthermore, Atmos Pipeline, Mid-Tex, West Texas, Colo-rado-Kansas, and the Kentucky and Virginia segments of Kentucky/Mid-States have infrastructure rate mechanisms that facilitate the timely recovery of outlays related to system upgrades.

Separately, non-regulated operations generated 5% of the company’s net income in fiscal 2013. The Atmos Energy Holdings subsidiary buys, sells, and delivers natural gas in the competitive sector of the energy industry. It serves some 1,000 customers in the Midwest and Southeast. The subsidiary provides storage and transportation services to municipalities, industrial companies, local gas distributors, and Atmos’ regulated Louisiana and Kentucky utility businesses.

Business OutlookFollowing a solid first-quarter 2014 operating performance, as of this writing, Atmos was preparing to release results for the seasonally-significant second quarter on, or around, May 7th. We look for the com-pany to beat the Wall Street consensus share-net estimate of $1.25 for the quarter, given below-normal temperatures in the service territory. The company appears on track to meet its fiscal 2014 earnings guidance of $2.66-$2.76 per diluted share. Indeed, the actual full-year result could come in close to the upper level of this range. This would be a respectable showing, considering that a $390 million secondary offering of 9.2 million shares of stock was completed last February. In fiscal 2013, Atmos earned $2.50 a share; the stock float at the end of that year was 90.64 million.

To 2017-2019, management projects that share net will advance 6%-8% annually, rising to $3.45-$3.65. We believe that such gains are attainable. The South’s economy is benefiting from a strong energy explora-tion sector, a reviving industrial market, and population migrations from other parts of the country. This fiscal year, Atmos’ capital outlays should total $830 million-$850 million. From fiscal 2015 to fiscal 2018, the company plans to spend $850 million-$950 million a year to maintain and expand its gas delivery network to meet growing customer needs. Regulators likely will allow fair returns. The rate base may well increase by $3 billion, to more than $7 billion, over the pull to 2018. In addition to strong cash flow, the recent stock issuance provides economical funding. Favorable credit ratings ought to allow the company to supplement its financing requirements with low-coupon debt. Through fiscal 2019, about $1.2 billion of long-term debt, out of $2.45 billion, falls due; the remainder matures more than 10 years out. Man-agement is careful to maintain a sound capital structure with a debt weighting of 50%-55%. We expect Atmos to sustain a return on equity of 9%, or better, over the next three to five years. Cash flow likely will be sufficient to increase the dividend 3%-4% annually, supporting a yield of 3%, or higher. We would not be surprised to see the share price attain new heights, which would be an added plus for investors. ■


Though not one of the largest, Maxim Integrated Products is a significant player in the global semiconduc-tor industry. The San Jose, California-based company is primarily focused on designing, manufacturing, and marketing linear (also known as analog) and mixed-signal (analog/digital) electronic devices. Maxim also produces digital integrated-circuit products. Furthermore, it offers circuit design tools. Major market segments served include consumer (38% of business), industrial (31%), computing (17%), and commu-nications (14%). Three main manufacturing plants are located in the United States, and there are two sig-nificant test facilities in the Philippines and Taiwan. The company also contracts with third-party producers and circuit testing outfits. Foreign sales represent some 88% of the total. Last fiscal year (ended June 29, 2013), sales tallied $2.44 billion and net income amounted to $530 million, or $1.77 a share, excluding special items, which were historical records.

Since its founding in 1983, Maxim has proved to be an effective competitor, thanks to proficient in-house design, high-quality manufacturing processes, and broad market diversification, supported by strategic ac-quisitions. The company first turned a profit in 1987 and, notwithstanding the pressures from periodic eco-nomic downturns, has stayed in the black ever since. A regular quarterly dividend was instituted in 2003. The dividend was increased each year, with the exception of 2010. In 2009 and 2010, the payout ratio (all dividends to net profits) exceeded 100%, as earnings fell in the wake of the severe 2007-2009 recession. Earnings and the payout ratio quickly strengthened, however, and dividend hikes resumed in 2011. From now to 2017-2019, we project solid mid-to-high single-digit sales growth. Likely better operating leverage should allow both per-share earnings and cash flow to advance at a yearly rate of around 10%, or greater.

Such gains ought to be enough to raise the dividend at an average annual rate of 8% to 9%. A yield in the 3% range should be maintained, going forward. Additional, success-ful acquisitions might prove our projections conservative.

We note that Maxim is a cyclical company and its shares generally track the performance of the broader stock mar-ket (beta=1.00). As denoted by the equity’s Safety Rank


Maxim Integrated Products


2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Dividends Declared

$0.80 $0.80 $0.84 $0.88 $0.96 $1.08 $1.17 $1.26 $1.35 $1.44

Dividend Yield

5.3% 4.3% 3.7% 3.4% 3.3% 3.4% 3.4% 3.3% 3.3% 3.3%


Timeliness(A) 3

Safety(B) 3

Recent Price $31.55

2017-2019 Price Forecast $35-$55



MAXIM INTEGRATED PRODUCTS

of 3, market risk, here, is about average. In the coming three to five years, the global economy likely will continue to expand at a modest pace. This should be sufficient for Maxim to achieve a respectable operat-ing performance. Share-price appreciation prospects appear attractive. (Dividend reinvestment and direct share-purchase plans are available via computershare; visit maxim-ic.com for the details.)

Building a Competitive BusinessAs noted above, Maxim was established in 1983. Jack Gifford, co-founder of Advanced Micro Devices, was instrumental in forming the company, as were several other leading scientists and inventors. In 1985, the MAX600 power converter (alternating current to direct current) was one of Maxim’s first proprietary products to win significant industry recognition. The company enhanced its technical ability to produce integrated circuits in 1989 by acquiring a wafer fabrication (fab) plant in Sunnyvale, California. Among the many business purchases made through the years, some of the more important are: Textronix’s Semi-conductor Division (wafer fab and high-speed production processes); Dallas Semiconductor (wafer fab and digital design); Vitesse Storage (enhanced computer interface connections for disk and optical data storage drives); Mobilygen (video data compression); Innova Card (financial transaction security products); Zilog Secure Trans (wireless microcontrollers used in point-of-sale and automated teller machines); Teridian (sys-tems on a chip for utility smart meters); Phyworks (optical transceivers used in high-speed broadband communications networks); SensorDynamics (sensors and micro-electromechanical devices); and Volterra Semiconductor (low-voltage enterprise, cloud computing, communications, and networking products). These acquisitions helped to boost manufacturing capacity and capabilities, expand the device lineup, and broaden international market coverage.

Today, Maxim is a well-established company with about half of its sales stemming from advanced inte-grated products. For the communications industry, Maxim makes products used in base stations, network & datacom devices, and various other telecom equipment. Also, in the computing sector, the company’s offerings are found in data storage machines, financial terminals, notebook computers, servers, desktops, and peripherals. In the consumer area, Maxim items reside in cell phones, digital cameras, handheld com-puters, home entertainment consoles, and appliances. Elsewhere, in the industrial market, the company’s products are utilized in automatic test equipment, cars and trucks, control & automation machines, elec-tronic instrumentation, medical devices, military & aerospace equipment, security systems, and utility net-works. More than half of Maxim’s fabrication takes place at its three plants located in California, Oregon, and Texas. Third-party foundries, such as Seiko Epson, Powerchip Technology, and Maxchip Electronics, produce about 47% of the company’s mixed-signal products.

Maxim vies for customers against the likes of Analog Devices, Semtech, Texas Instruments, Samsung, and Qualcomm. The companies compete on new products, time to market, product performance and features, quality and reliability, and customized design and applications. Independent distributors account for 31% of Maxim’s annual sales; Avnet Electronics, with a 14% share of the total, is the largest. Samsung, represent-ing 20% of sales, is Maxim’s biggest customer. No single product makes up more than 10% of the total. A research & development budget averaging 22% of annual sales helps to ensure a steady flow of new, meaningful products and, thereby, maintain the company’s competitiveness.


MAXIM INTEGRATED PRODUCTS

Operating TrendsThe first half of fiscal 2014 proved somewhat challenging for Maxim. Sales from continuing operations declined due to lower demand from the smartphone, notebook, and home entertainment markets. Solid uptake of automotive, tablet & e-reader, and data & networking products picked up some of the slack, and the October addition of Volterra lent support to the top line. In the six-month period, sales totaled $1.2 billion, versus $1.23 billion in the comparable fiscal 2013 term. While the first-quarter sales comparison was negative, the second-quarter match-up was positive, thanks to the acquisition. Costs related to the in-tegration of Volterra had an unfavorable impact on profitability, as did lower capacity utilization. Share net declined, year over year, in both quarters. In the recent three-month period ending in March, sales came in at $606 million, which was in the middle of management’s guidance and on a par with the year-earlier result; share net was $0.43. Sales from the mobile device and automotive sectors improved nicely. Volterra provided solid support. The gross margin, excluding special items, is running in the low-60% range and should move higher in the coming quarters, thanks to an improving mix and rising cost savings. For the final period of fiscal 2014, we estimate sales of $650 million and share earnings of $0.47; in the fiscal 2013 fourth quarter, Maxim earned $0.44 a share, on sales of $608 million. Full-year sales should tally $2.46 billion and share net $1.67 (exclusive of acquisition, restructuring, and asset impairment charges).

We expect stronger top- and bottom-line momentum in fiscal 2015. The company is making good progress in melding Volterra’s assets with its own. Volterra is providing meaningful time-to-market advantages in the enterprise and communications sectors. Maxim will leverage its global distribution to sell more Volterra products. Also, management has aggressively pursued new automotive, consumer, and communications business. In particular, Maxim has strived to put more components into smartphones. These efforts soon should begin to pay off. In fiscal 2015, sales may well rise more than 9%, to $2.7 billion, and earnings improve some 20%, to $2.00 a share. Longer term, product innovation, most visibly in the increasingly complex mobile device, automotive, utility, and medical segments, and expansion of the customer base ought to keep operating momentum favorable.

FinancesWhile it’s common for companies in the semiconductor industry to finance operations via cash flow and equity issuances, several do occasionally tap the debt market. In June 2010, that’s just what Maxim did. The company took advantage of a low-interest rate environment, issuing $300 million of 3.45% senior unse-cured notes. Those notes were retired in 2013, after $500 million in 3.375% unsecure notes, due in 2023, were sold to the public. During the second quarter of fiscal 2014, management issued another $500 million in debt, with a 2.5% coupon, to fund operations and stock buybacks. In the fourth quarter of 2013, the board of directors authorized up to $1 billion of share repurchases, without any expiration date, following $641 million in buybacks (23 million shares) completed under a 2011 authorization. As of March 29th, the debt-to-total capital ratio stood at 29%, a historical high for the company. This is a manageable level, but we believe that Maxim will limit its borrowing over the next several years, as cash flow builds. Annual capital spending, at 5%-7% of sales, is relatively modest. Cash and cash-equivalent reserves recently stood at more than $1.2 billion. On balance, we believe that this stock is a worthwhile holding, with moderate risk exposure, for the pull to 2017-2019. ■


FOOTNOTES

((A) The Timeliness Rank is Value Line’s assessment of a stock’s probable relative market performance in the 6-12 months ahead. It is computer generated, and uses input items including the company’s multi-year price and earnings history, recent price and earnings momentum, and earnings surprises. All data are known and actual. Stocks ranked 1 (Highest) and 2 (Above Average) are deemed likely to outpace the year-ahead market.

(B) The Safety Rank is a measure of potential risk associated with individual common stocks. It is computed by averaging two other Value Line indexes--the Price Stability Index and the Financial Strength Rating. Safety Ranks range from 1 (Highest) to 5 (Lowest). Conservative investors may wish to purchase equities ranked 1 (Highest) or 2 (Above Average) for Safety.

(C) Relative P/E is the company’s current P/E divided by the market P/E.

(D) Diluted earnings. First-quarter 2014 earnings report: May 1st; second-quarter earnings report: July 30th.

NOTES

© 2014 Value Line, Inc. All Rights Reserved. Value Line, the Value Line logo, The Value Line Investment Survey, The Most Trusted Name in Investment Research, “Smart research. Smarter investing.”, Timeliness, and Safety are trademarks or registered trademarks of Value Line, Inc. and/or its affiliates in the United States and other countries. All other trademarks are the property of their respective owners. Factual material is obtained from sources believed to be reliable and any information contained herein is provided without warranties of any kind. VALUE LINE IS NOT RESPONSIBLE FOR ANY ERRORS OR OMISSIONS HEREIN OR ANY DAMAGES OR LOSSES ARISING FROM ANY USE OF THIS REPORT. This report is strictly for each subscriber’s own, non-commercial, internal use. No part of this report may be reproduced, resold, stored or transmitted in any printed, electronic or other form, or used for generating or marketing any printed or electronic publication, service or product. Nothing herein should be construed as an offer to buy or sell securities or funds or to give individual investment advice. All investors must read applicable prospectuses before investing. Value Line Arithmetic and Geometric indices calculated by Thomson Reuters. Information supplied by Thomson Reuters.

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