The Fed just lowered interest rates. This oil stock is a buy now.

On September 18, the Federal Reserve cut the target range for the federal funds rate by half a percentage point, marking the first rate cut in more than four years.

Lower interest rates can stimulate capital investment, reduce the unemployment rate, and help accelerate economic growth. However, interest rate cuts have been followed by mixed results in the stock market — gains generally occur when recessions are avoided.

The ripple effects of the interest rate cuts remain to be seen. But the reduction should be generally good news for the energy sector, particularly exploration and production (E&P) companies. ConocoPhillips (COP 2.36%). Here’s why the dividend stock is a buy now.

Image source: Getty Images.

ConocoPhillips’ medium-term plan

Over the past year, there has been a flurry of mergers and acquisitions (M&A) in the oil space. ConocoPhillips initially sat on the sidelines before joining the party this spring when it announced a blockbuster deal to buy fellow E&P Marathon oil. It expects to close the deal in the fourth quarter.

ConocoPhillips expects the combined business to generate enough cash flow that it can accelerate growth, raise dividends and buy back shares. It plans to recoup the newly issued capital in the all-stock deal within two to three years. If successful, ConocoPhillips would emerge as a better business with no dilution to its shareholders or impact on its balance sheet. It’s a tall order, but ConocoPhillips recently returned a ton of capital to shareholders. In 2024 alone, ConocoPhillips plans to distribute at least $9 billion to shareholders through buybacks and dividends.

The benefits of lower interest rates

Higher oil prices may help ConocoPhillips achieve its goals. ConocoPhillips estimates a $120 million to $130 million change in annualized cash flow in 2024 for a $1 change in West Texas Intermediate (WTI) crude oil prices (when oil is in the range of 60 to 90 of dollars per WTI barrel). So the difference between $70 and $80 crude is over $1 billion in cash flow.

In 2024, ConocoPhillips targets full-year capital expenditures of $11.5 billion and operating costs of $9.2 billion to $9.3 billion. The business footprint will be even bigger once it integrates Marathon Oil.

In conclusion, ConocoPhillips has sizable working capital and financing commitments—namely, buybacks, dividends, operating expenses, and capital expenditures. Lower interest rates make borrowing costs cheaper, allowing ConocoPhillips to refinance debt if needed or take on new debt at a lower rate.

That said, ConocoPhillips boasts a lean balance sheet and low leverage. As you can see in the chart, ConocoPhillips has a debt-to-equity ratio of 27% and a debt-to-equity ratio of 0.14 — both near 10-year lows.

COP Data Debt to Equity (Quarterly) by YCharts

The lower the ratios, the less dependent a company’s capital structure is on debt. Leverage ratios tend to rise when oil prices fall, which you can see following the oil and gas recession of 2014 to 2015 and the COVID-19-induced collapse of 2020. In that sense, ConocoPhillips’ balance sheet is well-positioned for to bear the low oil prices.

A quality payment

A higher interest rate on risk-free products like a certificate of deposit or a high-yield savings account makes dividend stocks relatively less attractive. When interest rates are high, investors who care more about passive income than potential capital gains may gravitate toward the safe bet rather than bear stock market risks. The reverse is true in a lower interest rate environment.

ConocoPhillips is changing its dividend schedule to make it more predictable. It used to pay both a regular dividend and a variable dividend depending on the performance of the business. Now, it will split the variable dividend into the ordinary dividend for a quarterly payment of $0.78 per share — or an annual yield of about 2.8%. Based on management’s plans, investors can expect the company to prioritize buybacks and gradual increases in the regular dividend.

A dividend yield of 2.8% is not necessarily high yield territory. However, it is more than double the yield S&P 500. The 10-year Treasury rate just hit its lowest level in more than a year and is now at 3.7%, about a full percentage point below its 2024 high. So ConocoPhillips’ dividend is now at a striking distance from the risk-free rate. rate.

ConocoPhillips is built to last

Highly leveraged oil and gas companies can boom and bust based on borrowing costs and the price of oil. But ConocoPhillips is a balanced business that is positioning itself to succeed even if interest rates are relatively high and oil prices are mediocre.

Given the cyclical nature of the oil and gas industry, it’s better to choose a company built to withstand downturns than to bet on one that can only thrive when conditions are right.

ConocoPhillips has a solid dividend and has presented clear expectations for investors. It remains a top E&P to buy now.