27 January 2007

COP: Preliminary Analysis through Dec 2006

ConocoPhillips reported its preliminary financial results for the quarter ending 31 December 2006. The report included an Income Statement, some useful Cash Flow data, and several pages of supplemental data giving insight into the company's operations. A Balance Sheet, however, was lacking. While we can assume that the Balance Sheet for this corporate giant didn't change greatly during the last three merger-free months, the omission adds uncertainty to our analysis. We will have to revisit the analysis when ConocoPhillips submits a Form 10-K to the SEC containing a full set of financial data.

Cash Management. Since the Balance Sheet is the principal source of the data needed to compute a Cash Management score, we merely note now that the score was 5 at the end of September 2006. The Current Ratio was 0.9 then, and Long-Term Debt/Equity was 30 percent. The debt ratio ameliorated our concern that COP might have overextended itself with mergers. Accounts Receivable were 24.6 days of Revenue, up from 22.7 in September 2005. Note that Inventory/CGS and Finished Goods to Total Inventory -- two of the five Cash Management score components -- don't have the significance they do for a product manufacturer.

The Growth gauge now stands at 8 (out of 25) points, which is four less than its value at the end of September. Revenue growth has tailed off significantly: sales in the four quarters of 2006 were only 2 percent above those in 2005. Net Income year-over-year increased a more respectable 14 percent, but the growth rate is much less than it had been the previous few years. Similarly, CFO grew by 22 percent -- healthy but decelerating. The story repeats yet one more time with Revenue/Assets, now 112 percent. This ratio was 168 percent at the conclusion of 2005. We suspect that the merger with Burlington Resources increased the asset base more than it did revenues.

We estimate that the Profitability gauge score is 6 (out of 25 possible) points, down 2 points from the previous quarter. This value was determined without the benefit of a year-end Balance Sheet. The Return on Invested Capital was about 13 percent, off from 19 percent in 2005. FCF/Equity was 7 percent, which is at the lower end of its historic range and down from 11 percent one year ago. Operating expenses/Revenue has declined to 86 percent (a welcome achievement) from 89 percent a year ago. The slight reduction in the Accrual Ratio from 7 to 6 percent is a good development, but a negative Accrual Ratio (i.e., Cash Flow exceeding Net Income) would be even better.

With the year-end stock price of $71.95 -- much above the current level -- the Value gauge dropped all the way down to 4 points. The P/E ratio was still a modest 8, about half the equivalent value of the S&P 500. The PEG ratio moved up to 0.55 from figures in the deep-deep value 0.1 to 0.2 range. Price/Revenue has also edged up to 0.7.

The Overall gauge dropped to about 22 points (out of 100) because growth and profitability fundamentals have weakened. Although the value characteristics aren't as compelling as they were a year ago, a trailing P/E of 8 and a PEG of 0.55 will still get the attention of investors looking for companies selling at a discount relative to other alternatives.

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