04 May 2007

COP: Financial Analysis through March 2007

ConocoPhillips (COP), the third-largest integrated energy company based in the U.S., filed a 10-Q with the SEC for the quarter ending on 31 March 2007. This post reports on our analysis of those results. We updated our analysis to address certain details in this formal submittal that were not available in the original press release. Our results, adjusted to account for the new information, are reported in this post.

COP has global oil, gas, and chemical operations. Among international energy giants, it ranks fifth by Revenues and eighth by Market Capitalization. Unfortunately, COP's international holdings are becoming a concern, given the nationalistic trends involving energy assets in places like Russia, where it owns a chunk of Lukoil, and Venezuela. Holding the sixth spot on the Fortune 500, COP's heft is the product of mergers and acquisitions. Conoco, Inc., and Phillips Petroleum combined in August 2002. The resulting behemoth purchased Burlington Resources for $33.9 billion in March 2006 for its extensive natural gas operations in North America. The M&A activity poses a challenge for us because our methodology relies on a historical record by which we can gauge current results.

When we analyzed COP after the quarter that ended in December 2006, the Overall score was a disappointing 22 points. Of the four individual gauges that fed into this overall result, Growth was the strongest at 8 points. Value was weakest at 4 points, with the score driven down as the stock price surged in the fourth quarter.

With the available data from the most recent quarter, our gauges now display the following scores:

Cash Management. This gauge didn't change from December. The Current Ratio is now 0.9. It has been stable at this level, but we would prefer to see it higher. Long-Term Debt/Equity is a manageable 26 percent. The debt ratio was 28 percent in December and 36 percent in March 2006. The latter value has higher than normal because of the Burlington Resources acquisition. Accounts Receivable are 28 days of Revenue, which is a few days higher than the 25-day value one year earlier. There seems to be upward trend in receivables, for reasons that are unclear.

Growth. This gauge didn't change from December's 8 point score. Revenue actually declined 6 percent year over year, compared to a robust 32 percent gain a year ago. Net Income grew a modest 13 percent, down from a jaw-dropping 49 percent a year ago. The increase was slowed by a change in the income tax rate from 43 to 45 percent. CFO growth is an impressive 29 percent, although down from 31 percent a year ago. Revenue/Assets is 103 percent, compared to 118 percent immediately after the Burlington acquisition; looking back further, we see that the acquisition added more assets than revenue.

Profitability. This gauge increased 5 points from the 6 point level in December. ROIC grew to a moderate 13 percent from 12 percent a year ago. FCF/Equity jumped up to 11 percent from 6 percent. Operating Expenses/Revenue came down in the last year from 89 percent to 86 percent. The change was primarily due to an increase in Gross Margin, although higher Depreciation expenses hurt. The Accrual Ratio, which we like to be both negative and declining, moved in the right direction from +6 percent to +4 percent. This tells us that more of the company's Net Income is due to cash flow, and, therefore, less is due to changes in non-operational balance sheet accruals.

Value. COP's stock price fell over the course of the quarter from $71.95 to $68.35. The Value gauge, based on the latter price, is a weak 5 points, compared to 4 and 12 points three and twelve months ago, respectively. The P/E at the end of the quarter was 7.2. The average P/E for the Integrated Oil and Gas industry is a more expensive 11. To remove the effect of overall market changes on the P/E, we note that the company's current P/E is at a 55 discount to the average P/E, using core operating earnings, for stocks in the S&P 500. In recent years, the company's P/E has had an 50 percent discount to the market, as expressed by this measure. Companies tend to trade at a discount when their growth rates are less than average, particularly when there are worries about the sustainability of the growth rates (e.g., the price of oil could decline). The PEG ratio of 0.6 is indicative of a bargain stock. The ratio has increased from irrationally low levels. The Price/Revenue ratio, which is less affected by the one-time factors that cause wide swings in earnings, has been stable at 60 percent. The average Price/Sales for the Integrated Oil and Gas industry is 104 percent.

Now at a so-so 28 out of 100 possible points, the Overall gauge is stuck in low gear.

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