25 July 2007

COP: Financial Analysis through June 2007

We have analyzed ConocoPhillips's (COP) preliminary financial results for the quarter that ended on 30 June 2007. Since Conoco didn't provide a new Balance Sheet, our evaluation is incomplete. To estimate the gauge scores, we simply assumed that the Balance Sheet didn't change from March. This assumption is unsatisfying given the $4.5 billion charge recorded in the second quarter for expropriated assets. We will have to wait for a 10-Q submittal to complete our analysis.

With worldwide oil, gas, and chemical operations, ConocoPhillips is the third-largest integrated energy company based in the U.S. Among international energy giants, it ranks fifth by Revenue and eighth by Market_Capitalization.

Holding the sixth spot on the Fortune 500, Conoco'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.

Conoco's international holdings have become problematic, given the nationalistic trends in Russia, where it owns a chunk of Lukoil, and Venezuela. A disagreement with the Venezuelan government has caused Conoco to record in its second-quarter financial results "a complete impairment of its entire interest in its oil projects in Venezuela of approximately $4.5 billion, before- and after-tax." A $4.5 billion write-off for a company with $173 billion in assets is not a cause for panic, but it is worrisome.

Conoco shares have been surging, which must please super-investor Warren Buffett since the company he runs, Berkshire Hathaway, owns about 18 million shares of Conoco. Of course, $70 for a barrel of oil didn't hurt. A new $15 billion program to repurchase company stock through 2008 definitely helped the stock.

When we analyzed Conoco after the March quarter, the Overall score was a so-so 33 points. [We didn't foresee the impending big gain in the share prices. Was it because the surging price of oil outweighed all other consideration? Was it because the company's mergers have made historic data irrelevant?] Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 15 points. Value was weakest at 3 points, which really worried us at the time. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, our gauges display the following scores:

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. In the table below, we have excluded the $4.588 billion charge for expropriated assets.


June 2007 (actual)
June 2007
June 2006
Revenue (1)
Op expenses

CGS (2) (33377)

Depreciation (2016)

Exploration (259)

SG&A (3) (5301)

Operating Income


Other income

Equity income (4)

Interest, etc. (5)
Pretax income

Income tax

(3742) (3496)
Net Income


1. Revenue = Sales and other operating revenues.
2. CGS = Purchased crude oil, natural gas and products + Production and operating expenses
3. SG&A = SG&A expenses + Taxes other than income taxes
4. Equity income = Equity in earnings of affiliates - Minority interests
5. Interest, etc. = Other income - Interest and debt expense

Revenue was 5.3 percent above our estimate. We may have overweighted Conoco's guidance for the second quarter that maintenance and asset disposals would cut production, or maybe high oil prices are curative for many ills. We thought the Cost of Goods Sold (CGS) would be 67 percent of Revenue, and the actual value was 70.5 percent. Depreciation expenses were 4.3 percent of Revenue, a shade less than our 4.5 percent estimate. Sales, General, and Administrative (SG&A) expenses were 11.2 percent of Revenue, compared to our forecast of 11 percent.

The higher expenses outweighed the higher revenue to yield Operating Income 14.5 percent below the forecast value.

The gap was closed by Non-operating income $689 million greater than expected. The Income Tax Rate was 39.7 percent, instead of the predicted 44 percent. As a result, Net Income exceeded our prediction by 2.6 percent.

We find it a little trouble that the our-performance was due to non-operating factors.

Of course, the $4.5 billion charge, not included above, wiped out most of the net income in the quarter.

Cash Management. Since this gauge relies primarily on Balance Sheet data, which we don't have, we're going to omit a discussion of the various measures that drive the gauge.

Growth. This gauge decreased from 8 points in March to 3 points.

None of our measures helped the gauge that much.
  • Revenue growth = -8.1 percent, down from 27 percent in a year
  • Revenue/Assets = 103 percent, down from 120 percent in a year; sales efficiency is worsening
  • Net Income growth = -32 percent, down from 52 percent in a year (killed by impairment charge)
  • CFO growth = 15 percent; respectable, but down from 41 percent in a year.

Profitability. This gauge decreased from 11 points in March to 10 points.

The measures that helped the gauge were:
  • FCF/Equity = 12 percent, up from 7.5 percent in a year
  • Accrual Ratio = 0.3 percent, down from +6.3 percent in a year

The decreasing Accrual Ratio tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in non-operational Balance Sheet accruals.

The measures that hurt the gauge were:
The increase in Gross Margin was matched by increases in R&D and SG&A expenses, which is why operating expense were basically unchanged as a percentage of revenue.

Value. Conoco's stock price rose over the course of the quarter from $68.35 to $78.50. The Value gauge, based on the latter price, dropped to 0 points, compared to 3 points three months ago (and 5 points twelve months ago).
The average P/E for the Integrated Oil and Gas industry is also 12. The average Price/Revenue for the industry is currently 1.2.

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