15 July 2007

COP: Looking ahead to 2Q Results

Shares of energy behemoth ConocoPhillips (COP) have been surging. In the second quarter, the price per share rose from $68.35 to $78.50, but the upward move didn't stop there. The shares recently closed above $90, a gain of more than $11.50 in two weeks.

Billionaire extraordinaire Warren Buffett must be smiling. Berkshire Hathaway owns about 18 million shares of Conoco.

The gain occurred despite the company's disagreement with the Venezuelan government, which will cause Conoco to record "a complete impairment of its entire interest in its oil projects in Venezuela of approximately $4.5 billion, before- and after-tax, in its second-quarter financial results." While a $4.5 billion write-off for a company with $173 billion in assets is not a cause for panic, its failure to have a negative impact on the stock prices says something about the momentum in energy sector.

Of course, $70/barrel of oil didn't hurt. A new $15 billion program to repurchase company stock through 2008 also helped the stock.

Conoco's initial guidance for the second quarter indicated that maintenance and asset disposals would cut production. No estimates of revenue and income were given. In an update earlier this month, Conoco provided numerous details about business conditions but, again, revenue and income data were lacking. Given this murky guidance, the situation in Venezuela, and the fact that quarterly revenue peaked in December 2005 at $51 billion, we were tempted to forecast second quarter revenue at, or below, the first quarter's $41 billion. However, we have to believe that surging oil prices will have some positive effect on revenues. We're just not sure how much of an effect.

We turned to Yahoo Finance to see the estimates of professional analysts, but we left disappointed since exactly one analyst had the nerve to predict Conoco's revenue for the second quarter. This intrepid soul forecast the revenue at $61.64 billion, which seems incredible even with the current price of oil. Can revenues for a gargantuan company rise 50 percent in one quarter? We'll believe it when we see it.

Instead, we're going to set a more modest $45 billion target, without a whole lot of conviction, for second quarter revenues.

Conoco's Gross Margin has edged up over the last couple of years from about 25 percent of revenue to just over 30 percent. Since the company indicated that worldwide refining and marketing margins would be significantly higher in the second quarter than the first, we will assume a 33 percent gross margin in the second quarter. In other words, we're guessing the cost of goods sold will be 67 percent of $45 billion or $30.15 billion.

We'll also assume, based on historic data, a depreciation expense of 4.5 percent of revenue, or $2.025 billion. Similarly, we'll estimate SG&A expenses at 11 percent of revenue, or just under $5 billion. Per company guidance, we need to throw in another $270 million for exploration expenses. We'll assume $100 million for non-recurring operating charges, although this is probably where we will see the $4.5 billion Venezuela impairment charge. Let's take that elephant off the table for the moment.

These figures would result in an operating income of $7.5 billion.

We then need to consider non-operating income and expenses, such as equity in the earnings of affiliates, minority interests, and interest. Our normal extrapolations of historical data would suggest an estimate of $900 million net non-operating income. However, we're going to round that up to $1 billion because of the industry's current profitability. This pushes our estimate of pre-tax income to $8.5 billion

Conoco's effective income tax rate is generally between 42 and 46 percent, so we'll split the difference and assume 44 percent for the second quarter. With this assumption, the tax bill would be $3.74 billion.

Our estimate for net income is, therefore, $4.76 billion ($2.87 per share). Note that the Venezuelan charge would essentially wipe this out.

Since we have little confidence in the $45 billion revenue estimate, we ran the numbers again with $40 and $50 billion for this figure. With all the same assumptions described above, net income ranges between $4.27 billion ($2.58/share) to $5.25 billion ($3.17 per share).



Op expenses

CGS (30150)


Exploration (270)

SG&A (4950)

Op income

Other income

Equity income

Interest, etc.
Pretax income

Income tax

(3742) (3496)
Net income



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