16 December 2007

COP: Look Ahead to December 2007 Results

One might assume that soaring crude oil prices equates to windfall profits for energy behemoth ConocoPhillips (COP), which will announce its fourth-quarter earnings on 23 January 2008. In support for this assumption, one could note that Conoco shares have held up fairly well in a volatile market. Although below the $90 high established in July, the share price is up almost 16 percent year to date.

Conoco actually faces several significant challenges. Lower natural gas prices, compressed refining margins, and loss of its Venezuelan operations have all put pressure on Conoco's earnings. As a result, Conoco shares have lagged behind those of other major integrated oil companies.

Our analysis of Conoco after the September quarter produced an Overall Gauge score of 24 points, with the double-weighted Value Gauge contributing zero points to the total. One reason Conoco shares appear overvalued relative to historic norms is the termination of operations in Venezuela. About 9 percent of Conoco's crude-oil production in the September 2006 quarter came from Venezuela. However, we concluded that Venezuela was not the sole explanation for Conoco's low score. The refining margin, the price of natural gas, and operational efficiency all need to improve to impel the gauges upward.

Given its sensitivity to external factors, we struggle each quarter to model Conoco's next earnings report. The difficulty begins with the top line. We haven't found quarterly Revenue guidance provided by the company itself, and estimates of current Revenue based on previous growth rates hasn't been particularly accurate recently. The Yahoo Finance page includes a $74.7 billion Revenue estimate, but that figure was submitted by a single anonymous analyst. By comparison, 16 analysts submitted Earnings per Share estimates.

We have to dismiss the $74.7 billion Revenue estimate as unrealistic, since quarterly sales have been between $40 and $50 billion for the last few years. We're going to set a more modest $48 billion target, admittedly without much conviction, for fourth-quarter revenues. This figure is 4.2 percent greater that sales in the third quarter, and 16 percent greater than the very weak revenue figure of the December 2006 quarter.

Conoco's Gross Margin has edged up over the last couple of years from about 25 percent of revenue to about 30 percent, although it was a couple of points less in the third quarter. We'll set the gross-margin target in the fourth quarter at 29 percent. In other words, we're guessing the Cost of Goods Sold will be 71 percent of $48 billion or $34.1 billion.

We'll also assume, based on historic data, a Depreciation expense of 4.5 percent of revenue, or $2.2 billion. Similarly, we'll estimate SG&A expenses at 12 percent of revenue, or $5.8 billion given our revenue estimate. We will also add $250 million for exploration expense and $200 million for non-recurring operating charges.

These figures would result in an Operating Income just under $5.6 billion.

We then need to consider non-operating income and expenses, such as equity in the earnings of affiliates, minority interests, and interest. The net figure for these income and expense items has been trending up, and we will set our expectation at $1.2 billion. This pushes our estimate of pre-tax income to $6.8 billion

Conoco's effective income tax rate generally seems to be between 40 and 45 percent, so we will split the difference. If the rate is 42.5 percent in the fourth quarter, the tax bill would be $2.9 billion.

Our estimate for Net Income is, therefore, $3.9 billion ($2.35 per share).


Dec 2007
Dec 2006
Op expenses

CGS (34080)

Depreciation (2160)

Exploration (250)

SG&A (5760)

Operating Income
Other income

Equity income

Interest, etc.
Pretax income

Income tax

(2869) (2720)
Net Income


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