23 January 2008

COP: Financial Analysis through December 2007

We have analyzed ConocoPhillips's (COP) preliminary financial results for the quarter and year that ended on 31 December 2007. The report included a myriad of data, but the company hasn't yet updated its Balance Sheet. This omission is not unusual in a preliminary report for Conoco, and it will certainly be rectified in the 10-K filed with the SEC. Since the GCFR analysis methodology requires Asset and Liability data to compute Gauge scores, we are assuming for this post that the Balance Sheet did not change materially from the end of September.

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 was achieved with mergers and acquisitions. Most notably, Conoco, Inc., and Phillips Petroleum combined in August 2002. The resulting behemoth in March 2006 purchased Burlington Resources, which had extensive natural gas operations in North America, for $33.9 billion.

On 3 January 2008, Conoco gave investors some information on the energy industry's market and operating conditions during the fourth quarter, as experienced by the company. Conoco indicated that prices for oil and gas were higher (not exactly news), production was up, and refining margins were down (again). Conoco also announced that they would be adversely impacted ($250 million after-tax) by Alaska's retroactive production tax increase.

Conoco shares surged in the first half of 2007 and then bounced between $80 and $90. However, the stock market correction of 2008 knocked the share price down from $88 to close to $70.

Berkshire Hathaway, run by super-investor Warren Buffett, owned about 17.5 million shares of Conoco on 30 September 2007.

When we analyzed Conoco after the September quarter, the Overall score was a weak 24 points. Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 13 points. Value was weakest at 0 points. Many of the companies we analyzed in 2007 had weak Value scores; the market correction will probably result in higher scores.

Now, with the available data from the December 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 communicated expectations.


Dec 2007
Dec 2007
Dec 2006
Revenue (1)

Op expenses

CGS (2)

Depreciation (2206)

Exploration (268)

SG&A (3)

Operating Income
Other income

Equity income (4)

Interest, etc. (5)
Pretax income

Income tax

(2869) (2720)
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 soared past below our $48 billion target. We thought that Revenue in the recent quarter would be 16 percent greater than the very weak sales figure of the year-earlier quarter, but Revenue actually increased by 27 percent.

As for Operating Expenses, we thought the Cost of Goods Sold (CGS) would be 71 percent of Revenue, and the actual value was 72.2 percent. Exploration costs exceeded our $250 million estimate by $18 million. Depreciation expenses were 4.2 percent of Revenue, fractionally below our 4.5 percent estimate. Sales, General, and Administrative (SG&A) expenses were 11.3 percent of Revenue, compared to our forecast of 12 percent. Non-recurring costs came in $54 million above our $200 million estimate

Even with higher costs, greater than expected Revenue pushed Operating Income 7.5 percent above the forecast value. [We should mention at this point that our definition of Operating Income, which we use for all the companies we analyze, is not identical to Conoco's definition. The differences can be discerned from the footnotes above.]

Non-Operating Income was also greater than we expected, in this case by $155 million. The good news story continued with the Income Tax Rate, 40.3 percent vs. 42.5 percent forecast. As a result, Net Income surpassed our prediction by a healthy 12.6 percent.

Cash Management. This gauge declined from 13 points in September to 11 points now. However, the score might change substantially when we get up-to-date Balance Sheet data.

The measures that helped the gauge were:
The measures that hurt the gauge were:

Growth. This gauge didn't change from September's 3 points.

The measures that helped the gauge were:
  • CFO growth = 14.1 percent year-over-year; not bad, but down from 22.1 percent
The measures that hurt the gauge were:
  • Revenue growth = 2.1 percent year-over-year (despite the fourth quarter surge), down from the weak level of +2.3 percent in 2006
  • Revenue/Assets = 108.1 percent, down from 111.5 percent in a year; sales efficiency has worsened
  • Net Income growth = -23.5 percent year-over-year (hurt substantially by the Venezuelan impairment charge), down from +14.0 percent

Profitability. This gauge increased from 10 points in September to 11 points now.

The measures that helped the gauge were:
  • FCF/Equity = 14.7 percent, more than doubling last year's 7.2 percent
  • Accrual Ratio = -0.3 percent, down (a good thing) from +5.8 percent in the last 12 months
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:
A lower Gross Margin was the main reason Operating Expenses as a percentage of Revenue increased.

Value. The normal GCFR approach is to compute the Value gauge score with the last share price of the quarter. Conoco shares ended December at $88.30, which wasn't much below their 52-week high. Now, however, the shares are trading less than $72. We did the calculations with both prices and found that the shares have not dropped enough to increase the Value Gauge more than a couple of points. If we use the current share price, and we also ignore the $4.5 billion asset impairment charge earlier in 2007 due to events in Venezuela, the scores start to become more attractive. But, we don't typically ignore special charges, and are not doing so here.
The average P/E for the Integrated Oil and Gas industry is presently 11.7. The average Price/Revenue for the industry is currently 1.1.

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