27 April 2009

COP: Financial Analysis through March 2009

ConocoPhillips earned $0.56 per share in the first quarter of 2009.  This post provides the GCFR financial analysis of the results.

The earnings announcement included Income and Cash Flow statements, and a plethora of data for each business segment.  But, it did not include a Balance Sheet.  To compute preliminary gauge scores, we assumed that the company's various Assets and Liabilities didn't change in value since December.

We will adjust the results after ConocoPhillips files a complete 10-Q report with the SEC.

First, we present some background information.

Conoco, Inc., and Phillips Petroleum merged in August 2002.  Burlington Resources, with its extensive natural gas operations, was added in March 2006. 

ConocoPhillips (NYSE: COP) is the fifth-largest Major Integrated Oil & Gas company when assessed by Revenue, and it ranks seventh by Market Capitalization.  It is fourth on the 2009 edition of the Fortune 500 list of the largest U.S. corporations, up from fifth in 2008.

The roster of major oil and gas firms includes Exxon Mobil (NYSE: XOM), Chevron Corp. (NYSE: CVX), and BP p.l.c. (NYSE: BP).

The weak economy worldwide has reduced demand for oil and gas, which caused prices for energy products to fall dramatically.  Conoco's Revenue in the fourth quarter of 2008 was 15.5 percent less than in the fourth quarter of 2007.  Lower prices also meant that Conoco's assets were worth less.  The company decided to reduce the carrying value of its intangible assets and investments by $35 billion, which was about 19 percent of the company's Total AssetsAsset impairment charges led to a loss of $31.8 billion (minus $21.37 per share) in the fourth quarter of 2008. 

ConocoPhillips owns 20 percent of LUKOIL (OTC: LUKOY), which is responsible for more than 18 percent of Russia's oil production.  LUKOIL's shrinking market value was responsible for $7.4 billion of the fourth quarter's impairment charges.  Note that the LUKOIL charge was significantly greater than the widely publicized charge ConocoPhillips recorded in 2007, when troubles with the Venezuelan government resulted in a $4.5 billion charge for expropriated assets.

Berkshire Hathaway, Inc. (NYSE: BRK.A), run by super-investor Warren Buffett, and its affiliates owned about 79 million shares of ConocoPhillips on 31 December 2008, up from 17.5 million shares on 31 March 2008.  Buffett characterized the purchase of these shares, when energy prices were soaring, as his biggest mistake in 2008.

In October 2008, Conoco and Australia's Origin Energy, Ltd., (ASX:ORG) formed a 50/50 joint venture named Australia Pacific LNG.  The new company "will focus on coalbed methane production from the Bowen and Surat basins in Queensland, Australia, and LNG processing and export sales."

Looking back to the fourth quarter of 2008, the Revenue decline and the impairment charges combined to cut the GCFR Overall Gauge score from 54 to 46 of the 100 possible points.  The contrarian Value gauge was the only one that increased, and its rise was by a single point.  The Value score got a lift from the 41 percent drop in the price of ConocoPhillips shares, from $88.30 to $51.80, during 2008.

The decline continued in the first quarter of 2009:  the closing share price on 31 March was only $39.16.

Now, with the actual and estimated data for the first quarter, our gauges display the following scores:

  • Overall: 44 of 100 (down from 46)

Before we examine the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously announced expectations

Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats.  A common difference is the classification of income and expenses as Operating and Non-Operating.  The standardization is simply for convenience and to facilitate cross-company comparisons.


Revenue was 31 percent less than in the December 2008 quarter, and it was 44 percent less than in the year-earlier quarter.  Our prediction proved too optimistic by 9.2 percent.  After considering energy prices and refining margins, we estimated that quarterly Revenue would fall 24.6 percent from December 2008 to March 2009.

The Cost of Goods Sold [i.e., purchased crude oil, natural gas and products + Production and operating expenses] in the first quarter was 72.6 percent of Revenue, which equates to a Gross Margin of 27.4 percent.  Our forecast of a 25-percent margin proved too pessimistic. 

In the March 2008 quarter, the Gross Margin was 26.2 percent.

Depreciation expenses were 7.3 percent of Revenue.  We had predicted 6.5 percent.

Exploration costs were almost $175 million less than the value we had assumed based on the company's guidance.  The reason for the discrepancy isn't yet clear.

Sales, General, and Administrative (SG&A) expenses, which in our categorization is dominated by non-income taxes, were 12.8 percent of Revenue, which slightly exceeded to our 12 percent estimate. 

Non-recurring operating expenses were more than twice our estimate.

Operating Income was 70 percent less than in the March 2008 quarter.  While Revenue was lower than we predicted, and some costs were higher, the much better-than-expected Gross Margin was enough to push Operating Income 7.3 percent above our estimate.

Non-operating income and expenses, such as equity in the earnings of affiliates and interest, did not meet our expectations.  And, the effective income tax rate was a stunning 58 percent, compared to our 44 percent prediction.

As a result, Net Income was 80 percent less than the year-earlier value, and it was 36 percent less than our estimate.

Now, for the gauges:

Cash ManagementMarch 2009 (1)
3 months prior
12 months prior
Current Ratio
 1.5 years
1.2 years
0.9 years
Finished Goods/Inventory
Days of Sales Outstanding (DSO)24.5 days
21.5 days
28.2 days
Working Capital/Invested Capital-1.1%
Cash Conversion Cycle Time-1.3 days
-1.1 days
-2.5 days
Gauge Score (0 to 25)
1.  Data extracted from the Balance Sheet dated 31 December 2008.

The Cash Management metrics are likely to change when an up-to-date Balance Sheet is published. 

December's doubling of Long-term Debt to Equity is due to the increase in debt from $22 billion to $27 billion and the 40 percent reduction in Shareholders' Equity resulting from last year's huge impairment charges.  There is also less Cash Flow from Operations to cover the Debt.

We're not thrilled that Working Capital is negative, albeit slightly.

GrowthMarch 20093 months prior
12 months prior
Revenue growth7.8%
Revenue/Assets 133%
CFO growth
Net Income growth N/A
Gauge Score (0 to 25)10
Growth rates are trailing four quarters compared to four previous quarters.

The steep rise in energy prices, later reversed, powered sharp Revenue growth in the first half of 2008.  Although positive on a trailing year basis, Revenue fell sharply in the last two quarters.

Cash Flow has fallen precipitously, and Net Income growth is N/A because the company recorded a huge loss in 2008.

Revenue/Assets rose because the impairment charges cut deeply into Assets.

ProfitabilityMarch 20093 months prior
12 months prior
Operating Expenses/Revenue 89.4%
ROIC 16.9%
Free Cash Flow/Invested Capital-0.9%
Accrual Ratio
Gauge Score (0 to 25)9

The rise in the Operating Expense ratio was abetted by declining Revenue.  We expect the rise to reverse if the Gross Margin improvement seen in the first quarter is maintained in 2009.

ROIC's fall was cushioned by the impairment charges that reduced Invested Capital.

It's ironic that non-cash charges make the company's earnings appear to be of higher quality, as indicated by the much lower Accrual Ratio.

ValueMarch 20093 months prior
12 months prior
P/E vs. S&P 500 P/E N/AN/A56%
Price/Revenue 0.3
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)13

Since GAAP earnings were hugely negative in the fourth quarter of 2008, we don't learn anything from the Price/Earnings ratio.  However, it is interesting to see how low the Price/Sales and Price/Cash Flow ratio have dropped, even in the face of lower Revenue and falling Cash Flow.

If we back out $35 billion in fourth-quarter 2008 charges, the P/E multiple, on a trailing-twelve-months basis, would be about 8.4.

The price of ConocoPhillips shares fell 41 percent, from $88.30 to $51.80, during 2008.  The closing share price on 31 March was only $39.16.

Conoco's valuation ratios can be compared with other companies in the Major Integrated Oil and Gas industry.

OverallMarch 20093 months prior
12 months prior
Gauge Score (0 to 100)44

At the end of 2008, the historic decline in energy prices led ConocoPhillips to mark down the value of its intangible assets and investments by approximately $35 billion (about 19 percent of total assets.)  Although the company moved up a notch in the Fortune 500 list, Shareholders have much less Equity.

Discontinuities of this magnitude make year-to-year and quarter-to-quarter comparisons difficult.

In the first quarter of 2009, Revenue, Operating Income, and Net Income were all much lower than in 2008.  However, the company did make money in a very challenging time, and some Operating Expenses fell more than we anticipated.

We really need to see the 10-Q to get updated Balance Sheet data and to read the explanations for some surprising Income Statement data (e.g., a tax rate near 60 percent)

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