31 July 2009

COP: Income Statement Analysis for the June 2009 Quarter

ConocoPhillips (NYSE: COP) earned $0.87 per share during the three months that ended on 30 June 2009, down from $3.50 in last year's second quarter. 

This post examines the Income Statement for the quarter and compares it to our "look-ahead" estimates.  Our target for Conoco's Net Income in the latest quarter was $0.89 per share.

Our principal sources were the earnings announcement and the conference call transcript at Seeking Alpha.  Some background information about ConocoPhillips and the business environment in which it is currently operating can be found in the look-ahead.

In a second article, we will report Conoco's scores as measured by the GCFR Financial Gauges. The follow-up post will also provide the latest figures for the financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Revenue was 50 percent less than in the June 2008 quarter, but it was 15.3 percent greater than in the March 2009 quarter.  Our prediction was miraculously close: we were off by only 0.3 percent.  After considering energy prices and refining margins, we estimated that quarterly Revenue would rise 15 percent from the first to the second quarter of 2009.

To illustrate how much energy prices changed from the second quarter of 2008 to the second quarter of 2009, we have extracted the following data from the Industry Prices (Platt's) section of Conoco's earnings report.

WTI spot$123.98/barrel $59.54/barrel
Brent dated$121.38/barrel$58.79/barrel
Henry Hub gas$10.94/mmbtu$3.51/mmbtu

Despite the much lower Revenue than last year, reported production in the quarter, on a barrel-of-oil equivalent basis, was about 6.5 percent higher than in the second quarter of 2008.  Conoco attributed the increase

"to new developments in the United Kingdom, Russia, Canada, Norway, China and Vietnam, which more than offset the impact of base field declines. Production also increased due to the impacts of royalties and production sharing contracts, as well as improved well performance and less unplanned downtime."

Of the various costs and expenses reported by Conoco, we group "Purchased crude oil, natural gas and products" and "Production and operating expenses" and call the combination Cost of Goods Sold.  In the June quarter, CGS was 76.7 percent of Revenue.  Therefore, the company achieved a Gross Margin of 23.3 percent.  The Gross Margin was 23.9 percent in June 2008, so the recent quarter was slightly less profitable by this measure.  However, the Gross Margin fell significantly short of our 26-percent estimate, probably because realized refining margins were down so much.  We thought the Gross Margin would be closer to its 27.4 percent value in the first quarter of 2009.

Depreciation expenses were 6.6 percent of Revenue.  We had predicted 6.5 percent.

Exploration costs were substantially less than the $325 million we had assumed based on the company's guidance.  Perhaps, we misinterpreted the guidance, but the difference is trivial small compared to Conoco's $35 billion revenue.

We lump non-income taxes together with Sales, General, and Administrative expenses.  In the June quarter, the combination accounted for 11.8 percent of Revenue, compared to our estimate of 12 percent. 

Other operating expenses (i.e., impairments, accretion on discounted liabilities, and foreign currency changes), in the aggregate, were only $17 million, compared to our $200 million placeholder for this entry.  One interesting thing to note is that currency changes produced a gain of $142 million.  In the March 2009 quarter, currency changes were responsible for a loss of $131 million, which means there was a swing to the upside of $273 million between the first two quarters of 2009.

A second item of interest is that the Conoco recorded a $51 million impairment charge after some assets in Ecuador were expropriated.

Operating Income, by the way we define it, was 82 percent less than in the June 2008 quarter.  The lower-than-expected Gross Margin was responsible for Operating Income being 31 percent below our estimate.

Equity in the earnings of affiliates doubled our estimate and made up for most of the Operating Income shortfall.   Other income and interest expenses were 19 percent below our estimate.

The 44.8-percent effective income tax rate was not much more than our 44 percent prediction.

Rolling up all of the above, we see that Net Income was 76 percent less than the year-earlier value.  However, Net Income was only 3 percent ($0.02 per share) less than our estimate.

In summary, the historic decline in energy prices led ConocoPhillips from last year's peak took a big bite out of Conoco's Revenue.  However, the Revenue figure for the quarter came close to matching our estimate.  We were a disappointed the Gross Margin wasn't at least a couple percentage points higher, but the difference was made up for by items such as currency gain and equity in the earnings of affiliates.  Net income was just two cents per share shy of our estimate. 

Full disclosure: Long COP at time of writing

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