16 September 2009

COP: Look Ahead to September 2009 Quarterly Results

The GCFR Overall Gauge of ConocoPhillips (NYSE: COP) fell from 44 to 27 of the 100 possible points in the second quarter of 2009.  Our income statement and financial gauge analyses explained in some detail how this score was attained.

Lower energy prices and refining margins caused Conoco's Revenue to drop by 50 percent in the June quarter.  Earnings plunged from $3.50 to $0.87 per share. 

More positively, 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. 

We have now modeled ConocoPhillips's Income Statement for the soon-to-be-concluded September 2009 quarter.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data the company will announce in late July.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we set the stage with some background information about the company and the business environment in which it operates.

ConocoPhillips (NYSE: COP) is the fifth-largest Major Integrated Oil & Gas company when assessed by Revenue, and it ranks seventh by Market Capitalization.  Other majors include Exxon Mobil (NYSE: XOM), Royal Dutch Shell (NYSE: RDS.A), Chevron Corp. (NYSE: CVX), and BP p.l.c. (NYSE: BP).  ConocoPhillips is fourth on the 2009 edition of the Fortune 500 list of the largest U.S. corporations, up from fifth in 2008.

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

Energy prices (and, therefore, the revenues of energy producers) surged through the first half of 2008.  The price of crude oil exceeded $140 per barrel at its peak.  The global economy then stalled, and speculators exited the market.  Crude oil plunged below $40 by the end of 2008. 

Berkshire Hathaway (NYSE: BRK.A), run by investing guru Warren Buffett, owned 64.5 million shares of ConocoPhillips on 30 June 2009, down from 71 million shares on 31 March and about 79 million shares on 31 December 2008.  Buffett characterized the purchase of Conoco shares, when energy prices were soaring, as his biggest mistake in 2008.

The low price of crude oil at year's end led Conoco to conclude that the company's assets were worth less than before.  The company reduced the carrying value of its intangible assets and investments by $35 billion, which was about 19 percent of the company's Total Assets at the time.  Asset impairment charges led to a loss of $31.8 billion (minus $21.37 per share) in the fourth quarter of 2008.

Oil prices have rebounded this year to about $70 per barrel.  The recovery has been linked to fears of a weaker dollar and inflation.

The price of natural gas also soared and crashed last year, but this price has not rebounded.

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 in 2008 was responsible for $7.4 billion of the 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.

We're now ready to look ahead.

Conoco's Revenue is dependent, for the most part, on how much oil and natural gas it produces and refines, the cost of production, and the prices at which various energy products are bought and sold.  The company's Refining and Marketing segment provided 68 percent of total Revenue in 2008, and the Exploration and Production segment was responsible for 29 percent.

Geopolitical and natural forces can have a significant effect on productivity and prices.

During the conference call after the release of the second quarter's results, Conoco's Senior VP Finance and CFO, Sig Cornelius, discussed the company's outlook for the remainder of 2009.

[W]e expect E&P production to be up slightly for the full year, compared [to] 2008. We expect to give back some of our year-to-date gains over the next two quarters, as we execute our normal seasonal maintenance programs and begin to see the impacts of reduced gas drilling activity in North America. Additionally, we are experiencing some unplanned decreases due to the Ekofisk platform incident and expropriation of our Ecuador interests.

Our global refining utilization for the balance of the year is dependent on economic conditions. ... we would expect it to be in the mid 80% range, averaged across the portfolio, with higher rates in the US and lower rates internationally.

With respect to cost reductions, we have realized savings of around $900 million pre-tax so far this year, excluding explorations. This compares to our full year objective of $1.4 billion.

Given this outlook and current and historical energy prices and margins, we expect Conoco's Revenue in the third quarter to fall 41 percent from $70.0 billion in 2008 to $41 billion.  This amount is 15.7 percent more than Revenue in the second quarter of 2009.

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, which translates into a Gross Margin of 23.3 percent.  We considered the margin to be disappointing. 

We don't dare set our target for the third quarter Gross Margin any higher than 24 percent because of continued weak refining margins and normal maintenance activities.  In other words, we're estimating that the Cost of Goods Sold will be (1 - 0.24) * $41.0 billion or $31.2 billion.

Based on historic data, it seems reasonable to expect a Depreciation expense of $2.4 billion.  Similarly, we'll estimate SG&A expenses (mostly non-income taxes) at 11 percent of Revenue, or $4.5 billion.  We will then add $250 million for Exploration expenses and $200 million for non-recurring operating charges.

These figures would result in an Operating Income of $2.5 billion, down 70 percent from the September 2008 quarter when energy prices were much higher.

We then need to consider non-operating income and expenses.  For equity in the earnings of affiliates, our expectation is $900 million.  For other income less interest expenses, a net loss of of $200 million seems reasonable.  This pushes our estimate of pre-tax income to $3.2 billion.

ConocoPhillips' effective income tax rate is quite variable from quarter to quarter.  A rate of 44 percent would be appropriate if there aren't too many special tax matters in the quarter.  This rate would lead to provision for income taxes of $1.4 billion. 

After subtracting $20 million for Minority Interests, our estimate for Net Income becomes $1.76 billion ($1.17 per share).   In the year-earlier quarter, earnings were $5.2 billion ($3.40 per share).

Please click here to see a full-sized, normalized depiction of the projected results next to ConocoPhillips's 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.

Note:  Tradingcharts.com is the source for the historical charts of crude oil and natural gas futures.

Full disclosure:  Long COP at time of writing

No comments:

Post a Comment