28 October 2009

COP: Income Statement Analysis for the September 2009 Quarter

ConocoPhillips (NYSE: COP) earned $1.00 per share during the third quarter of 2009, down sharply from $3.40 in the same period of 2008.  The latest results surpassed the expectations of many analysts, but we were disappointed.  Our target for Conoco's Net Income in the latest quarter was $1.17 per share.

Since the shares fell almost 3 percent in value after the results were released, other investors must also have thought Conoco's earnings would be higher.

This post examines the Income Statement for the quarter in the earnings announcement, and it compares the entries on each line to our "look-ahead" estimates.  We've also garnered some insights from the conference call transcript made available by Seeking Alpha.

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 various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Some background information about ConocoPhillips and the business environment in which it is currently operating can be found in the look-ahead.

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 42.6 percent less than in the September 2008 quarter, but it was 13 percent greater than in the June 2009 quarter.  After considering energy prices and refining margins, we estimated that quarterly Revenue would be 41 percent less than in last year's third quarter.

Production in the quarter, including Conoco's share of LUKOIL (OTC: LUKOY), averaged 2.215 million barrel-of-oil equivalents.  This was 2.1 percent more than daily production of 2.170 million BOE in the same quarter of last year.  For the first three quarters of 2009, production rose 4.1 percent compared to the same period in 2008.  Therefore, production growth in the third quarter was weaker than in the first half of the year. 

Conoco indicated that production in the most recent quarter was adversely affected by problems at the Ekofisk field in Norway.

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 September quarter, CGS was 76 percent of Revenue.  Therefore, the company achieved a Gross Margin of 24 percent, exactly as we had estimated.

Refining margins remained weak.

Depreciation (including Depletion and Amortization) was 3 percent less than our $2.4 billion estimate. The reported figure was 5.8 percent of Revenue.

Exploration costs in the third quarter were 54 percent more than our $250 million estimate.  Costs due to dry holes, lease impairments, and "other" were all up substantially relative to the first two quarters of the year.

We lump non-income taxes together with Sales, General, and Administrative expenses.  In the September quarter, the combination accounted for 11.5 percent of Revenue, compared to our estimate of 11.0 percent. 

Other operating expenses (i.e., impairments, accretion on discounted liabilities, and foreign currency changes), in the aggregate, were $135 million, compared to our $200 million placeholder.  This was the first quarter in the last year in which foreign currency changes were not substantial.

Operating Income, which is the difference between Revenue and the operating expenses identified above, decreased by 74.4 percent, when compared to the September 2008 quarter.  It certainly wasn't a surprise to see Operating Income dive, but we thought this figure would be about 15 percent higher.  Lower-than-expected Revenue, higher exploration costs, and more burdensome non-income taxes costs caused Operating Income to fall below our target value for the quarter.

Equity in the earnings of affiliates was 12.8 percent more than our $900 million estimate. Other income and interest expenses were also about 10 percent more than our estimate of $200 million.

The 48.4-percent effective income tax rate was much more than our 44 percent prediction.

Net Income of $1.5 billion ($1.00 per share) was 71 percent less than last year's $5.2 billion ($3.40 per share). Net Income was also 15 percent less than our $1.76 billion ($1.17 per share) estimate.

In summary, the effects of the historic decline in energy prices (abating recently), resulting from lower global oil consumption, continued in the third quarter.  Conoco's Revenue fell 42.6 percent and was 2 percent below our estimate.  The Gross Margin was on target, but higher operating expenses in some categories meant that Operating Income was also worse than we expected. 

Conoco's share of earnings of affiliates was higher than our forecast, but income taxes were more burdensome.  Net income was much weaker than last year, and it was also below our targets.

Chief Financial Officer Sig Cornelius remarked during the conference call:

"we have begun to see some positive signs with respect to improvement in the global economy and corresponding energy demand, while there are still some challenges for North American natural gas marketing and refining, the picture today looks more encouraging than earlier in the year."

Natural gas prices remain low because of the economic conditions and new supply.

Full disclosure: Long COP at time of writing

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