23 August 2010

COP: Financial Gauge Analysis for the June 2010 Quarter

ConocoPhillips (NYSE: COP) earned $2.77 per diluted share on a GAAP basis in the second quarter of 2010, which ended 30 June.  Earnings per share dwarfed the $0.57 ConocoPhillips made in the same quarter of 2009.

The sale of equity investments in Syncrude and CFJ Properties boosted earnings in the most recent quarter.  Adjusted earnings, which exclude several special items, were $1.67 per share.

A previous article examined Conoco's Income Statement for the June quarter.  Reported and adjusted earnings both surpassed our $1.54 estimate.

We have now updated the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.  This post reports on the metrics for ConocoPhillips and the associated financial gauge scores.  The metrics were calculated using data from the company's current and historical financial statements, including those in the latest 10-Q.

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

ConocoPhillips is one of the ten biggest Integrated Oil and Gas companies, which produce, refine, transport, and market energy products.  The company's market capitalization is approximately $80 billion, and its revenue was almost $150 billion in 2009

ConocoPhillips was formed in 2002 when Conoco, Inc., merged with Phillips Petroleum.  It added Burlington Resources, which had extensive natural gas operations, in March 2006 (when gas prices were high).

In March 2010, Conoco announced it would sell half of its 20 percent stake in Russia's Lukoil (OTC: LUKOY).  This plan changed in July when Conoco decided to pursue the sale of its entire Lukoil investment by the end of 2011.

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

In summary, Conoco's latest quarterly results produced the following changes to the gauge scores:

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Current Ratio1.
LTD to Equity35.2%41.4%49.1%32.4%
Debt/CFO (years)
Inventory/CGS (days)N/AN/AN/AN/A
Finished Goods/InventoryN/AN/AN/AN/A
Days of Sales Outstanding (days)26.927.329.225.9
Working Capital/Revenue-0.8%-1.0%-0.4%-0.9%
Cash Conversion Cycle Time (days)
Gauge Score (0 to 25)8141315

The amount of Long-term Debt on Conoco's Balance Sheet has jumped twice in the last five years.  The first and larger jump corresponded to the $35.6 billion acquisition of Burlington Resources.  The second, more modest issuance of debt was related to the formation of a joint venture with Australia's Origin Energy, Ltd., (ASX:ORG) in 2009.

In the fourth quarter of 2008, Conoco recorded massive asset impairment charges.  Total assets fell from $185 billion to $143 billion, and Shareholders Equity dropped from $93 billion to $55 billion.  The company's Long-term Debt/Equity ratio increased from 23 percent to 49 percent.  The ratio has since been reduced to 35 percent, thanks to asset sales, debt repayments and retained earnings.  Nevertheless, a Google Finance stock screen indicates that Conoco's current LTD-to-Equity ratio is still high compared to many of its peers.

The ongoing efforts to sell assets, such as the Lukoil investment, and to trim capital spending should enable Conoco to reduce its debt level further. 

Growth30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Revenue Growth-3.9%-24.6%-19.7%2.8%
Operating Profit Growth3.3%-11.7%-5.7%0.4%
CFO Growth-3.6%-24.1%-39.5%2.4%
Net Income GrowthN/AN/AN/A125.6%
Gauge Score (0 to 25)44010
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

Conoco has achieved substantial Revenue increases in the first two quarter of 2010, but the gains were not quite enough to turn the trailing-year growth rate from negative to positive. 

Sales and other Operating Revenue of $45.7 billion in the second quarter was 29 percent more than last year.  The rise would have been even more impressive if production from the company's Exploration and Production business had not fallen 7.5 percent, from 1.87 million barrels of oil equivalent per day last year to 1.73 million BOE per day in the June 2010 quarter.  Conoco stated that production fell because of "normal field decline" and planned maintenance.

Weakness in Operating Profit and Cash Flow from Operations have kept the Growth gauge score down, but the growth rates for these measures have improved considerably.

The Net Income growth rate is N/A because of a loss in the earlier period.

Profitability30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Operating Expense/Revenue92.7%93.7%91.0%89.2%
Free Cash Flow/Invested Capital5.9%4.1%-2.8%6.1%
Accrual Ratio-1.8%0.8%-15.5%-0.2%
Gauge Score (0 to 25)5468

The Profitability gauge is also weak.  The one-percent improvement in the Operating Margin is a step in the right direction, but the margin is still significantly less profitable than it was in June 2009.

Small improvements were also achieved with the ROIC and FCF ratios, but the improvements were not nearly enough to stir the gauge score.

Free Cash Flow has benefited from a significant reduction in capital expenditures.

The recent decline in the Accrual Ratio is also welcome.  It often signals improved quality of earnings.

Value30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
P/E vs. S&P 500 P/E 0.50.8N/A0.5
Enterprise Value/Cash Flow (EV/CFO)
Gauge Score (0 to 25)5285
Share Price $)$49.09$51.17$42.06-

The Price/Earnings ratio came down, which the Value gauge views as positive, as earnings surged and the company's share price fell $2.  Earnings benefited from a one-time, $2.88 billion gain on the sale of an investment in Syncrude, which produces crude oil from Canadian oil sands.

The effect on the gauge score was muted because the P/E is only slightly below its long-term average.

The small decline in the Price/Sales ratio was also positive. 

Overall30 Jun 201031 Mar 201030 Jun 20095-Yr Avg
Gauge Score (0 to 100)22213034

Although the Overall score is still very low, signs of improvement were noted in some of the financial metrics.  The company has recently benefited from one-time gains on asset sales and reductions in capital spending.  A recovery in energy prices has also helped.  Lower production, on the other hand, has been a negative factor. 

Asset sales are slated to continue into next year. 

Full disclosure: Long COP at time of writing

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