30 October 2010

COP: Income Statement Analysis for the September 2010 Quarter

ConocoPhillips (NYSE: COP) earned $2.05 per diluted share on a GAAP basis in the September-ending third quarter of 2010, more than double earnings of $0.98 in the same three months of last year. 

Adjusted earnings, which exclude special items, rose from $0.95 to $1.50 per share.  Gains on asset sales were the principal difference between adjusted and reported earnings in the most recent quarter.

This post examines ConocoPhillips' Income Statement for the latest quarter and compares the entries on each line to our "look-ahead" estimates.  Adjusted earnings were $0.06 more than our $1.44 EPS estimate.

The principal sources for this income statement analysis were the earnings announcement, the ensuing conference call presentation[pdf], and transcript (the latter courtesy of Seeking Alpha).

In a second article, we will report ConocoPhillips' 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.

Before getting into t
he 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.  ConocoPhillips has business interests in 26 countries around the world, from Algeria to Vietnam.

The company was formed in 2002 when Conoco, Inc., merged with Phillips Petroleum.  It added Burlington Resources, with its extensive natural gas operations, in March 2006 (when gas prices were high). The company's market value is now around $92 billion. 

For financial data reporting, ConocoPhillips has six operating segments:  Exploration & Production, Midstream, Refining & Marketing, Lukoil Investment, Chemicals, and Emerging Businesses.  The Chemical segment consists of a joint venture with Chevron.

In 2009, ConocoPhillips earned $4.86 billion ($3.24 per share) on revenue of $152.8 billion.  In 2008, the roller-coaster rise and fall of crude oil prices resulted in record-high annual revenue of $246.2 billion.  However, $33 billion in charges slashing the carrying value of intangible assets and investments led to a $17 billion loss in 2008.

In October 2009, ConocoPhillips announced it would "improve returns and deliver long-term organic growth from a reduced, but more strategic, asset base."  The company signaled it would sell assets worth approximately $10 billion over the next two years, and it would trim capital expenditures in 2010 to $11 billion, from $12.5 billion in 2009. 

Following this plan, ConocoPhillips has sold equity investments in Syncrude and CFJ Properties.  The company is also pursuing 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.

Please click here to see a 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.

Sales and other Operating Revenues of $47.2 billion in the third quarter were 17.5 percent more than last year.  Our $45 billion estimate was 4.7 percent too low.

Production, not including a share of Lukoil's output,   averaged 1.72 million barrel-of-oil equivalents per day in the quarter, down 3.9 percent from the same period of 2009.  ConocoPhillips stated that production decreased because of "normal field decline" and asset dispositions.

Of the various costs and expenses reported by ConocoPhillips, we group (for simplicity) two items --  "Purchased crude oil, natural gas and products" and "Production and operating expenses" -- and call the combination Cost of Goods Sold.  In the September 2010 quarter, CGS totaled $36.6 billion or 77.6 percent of Revenue.  This equates to a Gross Margin of 22.4 percent, which is 160 basis points less profitable than the 24.0 percent margin in the same three months of 2009.

The margin decrease appears to be due to inventory valuations and the shutdown of the Wilhelmshaven refinery.

We had estimated the Gross Margin would be 23.8 percent, or 140 basis points more profitable than the actual percentage.  The lower-than-expected margin essentially offset the better-than-expected Revenue.

The Depreciation (including Depletion and Amortization) expense of $2.25 billion was 3.5 percent lower than last year's $2.33 billion.  As a percentage of Revenue, this expense declined from 5.8 percent to 4.8 percent.  The reported Depreciation expense was 2.3 percent less than our $2.3 billion estimate.

Exploration costs in the first quarter of $252 million were down 35 percent from the same period last year.  We had estimated $300 million for these costs.

Taxes other than income and Sales, General, and Administrative expenses totaled $4.72 billion, up 1.9 percent from last year.  The reported amount was a rather substantial 4.9 percent more than our $4.5 billion estimate.

Other operating expenses totaled $159 million, which was less than the $200 million we anticipated. 

Subtracting the various operating expenses discussed above from Revenue yields Operating Income of $3.20 billion, up 49 percent from $2.15 billion in 2009's third quarter.
Operating Income, though strong, fell 6.2 percent short of our $3.41 billion estimate.  Unexpectedly high SG&A/taxes outweighed some better-than-expected numbers.

Equity in the earnings of affiliates, $1.0 billion, was slightly more than last year's $981 million.  Our $750 million estimate proved to be too low by 25 percent.

In the September 2010 quarter, ConocoPhillips disposed of assets valued at $6.3 billion, which included the sale of $6 billion of LUKOIL shares.  The latter resulted in an $874 million gain, after tax.  We had not included an estimate for this gain in our earnings model, so the large gain enabled Conoco's actual results to exceed our estimates by a wide margin.

Other income (excluding asset disposal gains) less the interest expense amounted to a $264 million net expense, whereas we estimated $200 million.

The 41.8-percent effective Income Tax Rate was less burdensome than our 45-percent estimate.  It seems likely that the gain on asset sales was taxed at a lower rate than ordinary earnings.

Bottom-line Net Income rose to $3.06 billion ($2.05 per diluted share), compared to restated earnings of $1.47 billion ($0.98 per share) in the year-earlier quarter.   Adjusted earnings, which excludes the large gain on asset sales and a few smaller items, increased from $1.43 billion ($0.95 per diluted share) to $2.24 billion ($1.50 per diluted share).

Adjusted earnings exceeded our $2.16 billion ($1.44 per share) Net Income estimate by 3.7 percent.  Equity in the earnings of affiliates was greater than we expected and the income tax rate was less burdensome.

In summary, Revenue rose a healthy 17.5 percent even though production was down modestly.  Higher realized prices for oil and gas products boosted Revenue above our estimate of a 12-percent Revenue growth rate.  The Gross Margin, on the other hand, was less profitable than we had hoped because of inventory valuations and a refinery shutdown.  Taxes other than income and Sales, General, and Administrative expenses were $200 million higher than we expected, which brought Operating Income down below our projection.  On the non-operating side of the Income Statement, Equity earnings and a large gain on the sale of assets (mostly Lukoil shares) caused pre- and post-tax earnings to soar. 

Full disclosure: Long COP at time of writing

No comments:

Post a Comment