This post describes our model of
ConocoPhillips's (
NYSE: COP) Income Statement for the third quarter of 2010, which will end on 30 September.
The
purpose of the model is to establish a baseline for identifying
surprises, positive or negative, in the quarterly results the company
will report. Estimates for each line of the
Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.
We
begin by reviewing background information about ConocoPhillips and the
business environment in which it is currently operating.
ConocoPhillips is one of the ten biggest
Integrated Oil and Gas companies, which produce, refine, transport, and market energy products. The company's
market value is now around $80 billion, a little more than half its high.
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).
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, charges slashing the carrying value of
intangible assets and investments by $33 billion 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.
The
Wall Street Journal reported that Conoco's
"restructuring is mandatory"
because of the company's concentration in oil refining and natural gas,
which are two of the weakest sectors of the energy industry.
More details about the asset divestitures emerged in March 2010 when Conoco publicized its intent to
sell half of its 20 percent stake in Russian oil producer
Lukoil (
OTC: LUKOY), which it began acquiring in 2004. The
Financial Times quoted Conoco CEO Jim Mulva
as saying, "The new opportunities in Russia haven’t developed for us as
quickly as we would have thought." This plan changed in July when
Conoco decided to pursue the
sale of its entire Lukoil investment by the end of 2011.
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.
The
Refining and Marketing segment provided more than 70
percent of ConocoPhillips's Revenue in 2009, and Exploration &
Production contributed most of the rest. However, Exploration &
Production and the Lukoil Investment generated much of the year's Net
Income.
In 2009, ConocoPhillips's worldwide production, excluding Lukoil, averaged 1.85 million
barrel-of-oil equivalents per day, compared with 1.79 million boe/day in 2008.
The
price of crude oil in 2010 has generally been around
$80 per barrel. This price has settled above the $40 low in early 2009
when the global economy seemed most fragile, but well below oil's $140
peak in 2008 peak. Crude's price tends to move up or down based on
changing perceptions of how economic conditions will affect the demand
for oil, how geopolitical and other forces will affect the supply, the
availability of new energy sources, compliance with output quotas, and
the value of the dollar.
Natural gas prices also soared and crashed in 2008, but spot prices haven't had much of a rebound.
Investing guru Warren Buffett, of
Berkshire Hathaway (
NYSE: BRK.A),
characterized the purchase of ConocoPhillips shares, when energy prices were soaring, as his biggest mistake in 2008. Berkshire still owned
29 million COP shares on 30 June 2010.
ConocoPhillips earned $2.77 per diluted share on a
GAAP basis in the
second quarter of 2010.
If special items related to the sale of equity investments are
excluded, the adjusted earnings were $1.67 per share. Reported and
adjusted earnings both dwarfed the $0.57 per share reported by
ConocoPhillips in 2009's second quarter.
We're now ready to look ahead to ConocoPhillips's results for September 2010 quarter.
The press release on 28 July 2010 announcing
second quarter
results did not include any specific guidance for ConocoPhillips's
third quarter or the remainder of 2010. However, during the ensuing
conference call (transcript available from
SeekingAlpha), the company's management commented on expectations for production, refinery utilization, and costs.
Production
is expected to be "close to" 1.8 million BOE per day, as it was in
2008. New production should offset declines in mature fields. Refinery
utilization rates are expected to fall slightly in the third quarter.
Given these production comments, along with current
energy prices and margins, our estimate for
Revenue in the September 2010 quarter is $45.0 billion, which would be a 12-percent increase relative to the same 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. CGS has been close to 76 percent of Revenue, translating into a
Gross Margin
of 24 percent, in each of the last few quarters. Energy prices,
refining margins, and maintenance activities can affect the Gross
Margin.
We
are assuming the Gross Margin will contract slightly to 23.8 percent in
the September 2010 quarter. In other words, we're estimating that the
Cost of Goods Sold will be (1 - 0.238) * $45 billion = $34.3 billion.
Based on historic data, it seems reasonable to expect a
Depreciation expense of $2.3 billion. Similarly, we'll estimate
SG&A
expenses (including non-income taxes in our presentation) at 10 percent
of Revenue, or $4.5 billion. We will then add $300 million for
Exploration expenses and $200 million for non-recurring operating
charges.
These figures would result in an
Operating Income of $3.4 billion, up from $2.15 billion in September 2009.
We then need to consider non-operating income and expenses. The
ongoing reduction of the Lukoil stake would presumably result in lower
equity in the earnings of affiliates. However, we don't know the pace
of share sales, nor the cost basis for the shares sold. We are
estimating $750 million in equity earnings.
We're not making any
provisions for gains or losses on asset sales, as we have no data to
make an informed estimate. Items related to asset sales could have a
substantial impact on reported earnings.
For other income less
interest expenses, a net loss of $200 million would be typical. This
brings our estimate of pre-tax income to $4.0 billion.
ConocoPhillips' effective
income tax rate
is quite variable from quarter to quarter, but a rate around 45 percent
wouldn't be unusual when special tax matters don't interfere. This
rate would lead to provision for income taxes of $1.8 billion.
After subtracting $20 million for Noncontrolling Interests, our estimate for
Net Income becomes $2.16 billion ($1.44 per share). In the year-earlier quarter, the company made $1.47 billion ($0.98 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.
Notes:
http://futures.tradingcharts.com is the source for the historical price charts for crude oil and natural gas.
Another good source of information was the
ConocoPhillips Annual Analyst Meeting Presentation [6 MB pdf] on 24 March 2010.
Full disclosure: Long COP at time of writing
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