We updated our evaluation to incorporate the Balance Sheet for 30 June 2007, and the analysis results are reported below. For completeness, we're providing the entire analysis report. Information from our initial analysis that is still relevant is repeated.
The net effect of the current Balance Sheet on our results was to increase the Cash Management and Overall gauges by 3 points each.
With worldwide oil, gas, and chemical operations, ConocoPhillips is the third-largest integrated energy company based in the U.S. Among international energy giants, it ranks fifth by Revenue and eighth by Market_Capitalization.
Holding the sixth spot on the Fortune 500, Conoco's heft is the product of mergers and acquisitions. Conoco, Inc., and Phillips Petroleum combined in August 2002. The resulting behemoth purchased Burlington Resources for $33.9 billion in March 2006 for its extensive natural gas operations in North America.
Conoco's international holdings have become problematic, given the nationalistic trends in Russia, where it owns a chunk of Lukoil, and Venezuela. A disagreement with the Venezuelan government has caused Conoco to record in its second-quarter financial results "a complete impairment of its entire interest in its oil projects in Venezuela of approximately $4.5 billion, before- and after-tax." A $4.5 billion write-off for a company with $173 billion in assets is not a cause for panic, but it is worrisome.
Conoco shares have been surging, which must please super-investor Warren Buffett since the company he runs, Berkshire Hathaway, owns about 18 million shares of Conoco. Of course, $70 for a barrel of oil didn't hurt. A new $15 billion program to repurchase company stock through 2008 definitely helped the stock.
When we analyzed Conoco after the March quarter, the Overall score was a so-so 33 points. [We didn't foresee the impending big gain in the share prices. Was it because the surging price of oil outweighed all other consideration? Was it because the company's mergers have made historic data irrelevant?] Of the four individual gauges that fed into this composite result, Cash Management was the strongest at 15 points. Value was weakest at 3 points, which really worried us at the time. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]
Now, with the available data from the June 2007 quarter, our gauges display the following scores:
- Cash Management: 16 of 25 (3 points greater than the preliminary score)
- Growth: 3 of 25
- Profitability: 10 of 25
- Value: 0 of 25
- Overall: 27 of 100 (3 points greater than the preliminary score)
Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. In the table below, we have excluded the $4.588 billion charge for expropriated assets.
| ($M) | | June 2007 (actual) | June 2007 (predicted) | (actual) |
| Revenue (1) | | 47370 | 45000 | 47149 |
| Op expenses | | | | |
| | CGS (2) | (33377) | (30150) | (32142) |
| | Depreciation | (2016) | (2025) | (1965) |
| | Exploration | (259) | (270) | (134) |
| | SG&A (3) | (5301) | (4950) | (5031) |
| | Other | 0 | (100) | (141) |
| Operating Income | | 6417 | 7505 | 7736 |
| Other income | | | | |
| | Equity income (4) | 1487 | 1000 | 1143 |
| | Interest, etc. (5) | 202 | 0 | (197) |
| Pretax income | | 8106 | 8505 | 8682 |
| Income tax | | (3217) | (3742) | (3496) |
| Net Income | | 4889 | 4763 | 5186 |
| | | 2.95/share | 2.87/sh | 3.09/sh |
| | | | | |
2. CGS = Purchased crude oil, natural gas and products + Production and operating expenses
3. SG&A = SG&A expenses + Taxes other than income taxes
4. Equity income = Equity in earnings of affiliates - Minority interests
5. Interest, etc. = Other income - Interest and debt expense
Revenue was 5.3 percent above our estimate. We may have overweighted Conoco's guidance for the second quarter that maintenance and asset disposals would cut production, or maybe high oil prices are curative for many ills. We thought the Cost of Goods Sold (CGS) would be 67 percent of Revenue, and the actual value was 70.5 percent. Depreciation expenses were 4.3 percent of Revenue, a shade less than our 4.5 percent estimate. Sales, General, and Administrative (SG&A) expenses were 11.2 percent of Revenue, compared to our forecast of 11 percent.
The higher expenses outweighed the higher revenue to yield Operating Income 14.5 percent below the forecast value.
The gap was closed by Non-operating income $689 million greater than expected. The Income Tax Rate was 39.7 percent, instead of the predicted 44 percent. As a result, Net Income exceeded our prediction by 2.6 percent.
We find it a little worrisome that the out-performance was due to non-operating factors.
Of course, the $4.5 billion charge, not included above, wiped out most of the net income in the quarter.
Cash Management. This gauge increased from 15 points in March to 16 points now.
The measures that helped the gauge were:
- LTD/Equity = 25.6% manageable, and decreasing
- Cash Conversion Cycle Time (CCCT) = -0.9 days, down from 3.1 days, for this measure of efficiency
- Debt/CFO = 1.0 year compared to 1.0 and 1.4 years 3 and 12 months ago, respectively
- Working Capital/Market Capitalization = 0.3 percent, up from -3.8 percent
The measures that hurt the gauge were:
- Days of Sales Outstanding (DSO) = 27.5 days, substantially above the 20.3-day level one year earlier
- Current Ratio =1.0; weaker than we like, but matching the historic average
Note that the DSO change indicates the company is having more success getting its customers to pay their bills; rapid collection is a sign of efficiency because the payments received can be re-invested sooner.
Growth. This gauge decreased from 8 points in March to 3 points.
None of our measures helped the gauge that much.
- Revenue growth = -8.1 percent, down from 27 percent in a year
- Revenue/Assets = 104 percent, down from 120 percent in a year; sales efficiency is worsening
- Net Income growth = -32 percent, down from 52 percent in a year (killed by impairment charge)
- CFO growth = 15 percent; respectable, but down from 41 percent in a year
Profitability. This gauge decreased from 11 points in March to 10 points.
The measures that helped the gauge were:
- FCF/Equity = 12.3 percent, up from 7.5 percent in a year
- Accrual Ratio = 0.3 percent, down from +6.3 percent in a year
The decreasing Accrual Ratio tells us that more of the company's Net Income is due to CFO, and, therefore, less is due to changes in non-operational Balance Sheet accruals.
The measures that hurt the gauge were:
- ROIC = 10.5 percent, down from 13.5 percent in a year
- Operating Expenses/Revenue = 86.5 percent, down just a bit from 87.3 percent in a year.
The increase in Gross Margin was matched by increases in R&D and SG&A expenses, which is why operating expense were basically unchanged as a percentage of revenue.
Value. Conoco's stock price rose over the course of the quarter from $68.35 to $78.50. The Value gauge, based on the latter price, dropped to 0 points, compared to 3 points three months ago (and 5 points twelve months ago).
- Enterprise Value/Cash Flow = 6.4, very inexpensive, and down from 6.8 in June 2006
- P/E = 12, up from 7
- P/E to S&P 500 average P/E = 28 percent discount, compared to a 56 percent discount one year ago
- Price/Revenue ratio = 0.7, compared to 0.6 one year ago
The average P/E for the Integrated Oil and Gas industry is also 12. The average Price/Revenue for the industry is currently 1.2.
We're impressed that Conoco could take a $4.5 billion charge and still report an operating profit, albeit small, for the quarter. We're also in awe that company forged by mega-acquisitions has such a solid balance sheet. However, sagging revenues when the price of the underlying commodity is surging is a source of concern. One would also expect the profitability numbers to be better.
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