ConocoPhillips (NYSE: COP), global energy behemoth, recently announced its results for the third quarter of 2008. This post provides the GCFR analysis of the financial statements.
The company's report included Income and Cash Flow statements, and a plethora of data for each business segment, but it did not include a current Balance Sheet. Investors must wait for the company to file a 10-Q to obtain Asset, Liability, and Equity data. To compute the GCFR Gauge scores identified below, we assumed that the Balance Sheet did not change materially from the end of the second quarter.
Prior to the release of these results, ConocoPhillips had announced that third-quarter production might have been a little below that of the second quarter. The company also noted that it had experienced lower refining margins in the quarter because capacity utilization was down (partially attributed to hurricane impacts).
ConocoPhillips is the seventh-largest Major Integrated Oil & Gas company by market capitalization. Holding the fifth spot on the Fortune 500 list, Conoco's heft was achieved with mergers and acquisitions. Most notably, Conoco, Inc., and Phillips Petroleum combined in August 2002. In March 2006, ConocoPhillips purchased Burlington Resources, which had extensive natural gas operations in North America, for $33.9 billion.
Troubles with the Venezuelan government last year led ConocoPhillips to record "a complete impairment of its entire interest in its oil projects in Venezuela of approximately $4.5 billion, before- and after-tax."
Berkshire Hathaway, Inc. (NYSE: BRK.A), run by super-investor Warren Buffett, owned about 17.5 million shares of ConocoPhillips on 31 March 2008. However, Berkshire's public 13-F disclosure for the second quarter didn't indicate whether its ConocoPhillips position increased, decreased, or was eliminated. The 13-F stated that information regarding this position was included in a separate confidential filing. One observer suggested that the Berkshire's stake in ConocoPhillips might have increased substantially. (A new 13-F for the third quarter hasn't yet been filed by Berkshire Hathaway.)
Three months ago, our Overall gauge of ConocoPhillips registered a disappointing 27 of the 100 possible points. Readers are referred to this analysis of the second quarter 10-Q report for the details. The most encouraging finding was that the Growth gauge jumped in the June quarter to 21 of the the 25 possible points, an excellent score. However, a dismal one-point score on the double-weighted Value gauge outweighed the Growth component, keeping the Overall score in weak territory. The Value gauge indicated that the second quarter's 24 percent price rise in ConocoPhillips shares, to $94.39 on 30 June, was too much too fast.
And so it proved to be. COP shares trade today under $50Now, with the limited data available for the third quarter, our gauges display the following scores:
- Cash Management: 13 of 25 (up from 10 in June)
- Growth: 23 of 25 (up from 21)
- Profitability: 6 of 25 (down from 8)
- Value: 13 of 25, (up from 1)
- Overall: 48 of 100, up from 27
Before we examine the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously announced expectations.
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats. A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.
| ($M) | | September 2008 (actual) | September 2008 (estimated) | (actual) |
| Revenue (1) | | 70,044 | 63,000 | 46,062 |
| Op expenses | | | | |
| | CGS (2) | (52,667) | (45,675) | (33,482) |
| | Depreciation | (2,361) | (2,205) | (2,052) |
| | Exploration | (267) | (378) | (218) |
| | SG&A (3) | (6,132) | (6,930) | (5,152) |
| | Other | (225) | (150) | (249) |
| Operating Income | | 8,392 | 7,662 | 4,909 |
| Other income | | | | |
| | Equity income (4) | 1,199 | 1,500 | 1,289 |
| | Interest, etc. (5) | (124) | 50 | 166 |
| Pretax income | | 9,467 | 9,212 | 6,364 |
| Income tax | | (4,279) | (4,053) | (2,691) |
| Net Income | | 5,188 | 5,159 | 3,673 |
| | | $3.39/sh | $3.38/sh | $2.23/sh |
| Shares outstanding | | 1,528 | 1,525 | 1,644 |
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 in the third quarter exceeded the value in the year-earlier period by 52 percent! We had expected Revenue to grow by 37 percent; as a result, Revenue surpassed our prediction by 11.2 percent. Given the company's comments about stagnant production, we feared (erroneously, as it turned out) our Revenue estimate might have been too optimistic. Revenue in the last four quarters grew by 41 percent compared to the previous four quarters.
The Gross Margin in the quarter was 24.8 percent of Revenue, which fell short of our forecast of 27.5 percent. This actual margin, which is rather low for Conoco but not unprecedented, equates to a Cost of Goods Sold [i.e., purchased crude oil, natural gas and products + Production and operating expenses] of 75.2 percent of Revenue. The margin was 27.3 percent in the prior-year quarter.
Depreciation expenses were 3.4 percent of Revenue. We had predicted 3.5 percent.
Exploration costs were more than $100 million less than the $378 million we had assumed based on the prior company's guidance. The reason for large discrepancy isn't yet clear.
Sales, General, and Administrative (SG&A) expenses, which in our categorization is dominated by non-income taxes, were 8.8 percent of Revenue, much less than our 11 percent estimate. When Revenue soars, these costs evidently do not scale proportionately, which we had assumed.
Non-recurring operating costs exceeded our $150 million projection by $75 million.
Rolling up these Operating figures, Operating Income, as we define it, exceeded our forecast by 9.5 percent. It was an astonishing 71 percent more than in the year-earlier quarter.
On the other hand, net non-operating income and expenses, such as equity in the earnings of affiliates, minority interests, and interest, were $475 million less than our estimate.
The effective Income Tax Rate for the quarter was 45.2 percent, whereas we expected 44.0 percent. The rate was 42.3 percent a year ago.
With the rather significant differences between the actual figures and our estimates for the individual Income Statement line items, it can only considered dumb luck that our estimate for Net Income was within 0.6 percent of the reported figure. Net Income surpassed the year-earlier value by 41 percent.
Cash Management. This gauge moved up from 10 points in June to 13 points now. However, this score is likely to change when we analyze an up-to-date Balance Sheet.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| Current Ratio | 1.0 | 1.0 | 1.0 |
| LTD/Equity | 23.3% | 23.3% | 24.7% |
| Debt/CFO | 0.8 yrs | 0.9 yrs | 0.9 yrs |
| Inventory/CGS | N/A | N/A | N/A |
| Finished Goods/Inventory | N/A | N/A | N/A |
| Days of Sales Outstanding (DSO) | 25.1 days | 28.2 days | 27.8 days |
| Working Capital/Market Capitalization | -1.7% | -0.8% | -0.3% |
| Cash Conversion Cycle Time | -1.7 days | -1.6 days | -0.1 days |
Growth. This gauge increased from 21 points in June to 23 points now.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| Revenue growth | 41.3% | 26.2% | -8.9% |
| Revenue/Assets | 137% | 125% | 105% |
| CFO growth | 13.7% | 6.0% | 13.2% |
| Net Income growth | 78.6% | 61.4% | -33.6% |
The steep rise in energy prices, now dramatically reversed, powered sharp growth across the board.
The jump in Net Income appears especially robust because 2007 included a $4.5 billion impairment charge related to Conoco's Venezuelan operations.
Profitability. This gauge decreased from 8 points in June to 6 points now.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| Operating Expenses/Revenue | 88.3% | 88.6% | 87.4% |
| ROIC | 14.4% | 12.9% | 10.1% |
| FCF/Equity | 13.4% | 13.3% | 13.5% |
| Accrual Ratio | 3.3% | 2.3% | -2.0% |
It's disappointing that operating expenses grew at the same rate, if not faster, than soaring Revenue. The increasing Accrual Ratio indicates that less of the company's Net Income is due to CFO, and, therefore, more is due to changes in non-operational Balance Sheet accruals. This suggests lower quality earnings.
Value. Conoco shares fell from $94.39 to $73.25 during the third quarter, and kept on dropping in October. In keeping with the normal GCFR practice, we used the quarter-end share price to computer the Value gauge score of 13 points, up from 1 point in June.
| September 2008 | 3 mos. ago | 12 mos. ago | |
| P/E | 5.8 | 8.3 | 13.5 |
| P/E to S&P 500 average P/E | 35% | 45% | 79% |
| Price/Revenue | 0.4 | 0.7 | 0.8 |
| Enterprise Value/Cash Flow (EV/CFO) | 5.0 | 6.7 | 7.1 |
The Valuation metrics suggest a bargain basement stock. Clearly, investors expect the worldwide economic slowdown to slash future earnings.
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