ConocoPhillips's (COP) latest earnings report on January 30 disappointed investors.
The stock price fell 5% on the day of the release as investors reacted to lower earnings, decreased production due to asset sales, and a funding gap caused by its capital expenditures outpacing its cash flow.
But as is the case with other oil and gas companies that require heavy investments that don't pay off immediately, the perception of ConocoPhillips as a weaker company based on one quarterly financial report may not be close to reality.
The company has said as much, indicating that its asset sales and capital investments are designed to greatly "increase value for shareholders through portfolio optimization, focused capital investments that deliver growth in production and cash margins, improved returns on capital, and sector-leading shareholder distributions." Or put another way: like a plant or a tree, sometimes you have to do some pruning in order to get maximum growth.
Pruning they have, selling off about $12 billion since the beginning of 2012.
For the short term, the divestiture of assets is negatively impacting earnings. For the fourth quarter, the company earned $1.43 billion, or $1.16 per share, down 8% percent from the previous year. However, excluding certain charges, it earned $1.76 billion, or $1.43 per share. This was in line with consensus estimates of around $1.42 per share.
Full-year 2012 earnings were $8.4 billion, or $6.72 per share, compared with full-year 2011 earnings of $12.4 billion, or $8.97 per share. Part of the shortfall occurred with the spin-off of its downstream operations, which occurred in April 2012. Therefore, earnings from those operations appeared in only four months of 2012, versus the full year of 2011.
The company provided guidance for a 3% production increase, and for earnings for the first quarter to come in at around $1.58 to $1.60 per share.
But it's not just earnings that concern some investors. It's the funding gap. For 2013, the company's capital expenditures and dividend obligations will total about $19 billion, while cash flow is anticipated under $15 billion.
Others are not as concerned, pointing out that scheduled asset sales totaling $9.6 billion in 2013 should be adequate enough to fund operations. Optimists point to a reasonable debt-to-capital ratio of 31%. They are also enthused by CEO Ryan Lance' s explanation that disposed assets had margins of $20 per barrel, while new fields opening have double those margins.
ConocoPhillips is the world's biggest production and exploration company based on oil production and reserves. The firm searches for gas and oil in more than 30 countries and has reserves of 8.4 billion barrels of oil equivalent. In 2012 ConocoPhillips spun off its downstream refining and marketing unit as Phillips 66.
While ExxonMobil (XOM) and others have had success with having integrated upstream and downstream operations, ConocoPhillips last year went the opposite direction. Last year, the company broke apart its upstream and downstream business, creating ConocoPhillips and Phillips66 (PSX). This is a somewhat risky move, as the company now has no hedge against falling oil and gas prices like many of its competitors have.
The renewed focus on exploration seems to be paying off for now. ConocoPhillips is finding more fuel in most of its key territorial operations. Fourth-quarter production in the Lower 48 and Latin America increased 7% over the same period in 2011. Production in Canada grew 6%, and in Asia Pacific and the Middle east by 11%. Only in Europe was fourth-quarter fuel production down year-over-year, though the drop was a noticeable 22%.
Total production grew a modest 1.8%, with production hitting record numbers in its Eagle Ford and Bakken shales. The firm also had solid growth in reserve replacements, which totaled 156% for the year at 8.6 million barrels. The majority of reserves came from oil sands in Canada, as well as increased provable reserves at U.S. shale sites. ConocoPhillips continues to aggressively invest in exploration via both traditional venues like deep water drilling and less-conventional paths like oil sands and shale.
The company also pays a decent dividend with a current 4.6% yield. The amount of the dividend has grown from 47 cents a share in 2008 to a current 66 cents, a 40% increase. Yet it has a modest payout ratio of 39%, meaning it's spending less than 40% of its earnings by returning it back to shareholders.
Still, the dividend is high enough to give investors pause given its dwindling cash position. If cash deposits continue to decline, the dividend could be in danger as the company can only use asset sales as a source of operating capital for so long.
Many investors may not gush about ConocoPhillips until they see more cash on the books, and they want that cash coming from operations, not just from asset sales and debt absorption.
The company's cash flow from operations fell from $19.65 billion in 2011 to $13.5 billion in 2012, about 32%. The company's cash position has fallen each of the last three years, from $9.45 billion at the end of 2010, to $5.78 billion in 2011 and $3.62 billion at the conclusion of last year.
Also troubling is the company's quick ratio of 0.60. This is a measure of potential liquidity by dividing a company's cash, marketable securities and accounts receivable over its current liabilities. Experts say a quick ratio less than 1 means a company cannot quickly pay current liabilities if it had to.
ConocoPhillips trails the industry average for its five-year average return on assets (3% to 8.8%), five-year average return on investments (5.1% to 15.8%), and five-year average net profit margin (2.3% to 7.3%).
Despite The Concerns…
Some analysts believe this is a good time to buy ConocoPhillips. With its current price of around $57 a share, it is trading with a price-to-earnings ratio of under 9. Furthermore, the stock price is down 21% from where it traded this time last year and down 27% from a recent high of $78 set in March 2012.
With the decline, those bullish on the stock say it's undervalued - even if the company doesn't have much free cash lying around.