ConocoPhillips Had A Very Poor First Quarter

| About: ConocoPhillips (COP)

Summary

The company borrowed about $4.5 billion which was more than half of its available credit line.

Production remained basically level despite capital expenditures of less than $2 billion in the first quarter.

The dividend is not secure because there is no cash flow currently to support it. The company basically borrowed money to pay the dividend and the capital budget.

Rising commodity pricing would bail this company out of some serious problems, but that outcome is far from certain.

Cost cutting progress is not really determinable at this time as management has provided few specifics and no tangible goals. Break-even budget commodity pricing is still above current commodity prices.

When the last article was written, there was a sizeable gap between what the company stated it wanted to spend according to the budget, and the commodity pricing needed for that cash flow to be available. Accordingly, this stock was identified as a short sale candidate because the presented conditions for the budget to succeed were not there. Since that time, ConocoPhillips (NYSE:COP) common stock has been fairly volatile. It has rallied several times and has fallen back, which has presented numerous trading opportunities on both the upside and the downside. Overall though, the stock has rallied considerably (about 50%) with the rally in commodity pricing as the market has realized that higher commodity pricing will help the company out of its cash flow dilemma.

So now that the first quarter is over, it is time to look at the management review of progress made and see if the story makes any more sense than it had at the end of the fourth quarter.

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Source: ConocoPhillips First Quarter 2016 Conference Call, April, 2016

This slide is positively frightening to any investor in the company, let alone any investor who wants to depend on the dividends in the future. Interestingly, as this article is being written, the 10-K has not yet been filed. Such an act is a very loud statement about the value of shareholders to the company management.

The first quarter cash flow from operations before working capital was a whole $700 million before an adjustment for working capital items reduced the cash flow from operations to $400 million. Neither of those figures is anything close to what is needed to service long-term debt that at the end of the quarter was in excess of $29 billion. For a company the size of ConocoPhillips with nearly $30 billion in long-term debt, that amount of cash flow counts as no cash flow.

The company borrowed about $4.5 billion more long-term debt from its credit line of $7 billion. Even considering that more than half of the borrowing went to the additional cash balance so that the company management could state that the company had a lot of cash, this is a very scary amount to borrow at one time. Basically, about half of the borrowing went to the capital expenditures and dividends. That management had the audacity to even attempt to pay dividends is unbelievable in a situation like this, as the company needs to be financially stabilized first.

During the conference call, management stated several times that they did not want the long-term debt to total more than $25 billion, but when pressed to state how the debt would get back down to $25 billion, management simply stated that it was a medium-term project and brushed aside any questions that pressed for specific details. So clearly management has no idea how to pare the long-term debt down to the company goal from its current level.

One of the things that investors need to watch in the future conference calls is the tone of questions towards company management. There is a natural conflict of interest from analysts asking tough questions, and ConocoPhillips management handing out future business to the analysts' employers. So when an analyst asked a blunt question about the long-term debt, it is a sign that the employer of the analyst may not view future business from the company as a priority, or even a possibility. As more questions get tougher from more analysts, at a certain point they will constitute a Wall Street sell signal.

Management had used half of its borrowing capacity in one quarter. Since the budget will decrease in future quarters expect that production will decline. Much of that borrowing went to keep production volumes neutral. Production had decreased from the sales of some property, and the expenditures offset the natural decline plus the sales. But the company only has enough borrowing capacity for about four of these no cash flow quarters. The second quarter should have considerably better cash flow because commodity prices have rallied. In fact if these current prices hold reasonably well, the company could show a billion or more in cash flow. Still management talks about a budget assumption of $45 per barrel oil prices, and those prices are really not there yet, although they are close. So expect a gap between the budget projections and the cash flow yet again in the second quarter, though hopefully a much smaller gap. Oil prices could decline again which would drop cash flow nearer to first quarter levels.

The company is showing nearly $30 billion in long-term debt at the end of the first quarter. To service that debt properly and carry out the recently reduced capital budget (let alone pay dividends), cash flow of about $7 billion annually is needed. The company is nowhere near that during the first quarter and will probably miss that goal by quite a bit during the second quarter. As cost cutting takes effect and production improvements occur, the cash flow problem could mitigate, but management is very short on specifics, so clearly the company has a lot of work to do in this area.

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Source: ConocoPhillips First Quarter 2016 Conference Call, April, 2016

The above slide was clearly a trip to wonderland. First, the company borrowed more than half of its credit line (which shrunk about $250 million from the 10-K to the first quarter slide footnotes without a word from management) in the first quarter. That is hardly steps that a company takes to preserve cash and position itself for the long term. On top of that while operations needed about $1.5 billion in cash to fund the capital budget, the company paid dividends to increase the borrowing. The completion of some long-term projections this year may mean that capital budget needs are declining for the future, the company still needs to navigate the rest of the year, and during the conference call management lacked specifics relating to this topic. So clearly expenses are way out of line, and management does not have a date that they are willing to publicly disclose as to when expenses will be low enough to balance any reasonable budget.

Second, despite spending about nearly $2 billion in capital, the company did not show meaningful production increases. Management did trumpet about a 20% decrease in operating expenses. However, there needs to be far more tangible expense decreases or production improvements for this company to have any kind of future. The company really did not discuss operational improvements, costs by project, or the company's costs in comparison to the industry, in a meaningful, specific or comprehensive way. That lack of cost discussion further provides evidence to the stance that costs are out of control and the company has deeper problems than management admits. The huge first quarter loss reinforces that impression.

Management did state that asset sales were a priority, but really only a nominal amount of asset sales were concluded or were in process by the end of the first quarter. If asset sales were a priority as management states, then management would figure out a way to make those asset sales happen. The environment is tough but this company needs to raise cash so it's time to drop the selling prices and obtain cash where possible.

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Source: ConocoPhillips First Quarter 2016 Conference Call, April, 2016

The above slide was another effect of the reduced future borrowing capacity. The rig count will be reduced sharply, limiting the ability of the company to maintain or increase production in the future to some completing major projects.

Interestingly, the company touts its Bitumen production. But companies such as Suncor Energy Co. (NYSE:SU) have taken years to get their costs inline for this type of project. Plus Suncor depends upon its refineries to upgrade bitumen (and its related products) into more profitable products. ConocoPhillips does not have the refining capacity to upgrade its production so it must have low enough costs to make adequate profits from the bitumen production itself. That would appear to be a long-shot projection based upon the experience of other companies in the industry. So the bitumen projects in Canada could remain cash flow negative longer than the company would lead investors to believe. Many competitors have pegged the unconventional oil and gas wells as lower cost and lower capital requirements, as well as easier to ramp up and down. So quite possibly those Canadian operations should have been closed down or sold, and the cash (if any) invested in the unconventional projects, where the company supposedly had its best cost reduction results for the quarter.

Summary

The first quarter of 2016 was definitely not what the company needed to report at this time, though the results were predictable. It may not have been a disaster but it should be sub-par enough to prevent new investors from taking a position in the company.

There was really no cash flow from operations and without significant cash flow from operations, the company common stock has no predictable value. The company borrowed more than half of its credit line in just the first quarter. Now the company needs to prove that it won't burn cash quickly. The first quarter was not encouraging in this respect.

The company used nearly $2 billion in long-term borrowings to pay dividends and maintain its projected capital budget (which will decrease in the next three quarters). As such the dividend cannot be considered safe, even at its greatly reduced level. Corporate leverage has definitely increased with the reported loss and the increase in long-term debt. But there is no indication that lenders will increase the credit line in the future. Indeed, industry trends are going in the opposite direction. So this company needs to sharply decrease costs, increase cash flow, and increase operating results to reduce future borrowings. The increased commodity pricing so far in the second quarter will sharply reduce operating cash needs to maintain the newly reduced budget. This will also give the company time to reduce costs enough to survive or even thrive in the current environment. But other companies such as Murphy Oil (NYSE:MUR), Chevron (NYSE:CVX), and many smaller companies already have those lower costs. These companies have done far more to cut costs and have the operational results to prove it. They would probably be much better investments at this time.

Investors would be wise to consider other companies with much better costs such as Advantage Oil and Gas (NYSE:AAV), Birchcliff Energy (OTCPK:BIREF), Encana (NYSE:ECA), and many other low cost producers out there. Even BP (NYSE:BP) is in far better shape to maintain its dividend than this company, and BP does not have to borrow to bring its costs in line to the extent that this company needs to borrow.

Maybe this company is not the obvious short that it once was, but the stock clearly does not have a well defined future either. The stock will be volatile in the future and is best left to traders until some key issues are resolved. This is a speculative stock that is not meant for investors dependent upon dividend income or the faint of heart.

Management talked of increasing the dividend in the future, but that demonstrates a lack of focus on the challenges at hand. The conference call should have centered on cost reductions and increasing cash flow as well as how to repair the balance sheet in the future.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.