Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component in deciding whether to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at ConocoPhillips' (COP) earnings and earnings growth, profit margins, profitability ratios and cash flow.
Through the above-mentioned four main metrics, we will understand more about the company's profitability. And by comparing this summary to other companies in the same sector, you will be able see which has been the most profitable.
Earnings and Earnings Growth
1. Earnings = Sales x Profit Margin
- 2010 - $198.655 billion x 5.71% = $11.358 billion
- 2011 - $251.226 billion x 4.95% = $12.436 billion
ConocoPhillips earnings increased from $11.358 billion in 2010 to $12.436 billion in 2011, an increase of 9.49%.
2. Five-year historical look at earnings growth
- 2007 - $11.891 billion, 23.53% decrease over 2006
- 2008 - $(16.998) billion, 242.9% decrease
- 2009 - $4.858 billion, 449% increase
- 2010 - $11.358 billion, 233% increase
- 2011 - $12.436 billion, 9.49% increase
In looking at ConocoPhillips' earnings over the past five years, you can see that the company's earnings were greatly impacted by the financial crisis in 2008 into 2009. As stated in the company's 2008 annual report, "After reaching record heights, oil prices declined precipitously late in the year as an international financial crisis triggered a global recession that in turn reduced energy demand."
Since 2009 as the global demand for energy has picked up so have the earnings of ConocoPhillips. Overall the company's earnings are 4.58% higher than 2007.
3. Gross Profit = Total Sales - Cost of Sales
In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are ConocoPhillips' gross profits for the past two years:
- 2010 - $198.655 billion - $146.386 billion = $52.269 billion
- 2011 - $251.226 billion - $196.637 billion = $54.589 billion
4. Gross Profit Margin = Gross Income / Sales
The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
In reviewing ConocoPhillips' gross margin over the past five years, the margin has been declining even though sales and earnings have rebounded. The 5-year low for the gross margin was reported in 2011 with a margin of 21.72%. The 5-year high for the margin was in 2007 with a margin of 31.04%. The 2011 gross profit margin is below the 5-year average of 26.39%.
- 2007 - $60.383 billion / $194.495 billion = 31.04%
- 2008 - $65.701 billion / $246.182 billion = 26.68%
- 2009 - $40.068 billion / $152.840 billion = 26.22%
- 2010 - $52.269 billion / $198.655 billion = 26.31%
- 2011 - $54.589 billion / $251.226 billion = 21.72%
The decrease in the gross margin implies that management was less efficient in its manufacturing and distribution during the production process in 2011 compared to the 5-year average.
5. Operating income = Total Sales - Operating Expenses
The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.
- 2010 - $19.750 billion
- 2011 - $23.001 billion
6. Operating Margin = Operating Income / Total Sales
Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
Over the past five years, ConocoPhillips' operating margin has been directly influenced by global energy prices. In 2007 when energy prices were strong the company's operating margin was 12.01%. In 2008 when the price of energy plummeted so did ConocoPhillips' operating margin. Since 2008 the operating margin has recovered but is still not as strong as 2007.
- 2007 - $23.359 billion / $194.495 billion = 12.01%
- 2008 - $(3.523) billion / $246.182 billion = -1.43%
- 2009 - $9.582 billion / $152.840 billion = 6.27%
- 2010 - $19.750 billion / $198.655 billion = 9.94%
- 2011 - $23.001 billion / $251.226 billion = 9.15%
The 2011 operating margin of 9.15% is above the 5 year average of 7.18%. This implies that there has been a higher increase in the percentage of total sales left over after paying for variable costs of production such as wages and raw materials compared to the 5 year average.
7. Net Profit Margin = Net Income / Total Sales
A ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.
Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.
Like the Operating Margin ConocoPhillips' net profit margin has a correlation between energy prices and the net profit margin. The 2011 net profit margin is above the 5-year average of 2.83%.
- 2007 - $11.891 billion / $194.495 billion = 7.22%
- 2008 - $(16.998) billion / $246.182 billion = -6.90%
- 2009 - $4.858 billion / $152.840 billion = 3.18%
- 2010 - $11.358 billion / $198.655 billion = 5.72%
- 2011 - $12.436 billion / $251.226 billion = 4.95%
As the 2011 net profit margin of 4.95% is above the 5 year average of 2.83%, this implies that there has been an increase in the percentage of earnings that the company is able to keep compared to the company's 5-year average.
8. ROA - Return on Assets = Net Income / Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."
Unlike the Profit margins listed above, the 2011 ROA of ConocoPhillips has exceeded the 2007 ROA. The 2011 ROA of 8.11% is above the 5 year average of 2.67%.
- 2007 - $11.891 billion / $177.757 billion = 6.69%
- 2008 - $(16.998) billion / $142.865 billion = -11.89%
- 2009 - $4.858 billion / $152.588 billion = 3.18%
- 2010 - $11.358 billion / $156.314 billion = 7.27%
- 2011 - $12.436 billion / 153.230 billion = 8.11%
As the 2011 ROA of 8.11% is above the 5-year average of 2.67 and above the 2007 ROA of 6.69%, this implies that management has been more efficient at using the company's assets to generate earnings compared to its 5-year average and 2007.
9. ROE - Return on Equity = Net Income / Shareholders' Equity
As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.
- 2007 - $11.891 billion / $88.983 billion = 13.36%
- 2008 - $(16.998) billion / $55.165 billion = -30.81%
- 2009 - $4.858 billion / $62.467 billion = 7.76%
- 2010 - $11.358 billion / $68.562 billion = 16.56%
- 2011 - $12.436 billion / $65.224 billion = 19.07%
Like the ROA ConocoPhillips' ROE has rebounded nicely from the 2008/2009 recession and exceeded the 2007 calculation of 13.36%. As the 2011 ROE has rebounded nicely and exceeded 2007 results, this reveals that the company is generating strong profits compared to shareholders' equity.
10. Free Cash Flow = Operating Cash Flow - Capital Expenditure
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.
Over the past five years, ConocoPhillips' free cash flow has remained positive.
- 2007 - $24.550 billion - $11.791 billion = $12.759 billion
- 2008 - $22.658 billion - $19.099 billion = $3.559 billion
- 2009 - $12.479 billion - $10.861 billion = $1.618 billion
- 2010 - $17.045 billion - $9.761 billion = $7.284 billion
- 2011 - $19.646 billion - $13.266 billion = $6.380 billion
The latest number, on the plus side, indicates that ConocoPhillips has enough cash to develop new products, make acquisitions, pay dividends and reduce debt.
11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales
The higher the percentage, the more cash available from sales.
If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.
As ConocoPhillips cash flow margin is positive, it does not have to take the above measures to continue operating.
- 2007 - $24.550 billion / $194.495 billion = 12.62%
- 2008 - $22.658 billion / $246.182 billion = 9.18%
- 2009 - $12.479 billion / $152.840 billion = 8.16%
- 2010 - $17.045 billion / $198.655 billion = 8.58%
- 2011 - $19.646 billion / $251.226 billion = 7.82%
In analyzing ConocoPhillips' earnings growth over the past five years, you can see the effect the 2008 - 2009 recession had on the company. Overall, the company has rebounded nicely from the recession and has reported earnings in 2011 4.58% higher than 2007.
As illustrated above and using a 5-year time frame, the listed profit margins show mixed results. The gross profit margin has shown a decline over the past 5 years while the operating margin and net profit margin have shown a rebound since 2008. All of the listed margins are below the 2007 results when energy prices were at its peak.
The ROA and ROE show different results. Both the ROA and ROE indicate a strengthening in the profitability of the company as both metrics are above their 2007 metrics.
With free cash flow and the free cash flow margin both displaying positive cash, ConocoPhillips has enough cash to develop new products, make acquisitions, pay dividends and reduce debt without having to borrow or raise money to maintain operations.
The analysis of ConocoPhillips' profitability tells the story of a solid company with a declining gross margin but overall strong profitability. Over the past 5 years, the earnings as well as the other listed profitability margins and ratios have rebounded nicely from the 2008 - 2009 recession. ConocoPhillips has a large amount of free cash at hand, which means the company will likely continue to grow for the foreseeable future.
To read more fundamental analysis on ConocoPhillips please read my articles:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.