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By Ishtiaq Ahmed

ConocoPhillips (NYSE:COP) is one of the world's biggest production and exploration companies. The firm searches for gas and oil in more than 30 countries and has reserves of 8.4 billion barrels of oil equivalent. ConocoPhillips offers impressive dividends and a strong history of dividends. Currently, the firm has a dividend yield of 4.60%, and an annual dividend of $2.64. In my previous article, I explained how safe ConocoPhillips dividends are. However, in this article, I go a little deeper and analyze its cash flows and debt based on some essential metrics, in order to determine the financial health of the company.

Free Cash Flows:

 

 

  

Free Cash Flows

 
 

2012

2011

2010

2009

Net Income

$10,608

$12,436

$11,358

$4,414

Depreciation and other noncash charges

$6,523

$7,934

$9,060

$9,295

Funds from Operations (FFO)

$17,131

$20,370

$20,418

$13,709

change in noncash current assets

$563

$326

$1,859

$748

change in noncash current liabilities

$456

$398

$1,514

$482

Operating Cash flows

$16,112

$19,646

$17,045

$12,479

Capital Expenditures

$12,589

$13,266

$9,761

$10,861

Free Operating Cash Flow

$3,523

$6,380

$7,284

$1,618

     

Long Term Debt

$23,008

$22,623

$23,592

$22,656

Source: SEC Filings

In the previous three years, the company has experienced an increase in its net income. Especially in 2010, the net income almost tripled. The same pattern is evident in funds from operations of the company. At the end of 2011, FFO stood at a stunning $20 billion. The cash flows from operations stood at significantly improved levels in 2011 as compared to 2009. ConocoPhillips invests heavily in the business, and in the previous three years, the amount of capital expenditures has remained between $9.75 and $13.25 billion. At the end of 2009, the firm spent almost $11 billion in capital expenditures; however, by the end of 2011, the capital expenditures for COP had gone up to $13.26 billion.

The company generates healthy free cash flows. Although, the capital expenditures have been increasing, the firm has been able to post impressive free cash flows. For the first six months of 2012, the company reported just over $5 billion in net income. The company experienced a decline in net income due to decreased production levels and the spinoff of its refining business. Depreciation and amortization expense has also decreased for the company. As a result, I expect COP to report lower FFO than the previous year. However, the firm will still invest significantly, and the capital expenditures are expected to be around $12 billion for 2012. Accordingly, the firm will report lower free cash flows than the previous year. According to my estimates, the firm should report $3.5 billion in free cash flows by the end of 2012.

Essential Ratios:

 

 

  

Essential Ratios

 
 

2012

2011

2010

2009

Funds from Operations(FFO)/Total Debt

0.74

0.90

0.87

0.61

FFO/Capital spending requirements

1.36

1.54

2.09

1.26

Free Operating Cash Flow + interest expense/ Interest expense

5.55

7.56

7.14

2.26

Debt Service coverage

1.47

10.39

8.59

4.56

For my analysis, I have used four ratios. The first ratio indicates that the debt of the company is adequately covered with the FFO. The ratio has shown an upward trend over the past three years. However, I believe the FFO to debt ratio will be around 0.75 for the current year.

Nevertheless, the firm is generating enough cash flows to cover the long term debt. The second metric indicates that one of the most important components of the firm is easily covered with the FFO of the company. As I mentioned, capital expenditures are an integral cash outflow for COP, and the analysis shows that the firm is able to meet its capital spending requirements through its internally generated funds.

The last two metrics in the table indicate that the firm is able to meet its interest and debt payments sufficiently. ConocoPhillips has moderate levels of debt, and the debt levels have remained fairly stable over the past three years. The company reported long term debt of just under $19 billion at the end of the second quarter and over $4 billion in the short term debt. However, I do not believe the firm will pay off debt using cash flows. ConocoPhillips's debt is in line with the industry debt levels, and the company has debt to equity ratio of 0.4. I believe the firm will replace the old debt with new offering. The company should be able to meet its interest payments. The sharp fall in debt service coverage ratio for the current year is due to the payment of over $4 billion of long term debt.

Peer Comparison:

 

 

 

ConocoPhillips

BP

Exxon

Chevron

P/E

6.60

7.80

9.70

8.7

P/B

1.50

1.20

2.60

1.80

P/S

0.30

0.40

0.90

0.9

EPS Growth

N/A

6.40%

-0.90%

4.80%

Operating Margin

9.00%

6.90%

16.00%

19.30%

Net Margin

4.50%

4.50%

9.10%

10.80%

ROE TTM

19.30%

15.70%

28.30%

21.70%

Debt to Equity

0.40

0.40

0.20

0.10

Source: Morningstar.com

ConocoPhillips peers include BP PLC ADR (NYSE:BP), Exxon Mobil Corporation (NYSE:XOM) and Chevron Corp (NYSE:CVX). It is evident from the table that the firm is trading at a discount compared to its peers based on multiples. In addition, the firm has impressive margins and attractive ROE. While the debt to equity ratio is higher compared to peers, ConocoPhillips has a manageable debt to equity ratio of 0.4. It also supports the lowest market cap to sales ratio.

Summary:

My analysis indicates that the cash flows of the firm are in a healthy position, and the company should be able to maintain its current dividend level. During the current year, the company suffered a little due to reduced production levels and the spinoff of its refining business. However, the recovery in the energy sector and strengthening commodity prices should augment the earnings. Recently, due to the Euro zone crisis and the depressed oil prices, the stock took a slight beating. However, I believe the stock will return handsomely in the long term. COP stock has the potential to give healthy capital gains, as well as a juicy dividend yield.

Source: ConocoPhillips: Strong Dividends Set To Continue