ConocoPhillips (COP) reported second-quarter 2011 adjusted earnings of $2.41 per share, comfortably beating the Zacks Consensus Estimate of $2.20 as well as the year-earlier profit of $1.63.
The outperformance was mainly on the back of higher price realizations and better domestic refining margins, partially offset by lower upstream volumes.
Revenues in the reported quarter jumped more than 33% year over year to $67.0 billion, comfortably beating the Zacks Consensus Estimate of $57.8 billion.
Segmental Performance
Exploration and Production (E&P): The segment reported earnings of $2.6 billion during the quarter, reflecting an impressive 72.5% growth from the year-ago level of $1.5 billion. The improvement was aided by higher commodity prices, which were partially offset by higher taxes.
Daily production from the E&P segment averaged 1.64 million barrels of oil equivalent (MMBOE), down from 1.73 MMBOE in the year-ago quarter. Asset divestitures and the political unrest in Libya were the dampeners.
While the company’s production declined, the earnings impact was limited as it has shifted its focus toward higher margin production of oil sands, Lower 48 liquids and LNG (liquefied natural gas) production from North American natural gas.
Average realized price for liquids was $103.90 per barrel, compared with $71.09 in the year-earlier quarter. The price for natural gas was $5.50 per thousand cubic feet (Mcf) versus $4.60 realized in second quarter 2010.
Refining and Marketing: The segment recorded earnings of $740 million compared with $720 million in the year-ago quarter. The modest upswing was attributable to improved U.S. refining margins, which were partially mitigated by lower international refining margins on the back of foreign exchange impacts.
Domestic refining crude oil capacity utilization rate in the quarter averaged 90%, 6% lower from the year-ago quarter level. International capacity utilization rate averaged 96%, up significantly from 54% in the year-earlier quarter.
Midstream: The segment contributed $130 million to net income during the quarter, up substantially from the year-earlier level of $61 million, on account of improved natural gas liquids prices.
Chemicals: The segment recorded earnings of $199 million, up 44% from the year-ago quarter’s level of $138 million, mainly on higher margins in olefins and polyolefins, and higher volumes.
Financials
During the quarter, ConocoPhillips generated $6.3 billion in cash from operations. As of June 30, 2011, the company had $8.1 billion cash balance and $23.2 billion in debt, with a debt-to-capitalization ratio of 25%.
The company repurchased 42 million shares of its own stock, or 3% of shares outstanding, for $3.1 billion, bringing total shares repurchased to 9% of shares outstanding at the inception of the repurchase program in 2010. ConocoPhillips also paid $900 million in dividends and incurred $3.07 billion in capital expenditures.
In February 2011, ConocoPhillips announced a capital budget program of $13.5 billion for 2011, 90% of which will be exhausted for in exploration and development. The primary emphasis will be on the Eagle Ford Shale along with Permian, Bakken and Barnett Fields.
Further expenditures will be directed toward Canada (SAGD oil sands projects and Western Canada gas basins) and Alaska (Prudhoe Bay and Kuparuk Fields). Conoco plans to invest $14 billion to $15 billion per year from 2012 to 2015. Internationally, the primary emphasis will be on Australia followed by China and Poland.
Outlook
We remain optimistic on ConocoPhillips’ ability to generate free cash flow by unlocking capital tied up in non-core assets. Despite a production decline, upstream earnings increased year over year, boosted by strong realized pricing.
Again, we have a positive outlook on ConocoPhillips post split, as it holds the promise of unlocking significant value. The idea behind the spin-off is to create value for shareholders who like the volatility in the refining business.
Creation of two separate companies is also believed to be helpful in ways that the two separate entities will get to pursue greater opportunities in their respective market segments, without the constraints of the parent company, and better serve the needs of both investor groups. We expect this move will allow Conoco to narrow the return gap at which it historically lagged its peers.
ConocoPhillips’ exploration initiatives toward liquids rich plays such as Eagle Ford, Bakken and North Barnett shale plays are gaining momentum. Although we are encouraged by the recent discoveries and the company’s new exploration efforts, the improvements in the reserves base, finding and development costs, the production growth remain long-term stories.
Despite these positive factors, the company’s performances are weighed down by unpredictable global economic conditions and uncertain oil & natural gas prices. Hence, we maintain our long-term Neutral recommendation on ConocoPhillips, the third-largest U.S. oil company by market value after ExxonMobil Corp. (XOM) and Chevron Corp. (CVX).
Conoco holds a Zacks #3 Rank, which translates to a short term ‘Hold’ rating.
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