Saturday 19 March 2016

Analyzing ConocoPhillips’ Return on Equity (COP, XOM)

ConocoPhillips (NYSE: COP) reported return on equity (ROE) of -2.04% for the 12-month period ending in September 2015. This represents a sharp drop from its 2014 ROE of 13.21% and an even bigger drop from its 2013 figure of 18.3%. The company has a trailing 12-month net loss of $1 billion, down sharply from a net income of $6.9 billion in 2014. Its shareholders' equity, which stood at $44.2 billion as of September 2015, has declined more modestly. It was $51.9 billion at year-end 2014.

ROE Analysis

ConcoPhillips' precipitous drop in ROE from 13.21% in 2014 to -2.04% for the 12-month period ending in September 2015 came as a result of a commensurately sharp decline in net income. Like all large-cap oil and gas companies, ConocoPhillips has struggled amid a crash in oil prices throughout 2015. Oil, which traded as high as $147 per barrel for a time in 2008, fell below $30 per barrel in 2015, its lowest price since the 1990s. The company's main competitors, Exxon Mobil Corporation (NYSE: XOM) and BP PLC (NYSE: BP), also saw their net incomes and ROE fall considerably from 2014 to 2015 -- though Exxon Mobil managed to keep both figures positive.

DuPont Analysis

A typical ROE analysis looks at net income and shareholders' equity separately and evaluates the effect that each has had on changes in ROE. The DuPont analysis, by contrast, breaks ROE into its constituent components of net margin, asset turnover ratio and equity multiplier and seeks to determine the influence each has on ROE.

ConocoPhillips' net margin for the 12-month period ending in September 2015 was -2.82%, down from 12.37% in 2014. A February 2016 press release from the company acknowledges that low commodity prices have squeezed its margins and, as a result, it is taking active steps to bring expenditures in line with its reduced revenue. It cut its quarterly dividend from 74 cents per share to 25 cents per share, lowered capital expenditures by $1.3 billion and reduced operating costs by $700 million.

Its competitors suffered falling margins as well, with Exxon Mobil's dropping from 7.89 to 6.73% and BP's declining from 1.05 to -3.06%. ConocoPhillips had the largest drop of the three, making it reassuring that the company has acknowledged the root of the problem and taken quick and decisive steps to address it.

ConocoPhillips' trailing 12-month asset turnover ratio is 0.32. This figure, which measures how efficiently a company generates revenue from its assets, has fallen steadily from 1.62 in 2011. Its influence on ROE appears moderate, though not as pronounced as that of net margin. Exxon Mobil and BP, both with asset turnover ratios of 0.85, have seen their asset turnovers slow down as well in the wake of the oil price collapse.

ConocoPhillips' equity multiplier for the 12-month period ending in September 2015 is 2.4. This figure has remained steady for a decade. While the company's equity position has fallen slightly, the company has also reduced its debt load, keeping the ratio between the two consistent. A silver lining for ConocoPhillips amid the oil collapse is, at least, the company is not overleveraged. Its equity multiplier sits squarely between those of Exxon Mobil (2.0) and BP (2.7).

Conclusions

ConocoPhillips' steep drop in ROE resulted from severe declines in net income and net margin, both symptoms of broader oil market malaise. On the bright side, the company has come forward with the steps it is taking to counter its declining revenue resulting from low oil prices, which involve slashing expenditures in several areas, such as dividends, capital expenditures and operating expenses. Every large-cap oil and gas company has suffered in the wake of the oil crash. Investors in ConocoPhillips should at least be comforted that the company is being proactive in responding to it.

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