Heading into the second quarter, analysts expected that ConocoPhillips (COP -0.83%) would report another adjusted loss, with the consensus that it would repeat its first-quarter showing and lose $0.02 per share. However, the company surprised everyone by delivering an adjusted profit of $178 million, or $0.14 per share. Five factors drove that result, led by its ability to squeeze out more costs.
Despite that strong showing, analysts expect earnings to head backward in the third quarter, with the consensus that the oil giant will earn $0.06 per share when it reports later this week. Driving the downbeat view is that oil was weaker this quarter and that production could be under pressure due to the timing of asset sales and other issues. But investors have a couple of reasons to be optimistic that the company could beat expectations once again.
The early glimpse looked fine
ConocoPhillips has already provided a clue that there shouldn't be any downside surprises by preannouncing its expectation that third-quarter production would be within its guidance range. In mid-September, ConocoPhillips stated that output in the Eagle Ford shale had returned to pre-Hurricane Harvey levels and that the storm had a negligible impact on operations in the quarter. Likewise, the company said that the timing of the sale of its San Juan, Barnett, and Panhandle assets didn't detract from its production expectations. As a result, it reaffirmed that oil and gas output would be within its previous guidance range of 1.17 million to 1.21 million barrels of oil equivalent per day (BOE/D) during the quarter.
Because production seems to have hit the mark, the factor that could have the biggest impact on earnings is costs. However, ConocoPhillips has done an exceptional job keeping a lid on expenses over the past few years. Furthermore, one of the company's primary aims this year is reducing interest expenses. Last quarter, it paid off $3 billion in debt after it closed a megadeal with Cenovus Energy (CVE -2.24%) and received the proceeds. In that transaction, Cenovus handed over $10.3 billion in cash for full control of the two companies' oil sands joint venture, as well as some other assets in Canada. ConocoPhillips planned to use another portion of that cash infusion to retire an additional $2.4 billion of debt during the third quarter. These debt reductions, when combined with the fact that the company jettisoned several lower-margin assets during the quarter, could provide some unexpected upside to its financial results.
The secret sauce for another upside surprise
Another potential fuel for an upside surprise this quarter is ConocoPhillips' share repurchase program. The oil giant bought back $1 billion in shares last quarter thanks to the money from Cenovus and plans to repurchase another $2 billion in stock by year-end.
The initial buyback had a minor impact on shares outstanding last quarter due to its late-quarter timing. However, it's worth noting that the company bought back 2% of its total shares during the quarter, which would have added $0.01 per share to the bottom line if it had completed the repurchase earlier in the quarter. A front-end-weighted buyback could provide an unexpected lift to its per-share results in the third quarter.
In addition to the incremental earnings potential, the buyback could provide a meaningful boost to production on a per-share basis. According to the company's forecast, asset-sale-adjusted output will rise 3% this year. However, the buyback has the potential to drive production up 8% on a per-share basis, depending on the purchase price.
That ability to provide investors with incidental growth without flooding the market with more unwanted oil is leading other oil companies to announce buybacks. Last month Anadarko Petroleum (APC) joined the buyback brigade when it unveiled a $2.5 billion repurchase plan. Anadarko's CEO Al Walker said that the buyback was "a very attractive use" of its cash position, because it would be highly accretive to production and earnings per share. At the time of the announcement, Anadarko's buyback positioned the company to improve both numbers by 10% if it completed the entire repurchase program at around the then-current stock price. Given the size of ConocoPhillips' repurchase plan, it could deliver a similar boost to those metrics in the next year.
Don't expect a gusher but it should still be pretty good
Despite the impact from Hurricane Harvey and several asset sales, it looks like ConocoPhillips' production will be right on target this quarter. The company stands an excellent chance of beating expectations if it can keep driving down costs and make a meaningful dent in its share count via the repurchase program. That said, even if the company comes up short, it's still heading in the right direction: It has slimmed down to a stronger core, which should enable it to thrive in the current low-oil-price environment.