Oil and gas investors, hold your breath. Q3 2017 earnings in the energy sector are right around the corner, and one of the first companies to report is ConocoPhillips (NYSE:COP), the largest independent U.S. oil and gas exploration and production company.
Quarterly earnings releases are almost always going to have an impact on a company's stock, but this quarter could be make or break for Conoco's stock. Unlike many of its peers, including Apache Corporation (NYSE:APA), Conoco shares are up for the year, by 1.7%. That could change, though, if the company's earnings disappoint. Here's what to look for.
ConocoPhillips surprised everyone in Q2 by posting a net profit, albeit a small one. Still, the company finally proved that it could be profitable in a $50-per-barrel oil price environment, and that cheered investors. Trouble is, oil price environments can shift.
Although Conoco was able to turn a profit at $50 a barrel, West Texas intermediate (WTI) crude oil prices were below $50 for most of the third quarter. However, Conoco has generally used Brent crude prices in its projections, and Brent crude spent most of the quarter above $50, the point at which Conoco claims it can earn a 30% profit margin.
It's even possible -- more on why later -- that Conoco has managed to push its breakeven price below $50 a barrel. If that happens, and if the company's fortunes are indeed more dependent on Brent crude prices than on WTI crude prices, it should turn a nice profit in Q3. If that happens, expect investors to reward the stock. But if the company posts another loss, it will signal that Conoco still has work to do to cut costs and adjust its operations. And I'll be listening for management's explanation for a miss, if it occurs.
The good news is that Conoco doesn't expect any changes to its production guidance from Hurricane Harvey.
Margin and mix
During the third quarter, Conoco completed several of its previously announced asset sales that were projected to have a positive impact on the company's margin. This will be investors' first chance to see if the sales were all they were cracked up to be from that standpoint.
In March, the company announced it was selling its low-margin Canadian oil sands business to Cenovus for $13.3 billion in cash and stock. It followed that up with the sale of its San Juan Basin assets for $3 billion in April. Finally, the company disposed of its Panhandle assets to an undisclosed buyer for $184 million.
The Canadian transaction closed in mid-May, the San Juan Basin sale happened at the end of July, and the small Panhandle asset sale didn't close until almost the end of the third quarter, on Sept. 29. So we'll have to wait until Q4 to get a full sense of how the asset sales will affect Conoco. But because the Canadian transaction -- the largest of the bunch -- was closed back in Q2, and the San Juan transaction was closed relatively early in the quarter, the company's Q3 results should give us a sense of where things are headed.They also might shed some light on how other companies that have sold off Canadian assets, like Apache, may be affected by their own asset sales.
In particular, I'll be looking at the company's production mix, which it projected would move from about 35% oil to 50% oil. Oil has a higher margin than natural gas, so this change should have a positive impact on the company's finances. If the company's predictions about its production mix have come to pass, and its margin has indeed improved, that will be a great sign that Conoco is on track to continued profitability.
The last thing investors should watch is pretty straightforward: the balance sheet and earnings per share.
When the company announced its asset sales, management indicated that it intended to use the proceeds to reduce the company's debt load to below $20 billion and to buy back shares. With that in mind, I'll be looking carefully at Conoco's balance sheet to see whether -- and if so, how -- it's deployed the cash it received from its asset sales during the quarter.
We do know that the company spent $1 billion on share buybacks in Q2 and anticipated spending another $2 billion by the end of the year. That ought to boost earnings per share, but the exact amount will depend on how many shares the company repurchased during the quarter. Likewise, the company's long-term debt load will depend on how much debt reduction the company has chosen to undertake during the quarter.
ConocoPhillips is a much stronger company today than it was a year ago, thanks to its savvy asset sales. But concerns linger about its ability to succeed in an era of low oil prices. The company's reported post-asset-sale profitability, production mix, and balance sheet should tell investors a lot about whether the stock has a long-term upside, or whether it still has farther to go.