ConocoPhillips (COP) reported third-quarter earnings of $1.00 per share, above the Zacks Consensus Estimate of 93 cents. However, earnings per share were well below the year-earlier figure of $3.39.

This pronounced fall was mainly due to significantly lower commodity prices and a steep decline in refining margins, which more than offset production improvements and lower costs.

The Exploration and Production segment reported earnings of $978 million during the quarter, down nearly 75% year over year. The fall was mainly due to lower commodity prices, partially offset by higher volumes and lower operating costs. Daily production from the E&P segment (including Canadian Syncrude) averaged 1.79 million barrels of oil equivalent per day (MMBOE/d), up from 1.75 MMBOE/d in the year-ago quarter.

The year-over-year increase in production from new developments in the U.K., Russia, Norway, Vietnam, China and Canada has more than offset the impact of normal field decline. To some extent, production also increased due to higher operating efficiency and the impact of production-sharing contracts.

The Refining and Marketing segment reported a profit of $99 million, compared to a profit of $849 million in the year-ago quarter. The domestic refining crude oil capacity utilization rate for the quarter averaged 93%, compared to 90% a year earlier. International capacity utilization rate averaged 81%, versus 75% last year. Worldwide utilization averaged 90%, compared to 87% in the year-ago period.

The Midstream segment (which includes the company’s 50% interest in DCP Midstream LLC) contributed $62 million to the net income during the quarter, down approximately 64% year over year. The decline was due to lower realized prices and volumes.

ConocoPhillips’ earnings from its LUKOIL Investment segment came in at $545 million as against $438 million in the prior-year quarter. The year-over-year increase came primarily from refinery throughput. LUKOIL’s estimated contribution to the company’s quarterly E&P volumes was 424,000 barrels of oil equivalent per day. The Chemicals unit reported earnings of $104 million as against earnings of $46 million a year ago.

During the quarter, ConocoPhillips generated cash from operations of $2.9 billion. At the end of the quarter, the company had $30.5 billion in debt, with a debt-to-capitalization ratio of 33%. During the quarter, Conoco paid $700 million in dividends. The company invested $2.9 billion in capital expenditures.

At the beginning of the month, Conoco had increased its quarterly dividend by 6% to 50 cents per share (annualized rate of $2.00 per share) from the existing rate of 47 cents (annualized rate of $1.88).

Conoco intends to sell $10 billion of assets over the next two years. It has lowered its capex budget for 2010 ($11 billion vs. $12.5 billion) in an effort to strengthen its financial position and improve its balance sheet. It will use the sale proceeds to reduce its debt level and meet its stated target debt-to-capitalization ratio of 20% to 25% from the current level of 33%.

While Conoco wants to accelerate the return on capital employed (ROCE) through these strategic measures, it has been lagging behind its super-major peers in this respect. We believe that Conoco’s ability to bring its ROCE in line with its peers will become difficult, given its need for increased capital outlays to achieve upstream growth. Our Neutral recommendation remains unchanged.
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