ConocoPhillips is best known for its technological expertise in deepwater exploration and production, reservoir management and exploitation, 3-D seismic technology, high-grade petroleum c.o.ke upgrading, and sulfur removal.
Headquartered in Houston, Texas, ConocoPhillips operates in more than forty countries with about 30,000 employees worldwide and annual revenues approaching $180 billion.
The company has four core activities worldwide: Petroleum exploration and production. This segment, approximately 25 percent of revenues, primarily explores for, produces, transports, and markets crude oil, natural gas, and natural gas liquids on a worldwide basis. The company"s E&P operations are geographically diverse, producing in the United States (including a large presence in Alaska"s Prudhoe Bay), Norway, the United Kingdom, Canada, Australia, offsh.o.r.e Timor-Leste in the Timor Sea, Indonesia, China, Vietnam, Libya, Nigeria, Algeria, and Russia.
Petroleum refining, marketing, supply, and transportation. This segment, approximately 71 percent of revenues, purchases, refines, markets, and transports crude oil and petroleum products, mainly in the United States, Europe, and Asia. In the U.S. marketplace, COP products are mainly marketed under the familiar Phillips 66, Conoco, and 76 brand names.
Midstream. This segment, about 3 percent of revenues, gathers, processes, and markets natural gas produced by ConocoPhillips and others, and fractionates and markets natural gas liquids, predominantly in the United States and Trinidad. The Midstream segment primarily consists of a 50 percent equity investment in DCP Midstream, LLC, but also includes a 30.3 percent interest in Duke Energy Field Services, LLC.
Chemicals/Emerging Businesses/other. This 1 percent segment manufactures and markets petrochemicals and plastics on a worldwide basis. The Chemicals segment consists of a 50 percent equity investment in Chevron Phillips Chemical Company LLC (CPChem). There are also investments in power generation, waste hydrocarbon recovery, and other energy technologies.
Financial Highlights, Fiscal Year 2010.
Aided by the 2010 recovery in oil prices, revenues and earnings continued to grow at a double-digit pace. At the end of that year, that growth rate slowed considerably as a.s.set sales and slightly diminished E&P results came into play. At the same time, refining margins improved, keeping sales and earnings steady, if not spectacular.
Last year we mentioned the company"s intent to divest itself of $10 billion of its current a.s.set base and use the proceeds for share buyback. That actually happened, and in late 2010, the company completed a spinoff of approximately three-quarters of the 20 percent interest owned in LUKOIL, the Russian energy conglomerate, for a gain of approximately $2.4 billion. That cash was primarily used to repurchase shares, and the company announced a $6 billion continuation of its share buyback program in 2011. In short, the company is on a path to "right size" itself and spin off proceeds to shareholders.
In early 2010, Conoco announced their intention to sell off, over a period of three years, their 20 percent share in LUKOIL, The announcement was not met with joyous acclaim by the Russian government, but the government has said they will not attempt to block or hamper the sale in any way. This sale is independent of Conoco"s other planned a.s.set sale.
Reasons to Buy.
Oil and gas stocks have historically been cyclical with long-term growth as a trend. We like COP"s business mix and track record, and we applaud the "right sizing," a refreshing change from the usual pedal-to-the-metal growth strategies we see in place around the industry. The company has solid financials with an excellent earnings, cash flow, and dividend track record, in fact, a rare "quintuple play" with sales, earnings, cash flow, dividends, and book value all growing in double digits over the past ten years. This and the share buybacks suggest a focus on shareholder value not always found in the energy industry.
Reasons for Caution.
The dominance of the refining business means that operating margins will be volatile, and indeed, they have been over the past five yearsfrom the mid-20 percent range in 200607 to less than 1 percent in 2008 to a more "normal" 1617 percent in 2010. While the company is well diversified and appears to manage these ups and downs well, they do add some risk. The ambiguities of exploration and geopolitics add a bit more uncertainty to the risk profile.
AGGRESSIVE GROWTH.
Costco Wholesale Corporation.
Ticker symbol: COST (NASDAQ) S&P rating: A+ Value Line financial strength rating: A+ Current yield: 1.2%.
Company Profile.
Costco Wholesale Corporation operates a multinational chain of membership warehouses, mainly under the Costco Wholesale name, that carry brand-name merchandise at substantially lower prices than are typically found at conventional wholesale or retail sources. The warehouses are designed to help small to medium-sized businesses reduce costs in purchasing for resale and for everyday business use, but as most know, the individual consumer has been their big growth driver. The company capitalizes on size and operational efficiencies, like "cross-docking" shipments directly from manufacturers to stores, to achieve attractive pricing to its customers. Costco is the largest membership warehouse club chain in the world based on sales volume and is the fifth largest general retailer in the United States.
Costco carries a broad line of product categories, including groceries, appliances, television and media, automotive supplies, toys, hardware, sporting goods, jewelry, cameras, books, housewares, apparel, health and beauty aids, tobacco, furniture, office supplies, and office equipment. The company also operates self-service gasoline stations at a number of its U.S. and Canadian locations. Approximately 56 percent of sales come from food, beverages, alcohol, sundries, and snacks, and the rest from an a.s.sortment of hard and soft lines.
Additionally, Costco Wholesale Industries, a division of the company, operates manufacturing businesses, including special food packaging, optical laboratories, meat processing, and jewelry distribution.
Costco is open only to members of its tiered membership plan. As of August 2010 Costco has 566 locations, 416 in the United States and Puerto Rico, 79 in Canada, 32 in Mexico, 22 in the United Kingdom, 22 in Asia, and one in Australia.
Financial Highlights, Fiscal Year 2010.
Like all retailers, Costco felt the effects of the worldwide recession and turned in their first-ever year-over-year decline in revenues in 2009, down 1.5 percent versus 2008. Most of this was due to a decrease in comparable sales, partially offset by sales at new warehouses. The company fared well in the recovery, however, and returned sales to a steady track. Same-store sales had risen 4 percent in mid-2009, aided by more frequent visits, but not necessarily larger transactions. Membership fees continued their momentum, with higher fees and upgrades being absorbed by a very loyal customer base. Per share earnings likewise regained their momentum.
Reasons to Buy.
Costco is in an attractive best-of-both-worlds niche: They are a price leader consistent with the att.i.tudes of today"s more frugal consumer, yet they enjoy a reputation for being more upscale than their compet.i.tion. We also like the international expansion, and think the formula will play well overseas. Anyone who has hosted a visitor from abroad knows that Costco is a favored destination during the visit. The company has a strong brand in a highly compet.i.tive sector, and is gaining market share.
Costco has completed the coveted triple playdouble-digit compounded sales, earnings, and cash flow growth over the past ten years. We like the commitment to dividend growth though the yield isn"t so high at present.
Reasons for Caution.
One concern is the dependence on low margin food and sundry lines. With the ramp-up of Wal-Mart and Target groceries and stiff compet.i.tion elsewhere, Costco may not always be the food source of choice. That said, food does get customers into the store. We are also concerned about the company"s not surprisingly razor-thin 1.7 percent net profit marginseven a small change in supply/demand economics or cost structure can wipe out profitability. Most retail concepts run out of steam eventually as they run out of opportunities to expand, although Costco"s international expansion attenuates this concern somewhat. With these concerns in mind, recent share prices may be a bit rich.
CONSERVATIVE GROWTH.
CVS/Caremark Corporation.
Ticker symbol: CVS (NYSE) S&P rating: BBB+ Value Line financial strength rating: A Current yield: 1.0%.
Company Profile.
Stanley and Sid Goldstein were distributing health and beauty products in the early 1960s when they decided to branch out into retailing, opening their first Consumer Value Store in Lowell, Ma.s.sachusetts, in 1963. The CVS chain had grown to forty outlets by 1969, the year they sold the business to Melville Shoes. Melville underwent a restructuring in the mid-1990s, spinning off CVS and other retail units.
CVS Corporation is now the largest domestic drugstore chain, based on store count. CVS operates over 7,000 retail and specialty pharmacy stores in forty states and the District of Columbia. The company holds the leading market share in thirty-two of the 100 largest U.S. drugstore markets, more than any other retail drugstore chain.
Stores are situated primarily in strip shopping centers or free-standing locations, with a typical store ranging in size from 8,000 to 12,000 square feet. Most new units being built are based on either a 10,000 square foot or 12,000 square foot prototype building that typically includes a drive-thru pharmacy. The company says that about one-half of its stores were opened or remodeled over the past five years.
The Caremark acquisition in 2007 transformed CVS from a retailer into the nation"s leading manager of pharmacy benefits, the middlemen between pharmaceutical companies and individuals with drug benefit coverage. The Caremark acquisition forms the core of the company"s Pharmacy Benefits Management (PBM) operations, which now make up about 65 percent of sales.
CVS" purchase of Long"s Drugs in 2008 vaulted the company into the lead position in the U.S. drug retail market, ahead of Walgreen"s. Long"s is only the most recent in a series of acquisitions by CVS in recent years, including MinuteClinic, Osco Drugs, and Sav-On Drugs in 2006, Caremark (for $26.5 billion) in 2007, and finally Long"s (for $2.6 billion) in 2008. Earnings over the period have nearly tripled, although per share earnings have grown a somewhat more modest 55 percent.
MinuteClinic is especially interesting in today"s climate of examining health care costs, with 569 clinics in twenty-five states offering basic health services like flu shots and such in a convenient retail environment. All but twelve of these clinics are located in CVS stores, naturally serving to drive traffic into the stores and vice versa.
Financial Highlights, Fiscal Year 2010.
Softness in the Pharmacy Benefits segment, unfortunately, brought a dip of approximately 2 percent in total 2010 sales. The decline was attributed to generic drugs and the loss of a few key contracts. FY11 results should improve, however, with a new $8 billion deal signed with Aetna and increased Medicare Part D business. Per share earnings stayed relatively flat largely due to share buybacks. Operating margins continue to be challenged by the PBM business, down to 2223 percent from 2627 percent prior to the acquisition. The company faces some challenges with PBM but should fare well with cost cutting and innovation efforts.
Reasons to Buy.
People who shop CVS regularly can see the difference between these stores and the ubiquitous compet.i.tors, especially Walgreen"s. These stores are essentially big-box convenience stores, but we think the company does a notably good job of merchandising, offering a good mix of convenience merchandise, food, and health care products to truly capitalize on its convenient retail format.
That goes beyond the typical positives seen for this industry: the graying of the population, and the rather effortless spending on health care that still goes on. The company continues to feel that its leadership in sun-belt states will capitalize on this megatrend. The recent federal health care overhaul left Medicare Part D basically untouched, which at the end of 2009, provided prescription coverage to 27 million Americans who would otherwise not be eligible. Medicare Part D also encourages caregivers to use generic drugs whenever possible, and generics, while cheaper overall, generate higher margins for the pharmacy. Over the next five years, more than $50 billion in branded drugs will lose patent protection, creating further opportunities for generics and driving pharmacy margins even higher.
We are also behind its acquisitions of well-run smaller companies in the same business, Osco in particular, and we think the MinuteClinic idea will gain significant traction. Finally, the company has scored a quintuple play over the past ten years with double-digit compounded sales, earnings, cash flow, dividend, and book value growth over the period. That said, the dividend yield remains modest.
Reasons for Caution.
The PBM business continues to be challenging from both a sales and profitability standpoint. It may be too big, and it may be defocusing. It does seem that CVS is well managed in general, but PBM may stretch this to the limit. At the same time, if the company succeeds in optimizing the PBM business, shareholders could be rewarded considerably.
AGGRESSIVE GROWTH.
Deere & Company.
Ticker symbol: DE (NYSE) S&P rating: A Value Line financial strength rating: A++ Current yield: 1.6%.
Company Profile.
Founded in 1837, Deere & Company grew from a one-man blacksmith shop into a worldwide corporation that today does business in more than 160 countries and employs more than 40,000 people around the globe. Deere has a diverse base of operations reporting in two broad categories following a 2009 restructuring: Equipment Operations and Financial Services.
Equipment Operations includes the signature Agriculture and Turf Equipment segment, comprising about 85 percent of the business, and the Construction and Forestry Equipment segment, both segments being bolstered in the marketplace by the Financial Services segment. Deere has been the world"s premier producer of agricultural equipment for nearly fifty years. If it"s used on a farm and requires an engine, Deere likely offers it. With the Construction and Forestry segment, Deere is also the world"s leading manufacturer of forestry equipment, and a major manufacturer of heavy construction equipment (Caterpillar being the market leader in the heavy construction segment). They"re also the world leader in premium turf-care equipment and utility vehicles in both the commercial and consumer markets.
The Financial Services segment includes John Deere Credit, which is one of the largest equipment finance companies in the United States, with more than 1.8 million accounts and a managed a.s.set portfolio of nearly $16 billion. It provides retail, wholesale, and lease financing for agricultural, construction and forestry, commercial and consumer equipment, including lawn and ground care, and revolving credit for agricultural inputs and services. These services are available in all of Deere"s largest markets, including Argentina, Australia, Brazil, Canada, France, and Germany. Overall, international sales account for about 42 percent of the total.
Financial Highlights, Fiscal Year 2010.
Deere has clearly emerged from the slowdown with its main line businesses intact; in addition, it became leaner and meaner during hard times with a reduced cost structure. During the first half of 2010, sales continued to lag, but earnings were up 20 percent from the year before. During the latter part of the year, sales continued at a brisk clip and earnings tracked some 40-plus percent higher than 2009, in part due to a ten-year high operating margin exceeding 13 percent. Restructuring appears to have been effective in reducing costs without negatively affecting delivery of product or taking too large a bite out of the company"s underlying finances.