EUR 850.00 For Business Accounts Only

Morningstar | Concho Rolls Out Two-Year Outlook, With 25% Production Growth CAGR

Narrow-moat Concho delivered production of 287 mboe/d in the third quarter, which was above the high end of guidance, and trounced consensus for its earnings. Both guidance and analyst estimates were potentially skewed lower due to the recent RSP Permian acquisition (the deal closed well before the midpoint of the quarter and thus made more of a contribution in the period than many expected). Adjusted EBITDA and adjusted earnings per share were $793 million and $1.42 respectively.

In the release management rolled out an updated outlook for 2019-20, signaling the deployment of two incremental rigs by year-end (bringing the total count to 34). And in 2020 a 38-rig program is planned. That puts the firm on track for two years of overall growth with a 25% CAGR. And as the firm is prioritizing oil-weighted targets it anticipates a 30% CAGR for oil volumes over the same period. Further, while we had anticipated a gradual increase in the average lateral length of Concho’s horizontal wells being drilled, the step change to 9,700 feet in 2019 came sooner than expected. However, incorporating more rigs and longer laterals only pushed up our production forecast modestly, because judging by the number of planned wells the firm is expecting those laterals to take longer to drill (2019 guidance implies an average spud-spud of around 30 days, compared with 24 days inferred from 2018 guidance). On balance, our 2020 production forecast has increased to 459 mboe/d from 446 mboe/d (3%). After incorporating these results we have nudged our fair value estimate to $150/share from $147, which is still higher than the current price, following the recent slump.

The increased activity level didn't impact our valuation much because we doubt that the ongoing industrywide ramp in drilling is sustainable, given that there are at least 100 more light tight oil rigs in service than necessary to keep the market balanced in the long run. We therefore assume that Concho will revert to a more modest pace after 2020.

Our negative stance on crude is also unchanged, and our midcycle forecast is still $55/bbl for WTI. The justification in “Oil Prices Are Unsustainably High, Stretching Energy Valuations” is still valid, even though the recent sell-off in energy stocks means many of the bearish valuation conclusions no longer apply. Concho, as one of the few narrow-moat-rated industry cost leaders, is capable of thriving in a lower price environment. We therefore anticipate sustainable excess returns on invested capital over the next 10 years, while living within cash flows (even after incorporating the newly announced quarterly dividend of $0.50 per share, equating to a 1.5% yield). As such, the stock’s recent decline could be interpreted as a buying opportunity, albeit one with minimal margin of safety given our high uncertainty rating.