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Morningstar | Lowering Concho's FVE After Steep Capex Cuts

We are reducing our fair value estimate for Concho Resources to $104 after taking a second look at the firm's fourth-quarter financial and operating results. As a reminder, the firm came within guidance and delivered 7% sequential growth. But it also sharply reduced its 2019 capital budget because of the recent slump in crude prices. It now plans to spend $2.9 billion, which is about $500 million less than previously indicated. As a result, management now expects to release about 10 rigs over the course of the year and will exit 2019 with just 24 rigs in service (we were previously modeling 34). According to updated guidance, production will increase by 21%-25% year over year instead of 25%-30%.

In addition, we have increased our unit cost forecasts and slightly lowered our well performance expectations. To put that in context, we still believe that Concho is one of the lowest-cost operators in the U.S. upstream segment, based on its highly productive Permian Basin acreage. And even after moderating our estimates, we still think the firm's core acreage breaks even with West Texas Intermediate crude as low as $30/bbl. Nevertheless, our prior assumptions for 90-day initial production rates per 1,000 feet of 105 boe/d (Midland) and 200 boe/d (Northern Delaware) look too optimistic in comparison to recent trends. We are now anticipating 95 boe/d and 185 boe/d respectively.

As a sanity check, we note that our updated valuation equates to 7.6 times the consensus forecast for 2020 EBITDA. At the last close, the stock was trading with a multiple of 8.2 times, making it the most richly valued stock in our upstream coverage (other than Hess, which has major new projects in the pipeline after 2020). The average multiple was 5.9 times, and Concho's closest peers--Pioneer and Diamondback--were trading at 6.9 times and 6.8 times, respectively. We conclude that though Concho's high-quality assets warrant a premium valuation, our previous assumptions were too generous.