EUR 850.00 For Business Accounts Only

Morningstar | Raising Concho FVE on More Aggressive Drilling Program

After digesting Concho's second-quarter earnings release we believe our prior assumptions were too conservative, even after factoring in our bearish $55 per barrel midcycle forecast for WTI. Accordingly, we have raised our fair value estimate to $147 per share from $143. That makes shares look slightly undervalued, but with a very slender margin. We suggest investors wait for a pullback.

The RSP Permian acquisition closed in July, and the combined entity is reportedly running 32 horizontal rigs. This is the primary driver of our increased valuation, as we were previously modeling 27 rigs (per guidance issued when the RSP merger was announced, and reiterated in the first-quarter release). That will enable the firm to deliver considerably more growth than the market expects next year. Throughout 2019 we now expect quarterly production growth at a rate that translates to 27% annualized (ahead of the firm's targeted 20% CAGR). This growth could easily persist through 2020 if management chooses to maintain its current activity level. However, as we think surging shale production could be pressuring global oil inventories and prices by then our base case assumes a reduction to 28 rigs from there. For reference, with 32 rigs held flat and a terminal WTI price of $60, our valuation increases to $192 per share.

Execution during the quarter was solid. Production came in at 229 mboe/d in the second quarter, which was above the midpoint of guidance and 24% higher year over year. Likewise, the firm's financial results were slightly better than expected. Adjusted EBITDA and adjusted earnings per share were $574 million and $1.24 respectively, beating consensus estimates of $566 million and $0.93.

See "Coping with Frothy Oil Prices" for more color on our commodity price expectations.