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Initiating Coverage on Concho Resources: Permian Pure-Play


On Mar 17, we initiated coverage on Midland, TX-based independent oil and gas explorer, Concho Resources Inc. CXO. The company’s strategic acreage position in the Permian Basin is expected to drive continued productivity gains but the ongoing commodity price slump has ensured a Zacks Rank #3 (Hold) for the large-cap energy finder.

The Bullish Case

The company's core operations are focused in the prolific Permian basin. Concho Resources holds approximately 930,000 gross acres in the low-cost region and its high-quality, balanced asset base consists of more than 19,000 horizontal drilling locations with 8 billion barrels of net resource potential.

While Concho's track record of production growth remains strong, it has been achieved at a competitive cost structure. The company – currently executing on a strategy to remain within cash flow – expects to increase its output at a compounded annual growth rate (CAGR) of approximately 20% over the next three years.

Driven by its operational efficiencies, Concho Resources have been able to significantly reduce its cash cost structure. While lease operating expenses on a per barrel basis decreased 22% annually in 2016, cash G&A fell by 6%.

Finally, Concho Resources displays a healthy financial position, reflected by a debt-to-capitalization ratio of 26.4%, making the company less susceptible to financial risk. Importantly, the company – which aims to bring down leverage ratio to well under 1 before 2020 – managed to reduce its long-term debt in 2016 by retiring $600 million of bonds.

Regarding price performance, Concho Resources' shares increased 25% over the last one year, which comfortably outpaced the 11% gain for Zacks categorized Oil & Gas – U.S. Exploration & Production industry. This price performance is backed by an excellent estimates revision. The company’s current-year estimates have been revised almost 600% upward, over the last 60 days. Given its progress on the fundamentals, the stock should keep performing well in the quarters ahead.

The Bearish Case

However, Concho Resources is facing pressure on top line. Over the past three years (2014–2016), total revenues declined at a CAGR of 11.9%. Continued pressure on oil and gas prices are the primarily reasons for decrease in revenues. While the company is taking initiates through cost savings initiatives to boost its top line, it will take some time to witness a rebound in the same.

Moreover, Concho Resources anticipates 2017 capital spending of approximately $1.7 billion, assuming the midpoint of the guidance range. This is a 13% increase over the previous forecast for 2017 capital spending – mainly due to creeping service cost inflation. Rising prices might reduce profit margin and available cash.

Finally, Concho Resources currently generates substantially all of its revenue, earnings and cash flow from the production and sales of natural gas and oil from its Permian Basin acreage. Consequently, any significant downtime related to pipelines or processing plants in the region could adversely affect the company’s results.

Stocks That Warrant a Look

While we expect Concho Resources to perform in line with its peers and industry levels in the coming months and advice investors to wait for a better entry point before accumulating shares, one can look at Antero Resources Corp. AR, Pioneer Natural Resources Co. PXD and Abraxas Petroleum Corp. AXAS as good buying opportunities for investors interested in the energy space.

While Antero Resources and Pioneer Natural Resources are Zacks Rank #1 (Strong Buy) stocks, Abraxas Petroleum carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Founded in 2002, Denver, CO-based Antero Resources is an independent oil and natural gas company with focus on liquids-rich natural gas in the Appalachian Basin in West Virginia, Ohio and Pennsylvania. The company has an excellent earnings surprise history. It surpassed estimates in each of the last four quarters at an average rate of 239.10%.

An independent oil and gas exploration and production company based in Irving, TX, Pioneer Natural Resources focuses on the Permian Basin in Texas. The 2017 Zacks Consensus Estimate for this company is $2.04, representing some 1.117.63% earnings per share growth over 2016. Next year’s average forecast is $5.16, pointing to 153.53% growth.

Founded in 1977, San Antonio, Texas-based Abraxas Petroleum is an independent domestic energy company with assets in Texas, Wyoming, North Dakota, and Montana. Over the past 60 days, the Zacks Consensus Estimate for fiscal years 2017 and 2018 increased 25% and 90%, to 15 cents and 19 cents per share, respectively.

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