Seeking Alpha
Long/short equity, special situations, value
Profile| Send Message|
( followers)  

Summary

  • Concho Resources just finished a strong first quarter.
  • After strong momentum, Concho sells shares to deleverage and fund capital expenditures.
  • Shares might be a bit expensive at current levels, although a decent sell-off creates a nice entry opportunity for the long term.

Shares of Concho Resources (NYSE:CXO) continue to enjoy strong momentum, which might come to at least a temporarily halt after the company announced a sizable share sale next to releasing its first-quarter earnings.

While the company makes huge operational progress, the strong momentum made shares too expensive to my taste at current levels.

First-Quarter Headlines

Concho Resources reported first-quarter revenues of $661.0 million, which is up by 40.0% compared to last year. Revenues were aided by strong production, which rose 18%, coming in at 101,600 barrels of oil-equivalent. Production came in above a previously issued 98,000-101,000 barrels per day guidance.

Net earnings more than tripled, increasing from $30.1 million last year to $91.3 million, even as last year's earnings were aided by a $12.5 million profit resulting from discontinued operations. GAAP earnings came in at $0.87 per share.

Non-GAAP adjusted earnings rose from $60.3 million to $106.6 million.

Taking Advantage Of Current Momentum

Shares of Concho have risen by a quarter so far in 2014, and trading at $135 per share, have returned some 65% in a one-year time span.

This prompted the company in deciding to sell 6 million new shares to fund its ambitions, as well as to reduce debt. If underwriters exercise their option to purchase another 900,000 stocks, the issue could raise roughly $931 million in gross proceeds, based on a stock price of $135 per share.

Strong Future Growth Base...

Concho ended 2013 with 503 million barrels of oil-equivalent in proven reserves. This came after the company reported a 266% reserve replacement ratio for the last year.

Based an average production of 101,600 barrels of oil-equivalent per day in the first quarter, Concho has 13-14 years of proven reserves at current production levels. Note that for 2014, Concho foresees 20-24% production growth.

Concho believes its inventory of 22,000 drilling locations could result in 3 billion barrels of oil-equivalent resource potential, roughly 6 times its current proven reserves estimates.

To sustain and drive future growth, Concho has a $2.6 billion capital budget, which includes a $100 million to the announced midstream joint venture. This should allow the business to meet its ambitions under the "2x3 growth plan", which calls for production to double by 2016 compared to the base year of 2013.

... And Another Midstream Joint Venture

Like many other exploration and production businesses, Concho is forming joint ventures for midstream assets. This allows Concho to improve its price realization and secure transportation of crude, as well as to create more operational flexibility.

The new venture is formed with a private entity, which has not been named in the press release. The new entity will construct transportation in the Northern Delaware Basin with optional multiple delivery points. The new system should be operational in the latter half of 2015.

The initial system consists of roughly 400 miles of gathering pipelines and storage with an initial capacity of 100,000 barrels per day, which could optionally be expanded by another 20,000 barrels.

Valuation

Concho Resources hardly holds any cash on its balance sheet, while total debt including credit facilities and bank overdrafts total about $3.7 billion. This calculation excludes the potential proceeds from the announced share sale, which could reduce leverage to roughly $2.8 billion.

The company has entered into a new 5-year credit facility last week, with a total borrowing base of $3.25 billion and a commitment of $2.5 billion.

At $135 per share, Concho is valued at roughly $14.1 billion, which would increase to around $15 billion following the proposed equity sale. For the year, I foresee revenues at about $2.8 billion, with earnings of about $350-$400 million.

As such, the $15 billion valuation is rather steep, at 5.4 times annual revenues and 40 times annual expected earnings for 2014.

All About The Future

Based on the aggressive growth plans, Concho could report revenues of about $5 billion by 2016, as earnings could come in around a billion.

This is driven by an expected doubling of production between 2013 and 2016. Better drilling and production efficiencies, and improved realizations through the announced midstream venture should bode well for earnings on top of headline revenue growth.

Things look great for this Permian basin company, which operates at the border of Texas and New Mexico. While this bodes well for the company itself, it does not automatically translate into a great investment opportunity. This is especially the case as shares have already risen some 65% over the past year. Strong momentum into 2014 prompted the company in selling shares, thereby diluting the current share base by about 6-7%.

Current multiples are too steep for me, even when factoring in the expected earnings growth in the coming two or three years. After the strong momentum, shares are due for a correction, which provided that it is steep enough, could provide a nice entry opportunity for the long haul.

Source: Concho Resources - Strong Momentum After Strong Operational Performance