Continental Resources: Production Significantly Exceeds Initial Guidance

| About: Continental Resources, (CLR)

Summary

Continental has demonstrated the ability to produce well above its initial guidance and limit production declines despite drastically reduced capital expenditures.

2016 production is now expected to decline just 3%, while the 2016 exit rate is expected to be down 11%.

This is much better than earlier expectations although it does involve a decline in the share of higher value oil production.

Continental's valuation seems quite high despite the strong production performance though.

EV/EBITDA for 2017 at $65 oil is estimated at 9.6x, above historical averages. The top end of the historical range would indicate a share price of $34 instead.

There was previously some skepticism about Continental Resources' (NYSE:CLR) ability to average 200,000+ BOEPD during 2016 with a drastically reduced capital expenditure budget, but it appears that Continental is able to easily do that. Continental's 2016 exit rate is expected to be around 11% higher than initially expected, although this was achieved partly by an increase in the share of production of lower value gas.

However, despite the strong production results, Continental remains overvalued based on historical metrics. Even with a valuation based on $65 oil, Continental's forecasted 2017 EV/EBITDA multiple is approaching 10x.

Q2 Results

Continental now expects to average 215,000 BOEPD during 2016 and exit 2016 with roughly 200,000 BOEPD in production. These are strong production results with a budget of only $920 million for non-acquisition capital expenditures, representing a 3% year-over-year decline. Continental's exit rate is affected more heavily, with an estimated 11% decline versus 2015's exit rate. However this is much better than the 180,000 BOEPD exit rate that Continental previously indicated it would reach with its $920 million budget for 2016. This shows that leading operators can maintain production (or have modest production declines) with far less capital expenditures than previously believed.

Continental's production numbers are skewed a bit by a focus on gassier plays, although this is partially mitigated by cost reductions. At 65% oil (the Q4 2015 production split), $50 WTI oil and initial 2016 differential expectations, Continental's production would translate into $32.88 per BOE in revenue. At current expectations for 60% oil, revenue would be $31.50 per BOE despite a slight decrease in oil differentials.

Per BOE

YE 2015

YE 2016

Revenue

$32.88

$31.50

Production Expense

$4.50

$4.00

Production Taxes

$2.30

$2.21

Cash G&A

$1.50

$1.40

Net Production Margin

$24.58

$23.89

Click to enlarge

This results in Continental's net production margin decreasing by around 2.8% at $50 oil. Thus 200,000 BOEPD with the current production mix and costs is roughly equivalent in net production margin to a bit over 194,000 BOEPD in production using the 65% oil split and the original projected costs. Still, this 14% adjusted decline in the year-end exit rate exceeds prior expectations for what Continental could do with a sub-$1 billion capital expenditure budget.

Valuation

Continental has done well production wise, but that doesn't mean that it isn't potentially overvalued still given its strong share price performance over the past few months.

I previously looked at Continental's valuation a few months ago and estimated that it would end 2016 with approximately 200,000 BOEPD in production. Continental's updated exit rate guidance confirms that assumption, although I will tweak those number to lower Continental's oil differential slightly and increase its oil production percentage slightly.

Units

Price Per Unit

Revenue ($ Million)

Oil (Barrels)

43,800,000

$57.50

$2,519

Natural Gas (MMBtu)

175,200,000

$3.00

$526

Net Service Operations

$18

Total

$3,063

Click to enlarge

I am also reducing Continental's operating costs and cash G&A numbers to reflect the progress that it has made in those areas. As a result, Continental's EBITDA is estimated at $2.455 billion at $65 oil, up from $2.363 billion before.

$ Million

Revenue

$3,063

Less: Operating Costs

$292

Less: Production Tax

$214

Less: Cash SG&A

$102

EBITDA

$2,455

Click to enlarge

At an 8x EV/EBITDA multiple and $65 oil, Continental would have an enterprise value of $19.64 billion. After giving effect to the debt reduction for the SCOOP transaction, Continental's shares have an estimated value of $34 using that multiple and oil price.

Conclusion

Continental Resources has exceeded production expectations, with guidance pointing to a minimal year-over-year production decline and a 11% exit rate decline despite only $920 million in non-acquisition capital expenditures. Some of this production was boosted by a focus on gassier plays, and Continental's production margin has declined by 3% per BOE despite cost reductions. Continental did indicate that it could boost its oil production by completing its DUCs in the Bakken.

The market does appear to be giving Continental a substantial premium for its strong production levels and apparently manageable debt situation. I think this premium is too much though as Continental is still valued at a 9.6x EV/EBITDA multiple based on $65 oil, while an 8.0x multiple would lower its estimated share price to $34. I wouldn't short Continental right now with oil at $42 (as its price would likely go up in tandem with out). However if oil rebounds to around $50 and Continental's price keeps increasing, I think it would make a decent short candidate.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.