Continental Resources: Still Making Waves
- The deferred production is now clearly back online.
- In more normal times, balance sheet ratios are conservative.
- Low costs and above average profitability have long been hallmarks here.
- Long-term debt should be less than double the cash flow that will be reported in 2021.
- Hedging was not a lot of help to the company this year.
- This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Learn More »
Continental Resources (NYSE:CLR) is a giant in the unconventional industry that still acts like an upstart. Management deferred a significant amount of second quarter production until prices improved considerably. That is the kind of action that everyone wishes they could take. However, such a move normally impacts key balance sheet and other financial ratios. Therefore it requires the backing of lenders before the action hits the news outlets. Now things are heading back to normal. So this company can be expected to generate the usual conservative balance sheet ratios in the near future.
Second Quarter Revisit
The company posted some scary production numbers in the second quarter while taking on some debt from that dramatically lower production.
Source: Continental Resources Second Quarter 2020, Press Release
Deferring production when it cannot be sold for a reasonable price is absolutely the best thing to do. But many companies have enough loan commitments that they cannot do what is shown above.
The other thing is that materially lower production can result in a quarter of very low cash flow and other numbers (not to mention what this does to key ratios). Fortunately, the issues of the second quarter relaxed about as fast as they appeared. But what happened here in the second quarter may well be one of the most gutsy calls the industry has seen in some time.
One of the things to remember is that management is paid to make these calls. Very few have the nerve to do anything close to that. This management generally is not afraid to take a stand and then accept whatever happens as a result.
Cash flow from operating activities is slowly returning to normal.
Source: Continental Fourth Quarter 2020, Earnings Press Release
Cash flow for the current fiscal year is less than half of the cash flow in the previous fiscal year. Much of the production comes from the Bakken with a significant contribution from Oklahoma. Continental is one of the few major companies that has no significant Texas exposure.
Source: Continental First Quarter 2021 Earnings Press Release
Then again some cold weather and a decent energy price rally "blew out the doors" for the first quarter earnings report. This caused management to raise all kinds of guidance numbers for the year. The second quarter comparison will be awesome because back then the company simply withheld production until pricing improved. Those wells build up pressure and the results of that "extra" production have been evident on a declining basis since they returned to production.
Therefore investors get a glimpse as to how pricing is acting for some significant basins in the United States outside of Texas. There is a disadvantage to being relatively far away from export terminals and refining capacity. However, this company attempts to make up for this with lower costs.
Source: Continental First Quarter 2021, Earnings Press Release
Notice in the first quarter, the outstanding natural gas premium. Oil still brings in most of the cash flow. But natural gas did contribute to the large first quarter cash flow jump.
Clearly the increase in pipeline capacity in the Bakken has increased the realized price and decreased transportation expenses. But unless refining capacity catches up to the Gulf coast (along with exporting ability) somewhere near North Dakota in the great lakes region, there will always be a fair amount spent on transportation along with some sort of pricing discount.
Offsetting that, this company has some of the lowest lease operating expenses in the industry for a major oil producer. Similarly, the administrative expenses also appear to be under excellent control.
Since things are expected to be closer to normal in the current fiscal year, that cash flow figure previously noted should increase to more than half of debt. For most lenders that is a very conservative figure.
Many times low cost leaders have some leeway with lenders because the lenders realize that low cost leaders often bounce back to sufficient profitability in a wider range of recovery industry conditions. So while some competitors had to produce into abysmal prices during the second quarter, this company had more leeway to shut in production.
What would help here is a better hedging program. This company tends to be an opportunistic hedger. Therefore management often takes a hedging position only when management believes such a position is warranted. In the past that has resulted in some rather dramatic decisions. This year, the finances did not materially benefit from the hedging. So an argument could be made for consistent hedging (for a zero sum game) for more predictable pricing (and possibly better average pricing over time). Such a plan would eliminate unforeseen volatility like the second quarter.
Source: Continental Resources February 2020, Investor Presentation
On the positive side, management intends to reduce debt further in the long term. This would allow for more of those "significant policy decisions" without materially harming the balance sheet.
Clearly the first quarter boosted the debt reduction efforts far beyond what anyone could have reasonably predicted. So that extra cash could become apparent in a number of ways when the debt goal is realized sooner than originally envisioned.
Continental has an excellent long term growth track record. That track record should continue into the future. For that reason alone, this stock is worth considering by those investors that can handle a volatile stock.
One risk is that Harold Hamm, a founder and Executive Chairman, is getting older. Companies like this one that have had strong guidance since inception often stumble for a few years after someone like Mr. Hamm retires. Mr. Hamm is doing what he can to plan for a smooth transition to the "after he is gone" period for the company (and thereby minimize this risk). But it is still worth noting because there are not too many Harold Hamm type people in any industry.
This stock has begun recovering from the second quarter nadir.
Source: Seeking Alpha Website May 4, 2021.
The stock has a way to get to get back to where it used to be. This company generates a lot of cash from operating activities when oil prices are in the WTI $50s range. Therefore the rally that has begun for this stock price has a way to go.
Now the impairment charge that was taken due to the "lower of cost or market" type calculations will decrease depreciation in the future. Therefore profitability during the coming recovery should be better at any price point just because that impairment charge lowered noncash charges.
This company is also a leader in the ability to grow under various future commodity price scenarios because of the low costs.
Source: Continental Resources February 2020, Investor Presentation
Any time you see a presentation where more than 200,000 BO are produced within the first year of production, you have a very profitable well. This company has a lot of those very profitable wells.
Far more importantly, continuing industry advancements demonstrate that the company can keep expanding the acreage that is producing those outstanding results (as shown above as "step outs"). That is likely to continue as most managements do not see an end to continuing well design improvements and other operational advances.
This company as a cost and profitability leader has a bright future. It would be a cyclical growth company. But there is a lot of potential to grow in the future.
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