This Oil Stock Rose a Stunning 858% in 2016. And, It Might Still Have Fuel Left in the Tank for 2017

By Matthew DiLallo Markets Fool.com

Oil prices staggered into 2016, plunging to lows not seen in more than a decade by mid-February, taking oil stocks down with them. However, prices would go on to rebound sharply off the bottom, fueling an epic rise in large-cap oil stocks. Meanwhile, the stock prices of several smaller producers more than doubled last year. That said, none came close to matching the stunning rebound in Resolute Energy (NYSE: REN):

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REN data by YCharts.

Here's what fueled that amazing run and what could keep the momentum going in 2017.

Igniting the rally

Crashing oil prices pulverized Resolute Energy's stock from mid-2014 through the middle of last year, as it plunged more than 70% amid concerns that a heavy debt load would sink it into bankruptcy. However, the company worked feverishly to address that problem by unloading a boatload of assets in 2015, bringing in $275 million in cash. The company continued to sell assets in 2016, agreeing to part with its midstream business for up to $100 million in early July. That transaction seemed to be what ignited the company's rally last year as the stock more than doubled shortly after the announcement.

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Resolute's rally was seemingly unstoppable from there as a combination of rising oil prices, continued operational improvements, and the completion of a string of strategic initiatives drove the stock higher. One of the highlights was the acquisition of 3,293 net acres in the red-hot Delaware Basin for $135 million. What was noteworthy about this deal is that it increased Resolute's interest in acreage it already owned, enabling the company to keep a larger percentage of the production and cash flow from its operated wells. It also provided the company with greater control over the future development of this acreage, giving it the flexibility to drill its best opportunities when it saw fit. In addition to that deal, the company would go on to strengthen its balance sheet by completing a $60 million preferred stock offering and a $160.8 million common stock offering, which enabled the company to fund its Delaware Basin deal and pay down debt. As a result of these strategic initiatives, Resolute Energy ended 2016 in a stronger position than where it started.

Image source: Getty Images.

Ready to rock

Last year's successes allowed Resolute Energy to enter 2017 with the resource base and capital to deliver explosive production growth. As things currently stand, the company expects to invest $210 million to $240 million in capex this year, which should drive production up to a range of 24,000 to 28,000 barrels of oil equivalent per day (BOE/d), which is an 85% year-over-year increase in output at the mid-point. That is an incredible growth rate for a company of its size at current commodity prices.

That said, there are two important cautions with Resolute's growth rate. First, it only expects to fund 65% of its capex budget with internally generated cash flow at current oil prices, with the balance of the funding coming from additional borrowings under its revolving credit facility. That is a red flag considering that the company's prior debt issues are what decimated its stock price as oil prices crashed. Also concerning is Resolute's projection that total debt-to-Adjusted EBITDA will end the year at about 3.2 times, which is rather high for an oil company considering the current market environment.

Contrast this plan with those of other Permian Basin producers. Concho Resources (NYSE: CXO), for example, sees its output growing 18% to 21% this year, off a production base that averaged 152,900 BOE/d during the third quarter of last year. Further, Concho Resources can deliver that healthy growth rate while living within cash flow at current commodity prices. As a result, Concho Resources' net debt-to-EBITDAX ratio will remain well within its comfort zone of less than 2.0 times.

Meanwhile, most companies that plan to outspend cash flow to grow are doing so because they have excellent balance sheets. For example, Pioneer Natural Resources (NYSE: PXD) sees its output rising 13% to 17% this year off a base of 239,000 BOE/d during the third quarter. Further, Pioneer Natural Resources expects to grow its output by a 15% compound annual rate through 2020 while living within cash flow starting next year as long as crude averages $55 per barrel. As a result, Pioneer Natural Resources sees its net debt-to-operating cash flow ratio remaining below 1.0 times over that timeframe. PDC Energy (NASDAQ: PDCE), likewise, can deliver exceptional production growth this year thanks to a strong balance sheet. In fact, PDC Energy expects to spend up to $775 million to boost production by 40% at the midpoint. While PDC Energy plans to outspend cash flow by around $200 million, it still intends to end the year with at least $200 million of cash and a debt-to-EBITDAX ratio of 1.8 times.

Investor takeaway

Compared to these peers, Resolute Energy's 2017 growth plan is overly ambitious. Consequently, if oil prices rise, this big bet to boost production could pay off and send the stock even higher in 2017. However, investors also need to beware that this the plan could backfire if oil prices plunge because it would put the spotlight back on Resolute's weaker balance sheet, which could incinerate some of last year's gains. Given that skewed risk-reward, investors are better off considering one of its more conservative peers as these stocks are not likely to crater if crude takes a step back.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.