2 No-Brainer Stocks to Buy in the Permian Basin

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The Permian Basin in Western Texas is the place to be these days. Thanks to the oil-rich nature of its rocks and lower drilling costs, shale drillers can earn lucrative returns by drilling new wells in the Basin at current oil prices. That has fueled a land rush over the past year as drillers have snapped up acreage so they can deliver high-return growth in the years ahead.

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That said, while hundreds of companies are currently operating in that legacy oil play, two pure-play producers stand out as no-brainers for investors seeking to ride the industry's coat tails: Pioneer Natural Resources (NYSE: PXD) and Concho Resources (NYSE: CXO). Here's why investors who want to add the power of the Permian to their portfolio should consider this duo.

The Midland Basin leader

Pioneer Natural Resources is the largest acreage holder and producer in the Midland Basin side of the Permian. It currently produces about 242,000 barrels of oil equivalent per day, which is more than the combined output of the next three largest producers: Encana (NYSE: ECA), Diamondback Energy (NASDAQ: FANG), and Parsley Energy (NYSE: PE). Overall, Pioneer has more than 800,000 total acres in the play, which it estimates holds more than 20,000 high-return drilling locations that could eventually unlock 11 billion barrels of oil equivalent (BOE) resources. That inventory supports the company's view that it can boost its oil output by a 15% compound annual growth rate over the next decade, which it can achieve within cash flow at just $55 oil.

In addition to that vast portfolio of drilling locations that can earn internal rates of returns in the 40% to 75% range at $50 oil and $3 natural gas, Pioneer also boasts one of the best balance sheets in the sector. The company currently has a net debt to 2017 operating cash flow ratio of just 0.2 times. Further supporting its strong financial position is the fact that it has $2.4 billion of cash and liquid securities as well as $1.5 billion of available credit.

Despite that industry-leading resource base and top-tier balance sheet, Pioneer Natural Resources' stock price has taken a hit this year because of a misconception about a change in its gas to oil ratio. However, as the company's CEO recently pointed out on its second-quarter conference call, this change is a good thing because while the company is producing more gas per well, it isn't producing any less oil. As a result, the company remains on pace to hit its long-term growth targets.

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A pure-play on the entire Permian

Concho Resources shares many of the same qualities as Pioneer. However, one key difference is that its acreage position covers the whole Permian Basin, including the Midland Basin to the east as well as the northern and southern sections of the Delaware Basin and the New Mexico shelf. Overall, Concho controls 940,000 total acres in the region, which it estimates holds more than 19,000 future drilling locations that could unlock more than 8 billion BOE of resources.

That diversification across the basin is worth noting because the Delaware seems to be more oil-rich than the Midland. Evidence of this is the higher oil content as a percentage of production for producers that operate on both sides of the play. For example, while Pioneer expects oil to be about 58% of total output this year, Concho sees oil accounting for around 63% of its output. We see similarly higher oil percentages at other pure-play Permian drillers that operate in both Basins, including Parsley Energy at 67% and Diamondback Energy at 75%. That greater percentage of production from oil is worth noting because oil has higher margins than gas.

Another important facet of Concho Resources is its top-tier balance sheet. The company currently boasts a leverage ratio of just 1.5 times, which is below its peer group average of 1.9 times. That excellent financial profile, when combined with the fact that Concho can deliver 20% compound annual production growth over the next three years within cash flow at current oil and gas prices, makes it a no-brainer for investors who want exposure to the entire Basin.

Great companies at even better prices

Concho Resources and Pioneer Natural Resources control top-tier positions in the Permian Basin, which should fuel robust growth over the next few years at current oil prices. Add in the fact that both boast strong balance sheets, and these oil stocks can thrive even if crude dips. That said, crude prices have actually risen more than 5% over the past year, which is why it's a head-scratcher to see that both stocks have slumped double-digits. That sell-off seems like a no-brainer opportunity for long-term investors who want to add the Permian to their portfolio.

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