Concho Resources (NYSE: CXO) has quietly flown under the radar of investors over the past year. Its stock has basically flatlined while popular shale drillers EOG Resources (NYSE: EOG) and Encana (NYSE: ECA) are up more than 7% even as crude has slumped 13%. One result of that underperformance is that Concho's stock trades for just 12 times enterprise value-to-EBITDA, while its rivals fetch 19 times EV-to-EBITDA multiples. For whatever reason, it appears that investors are overlooking not only this valuation gap but also the fact that Concho Resources is a pure play on the fast-growing Permian Basin and has one of the best balance sheets in its peer group.
The Permian, the whole Permian, and nothing but the Permian
Concho Resources currently controls more than 600,000 net acres across the legacy Permian Basin of Texas. What's noteworthy about its substantial acreage position is that the company operates in all four key geographic areas: New Mexico Shelf, Northern Delaware Basin, Southern Delaware Basin, and Midland Basin. The company estimates that it can drill more than 19,000 horizontal wells across that acreage in the future, potentially unlocking a resource potential of as much as 8 billion barrels of oil equivalent (BOE). Notably, that number ballooned 60% last year as a result of additional testing, and could zoom higher in future years as the company obtains more well data.
Contrast that broad Permian scope with the varied exposure of the more popular EOG Resources and Encana. EOG Resources primarily operates in the Northern Delaware Basin and Northwest Shelf, controlling nearly 560,000 net acres. While the company expects to drill only 6,330 future wells on that acreage position, it's an oil-rich region that contains an estimated 6 billion BOE of resource potential according to EOG. In addition to the Permian, EOG also holds acreage in the Eagle Ford Shale, Powder River Basin, and Bakken. Meanwhile, Encana has 12,000 future drilling locations in the Midland Basin, along with acreage in the Eagle Ford, as well as Canada's Montney and Duvernay shale plays.
While diversification across several shale plays provides EOG Resources and Encana with optionality, the pure focus on the high-return Permian is fueling faster growth for Concho Resources. The company expects its output to rise 21% to 25% this year, along with 25% oil growth, while living within cash flow. Further, it sees 20% compound annual growth through 2019, also while living within cash flow around current prices. By contrast, EOG Resources sees its oil output growing 18% this year, and by a 15% to 25% compound annual growth rate through 2020, depending on oil prices. Meanwhile, Encana expects to deliver 60% growth from its core assets by 2021.
Concho's faster growth pace is in keeping with the company's history of delivering peer-leading production growth. Over the past decade, for example, it has achieved a peer-group-best 23% compound annual average production growth per debt-adjusted share. Why is that important? The company's ability to continue growing at a quicker pace than its peers could create more value for its investors in the coming years, especially considering its currently cheaper valuation. For perspective, thanks to its peer-leading production growth over the past decade, Concho's stock is up a remarkable 830% compared with just 150% for EOG and 70% for the S&P 500.
All that growth without breaking the bank
As mentioned, Concho Resources expects to achieve its more robust growth rate while living within cash flow at crude prices around their current level. So the company won't need to tap into its already top-notch balance sheet. Currently, the company has a net debt-to-EBITDA ratio of 1.2, which is the third best among its peer group and well below the average of 2.0. While EOG Resources also has a strong balance sheet with less leverage than its peers, it ranks sixth out of its peer group.
Encana, likewise, has a solid balance sheet, which it has improved significantly over the past few years. However, it's not on the same elite level as Concho and EOG. Further, Encana plans to outspend cash flow this year as it jump-starts its five-year growth plan. Because of that, it is at risk of seeing its credit metrics deteriorate if oil prices continue slumping. That situation could cause the company to slow its growth pace next year, with the potential that it will only be able to maintain its production rate if crude remains in the low $40s.
EOG Resources and Encana are solid oil growth stocks, with prime positions across several shale plays. That said, neither expects to grow output as fast as the Permian-focused Concho Resources, which also boasts one of the best balance sheets in the industry and has a cheaper valuation. Despite that better value proposition, investors appear to have overlooked Concho's stock since it hasn't budged in the past year, while both EOG and Encana are up. Because of that underperformance, investors have a chance to pick up this compelling oil stock before the market realizes its mistake.
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