1 Under the Radar Stock to Play America's Biggest Oil Patch

Why Concho Resources’ vast, high-quality acreage position and aggressive growth plans make it a promising way to invest in the resurgence of the Permian Basin.

Jun 14, 2014 at 3:00PM

Technological advances and the rapid growth in horizontal drilling have unlocked a number of exciting plays within West Texas' Permian Basin that are believed to have unparalleled resource potential.

The Spraberry/Wolfcamp formation, for instance, could hold some 50 billion barrels of oil equivalent, according to Pioneer Natural Resources (NYSE:PXD), one of the premier operators in the basin. That's nearly double the resource potential of the prolific Eagle Ford shale.

For investors looking to capitalize on the Permian's explosive potential, one of the most attractive options is Concho Resources (NYSE:CXO), a pure-play Permian-focused oil and gas producer whose vast, high-quality acreage position in the basin and aggressive plans to accelerate growth could lead to a big payday for its shareholders.

Linn Energy Permian

Photo credit: LINN Energy LLC

Permian-fueled growth
Midland, Texas-based Concho Resources is an independent oil and gas company with primary assets located in the Permian Basin of western Texas and southeastern New Mexico. Concho's most prized asset is the Permian's Delaware Basin, where the company is spending more than two-thirds of its upstream capital budget this year.

In the first quarter, strong and consistent performance in the Delaware Basin, where Concho is making greater use of horizontal drilling to coax more oil and gas from the ground, fueled 18% year-over-year growth in company-wide production, as first-quarter net horizontal production from the Delaware Basin surged 82% year over year and 18% sequentially to 42.3 Mboe/d.

As a result of this strong production growth and higher realized oil and gas prices, Concho's first-quarter adjusted net income jumped to $106.6 million, or $1.01 per diluted share, up from $60.3 million, or $0.58 per diluted share, in the year-earlier quarter, and operating cash flow surged 117% year over year to $476.0 million.

In addition to rapid production growth, the company has managed to significantly reduce well costs and the average number of days it takes to drill a horizontal lateral well. Well costs on a typical well have fallen from $5.6 million to just $5 million over the past six months, while drilling days in the northern and southern Delaware Basin have declined by 21% and 18%, respectively, over the same period.

Aggressive three-year growth plan
While these are already no doubt impressive accomplishments, Concho's future looks even brighter as it embarks on its aggressive three-year growth plan, which it announced in November of last year. This so-called "two by three' plan aims to double the company's annual production to over 67 million barrels of oil equivalent ("MMBoe") by 2016, implying a 25% compound annual growth rate.

The key thing to note about this plan is that it should significantly improve the company's returns, margins, and cash flows because the new production will be increasingly oil-weighted. This should allow the company to fund an increasing portion of its capital expenses from operating cash flow and allow it to improve its balance sheet and reduce its leverage ratio (debt-to-EBITDAX) to less than 1.5x by 2016.  

Massive resource potential
Another reason to be bullish on Concho is because the company may be sitting on a truly massive quantity of oil and gas that's not reflected in its share price. According to the company's estimates, its resource potential in the Permian is more than 6x its current proven reserves. As it delineates and derisks its acreage over the next few years, it could add a whole lot more barrels to its proven reserves, boosting its net asset value and share price.

Indeed, this is a common trait among many Permian-focused operators. Pioneer Natural Resources, for instance, estimates that its additional net recoverable resource potential in the Permian is 22x its current proven reserves. Similarly, Diamondback Energy (NASDAQ:FANG) pegs its total recoverable resource potential in the basin at 393 million BOE, more than 6x its current proven reserves of 63.6 million BOE.

Investor takeaway
Concho's massive, high-quality acreage position in the Delaware Basin, aggressive three-year growth plan, and expected improvement in margins and cash flows make it a compelling way of investing in the resurgence of the Permian Basin. While shares of Concho aren't exactly cheap -- the company trades at roughly 25x forward earnings and just under 4x book value -- successful delineation of its Delaware Basin acreage offers huge upside potential that could lead to multiple expansion over the next few years.

Will this stock be your next multi-bagger?

While Concho Resources could have significant upside, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.

Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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