Concho Resources (CXO) has spent the past few years driving down its costs so it could start generating free cash flow at lower oil prices. That strategy has started paying dividends, which was evident in the company's fourth-quarter report. As a result, it was able to give investors a big raise this year.

Ending on a high note

Concho Resources produced 215,000 barrels of oil per day during the fourth quarter, which exceeded the high-end of its guidance range. That's 8% above the year-ago level and pushed its full-year total to 25% higher than 2018's average.

The word dividends with a hand drawing an upward sloping line.

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That gave the Permian Basin-focused energy company the fuel to generate $206 million, or $1.03 per share, of adjusted net income during the period, which beat analysts' expectations by $0.23 per share. Meanwhile, it produced $801 million in operating cash flow and $187 million in free cash after its capital expenses. 

One of the highlights during the quarter was the completion of the sale of its New Mexico Shelf assets. That sale not only offloaded a lower margin business but also provided Concho Resources with $925 million in cash that it used to pay down additional debt and jump-start a share repurchase program. Overall, the company sold $1.3 billion in assets last year, enabling it to achieve its debt-reduction target and repurchase $250 million in stock. 

Expecting even better things in 2020

Concho Resources plans to invest another $2.6 billion to $2.8 billion on drilling new oil and gas wells and building out related infrastructure this year. While that spending range is 10% lower at the midpoint than 2019's level, it's enough money to grow the company's oil volumes by 10% to 12% after adjusting for the sale of its New Mexico Shelf assets. 

The company can fully finance that capital program on the cash flow it produces at $50 oil -- which is slightly below the current price -- with about $350 million to spare. Because of that, Concho Resources announced that it would increase its recently initiated dividend by 60%. Meanwhile, it will use the excess cash it has left after paying that higher dividend to continue repurchasing shares. The level of repurchases will rise with the price of oil since it could generate $650 million in free cash if crude averages $60 a barrel. That number will increase to $750 million if natural gas liquids (NGL) prices improve.

One of the drivers of the company's ability to generate so much excess cash at lower oil prices is its efforts to reduce costs. In 2015, Concho's lease operating expenses, general and administrative expenses, and interest costs totaled $14.79 per barrel of oil equivalent (BOE). That number has fallen 36% since then -- down to $9.44 per BOE last year -- due to rising production and debt reduction. It expects this metric to further improve to an average of $9.00 per barrel this year. Add that to the company's improving capital efficiency, where it can produce more oil for less capital, and it's on track to deliver a gusher of free cash flow this year. 

The strategy is clearly paying dividends

Concho Resources has been working hard to reduce its costs so that it can produce more cash at lower oil prices. It has been highly successful so far. Because of that, the company can return more money to its investors this year, which includes giving them a 60% dividend increase. With the potential for even more cash to head their way via its share repurchase program, Concho's stock could have a lot of upside this year, especially if oil and NGL prices improve.