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Why This Under-$8 Oil Stock Jumped 20.5% This Week

By Neha Chamaria – Oct 1, 2021 at 5:19PM

Key Points

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Higher oil prices are easing Centennial Resource's biggest worry: debt.

What happened

It was a pretty big week for oil and gas stocks, with Centennial Resource Development (CDEV -3.64%) turning out to be one of the top performers in the upstream oil industry. Centennial Resource shares closed Friday up 4.8%, and that drove the stock's weekly gains to a solid 20.5%.

So what

Oil prices soared this week, with Brent crude surging past $80 per barrel, a level last seen in 2018. Natural gas prices also shot up this week to cross $6 per million British thermal units, and although prices softened a bit as the week progressed, they're still hovering around multi-year highs. Oil and gas prices surged as demand remained strong amid tight production thanks largely to Hurricane Ida -- a substantial portion of production in the Gulf of Mexico remained offline this week.

Although higher prices should benefit most oil and gas producers, investors in Centennial Resource are particularly excited for a couple of reasons.

A person working on an oil and gas pipeline.

Image source: Getty Images.

During its second quarter ended June 30, 2021, Centennial Resource generated record free cash flow (FCF) worth $34.2 million on higher production and rising oil prices. It realized an average sales price of $60.99 per barrel of oil (before accounting for hedging losses).

With oil prices jumping significantly since, investors expect Centennial Resource to deliver even stronger cash flows in its third quarter and put it to good use. Last quarter, the company pared down debt and projected its full-year FCF to be between $140 million and $170 million, up significantly from its previous 2021 FCF target of $55 million-$75 million.

Importantly, the incremental cash flows should help Centennial Resource repay larger amounts of debt. Point is, Centennial Resource has prioritized debt reduction and doesn't pay a dividend yet. But with most oil stocks doling out hefty dividends to shareholders with rising oil prices, investors hope the unprecedented rally in oil and gas prices should help the company reduce its debt worth $1 billion as of the last quarter at a faster pace, and eventually encourage it to consider returning some capital to shareholders.

Now what

To be sure, Centennial Resource may not make as much money from higher oil prices given its conservative business approach under which it hedges a substantial portion of oil production. That, however, is a prudent strategy for a commodity company with high debt, and I don't blame Centennial Resource for hedging given the kind of volatility we've seen in oil prices over the past year or so.

In another important update, Reuters reported earlier this week that Centennial Resource is looking to sell some assets in Texas to capitalize on higher oil prices. That means the company is not just banking on higher oil prices to boost cash flows but also looking for opportunities to monetize assets while it can.

A stronger cash-flow profile and balance sheet should go a long way in boosting Centennial Resource's long-term prospects, and that's what investors bet on this week.

Neha Chamaria 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.

Stocks Mentioned

Centennial Resource Development, Inc. Stock Quote
Centennial Resource Development, Inc.
CDEV
$9.79 (-3.64%) $0.37

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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