Permian Basin focused oil driller Laredo Petroleum Inc (NYSE: LPI) did something that few oil companies managed to do this quarter: It only met analysts' earnings expectations. That was a disappointing result as nearly all of its peers exceeded what analysts expected making Laredo's quarter look sub-par, which is why the stock initially sold off. That said, looks can be deceiving as the report contained three very positive developments that investors won't want to miss.
1. Costs have come down significantly
One of the recurring themes during the second quarter for the oil industry is the significant reduction in costs it has been able capture in such a short period of time. That theme was on full display at Laredo during the second quarter as its costs per barrel of oil equivalent, or BOE, plunged 28% year-over-year. As a result costs are now just $13.52 per BOE, which is down from $18.85 in the year-ago quarter. This is helping it mitigate some, but certainly not all, of the weakness in oil and gas prices.
Driving some of this cost reduction are investments that Laredo made in water handling and disposal infrastructure as well as initiatives to reduce electricity and fuel in the field. These investments are expected to continue to pay off as the company sees additional cost savings being realized in future quarters.
2. Underlying profitability has been astoundingly stable
The combination of falling costs when combined with the 38% year-over-year surge in Laredo's production has had a remarkable impact on its bottom line. The company's adjusted EBIDTA, which is a proxy for underlying cash flow, was $117.9 million during the quarter, which was actually flat year-over-year despite a 46% decrease in realized oil prices. Meanwhile, cash flow from operations actually increased from $89 million to $89.8 million year-over-year.
3. Production growth is accelerating
This stable cash flow is giving the company the confidence to increase its 2015 capex budget to drive better-than-expected production growth. The company is now planning to spend $595 million to fund additional drilling as well as additional investments in its Medallion pipeline system. This is a fairly significant increase from the initial budget of $525 million. That said, cash flow alone isn't funding this increase as the company did announced the sale of some non-strategic properties for $65 million, which will fund most of the incremental spending.
This extra capital is expected to accelerate production growth, which is now expected to be 17%-19% higher than last year. While that's below its long-term average of 26% per year, this is the second time the company has ratcheted up production growth as the initial guidance was for 12% production growth before being bumped to a range of 13%-15% as a result of reduced well cost estimates. A big reason why Laredo is accelerating production growth is because its returns in some cases are on par with the near 50% return it was earning in 2013 before oil collapsed.
Investor Takeaway
While Laredo Petroleum's report didn't wow investors, the company still made a lot of solid progress during the quarter. What's most intriguing is the fact that the company kept cash flow flat as it used a combination of production growth and cost cutting to overcome a significant drop in its realized oil price. Further, the company is making strong progress on improving well returns back to the level before oil collapsed, which is why it's starting to accelerate production growth.
