Continental Resources: A Great Stock For Oil Bulls

If youre bullish on oil, then Continental Resources (CLR) is the stock for you. I believe the company will likely significantly grow its earnings in 2018 due to higher realized prices and around 20% production growth. Meanwhile the company, which burned cash flows in 2017, will likely report strong levels of free cash flows in 2018. That should fuel its stocks outperformance.

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The oil prices have improved substantially since the start of Q4-2017. The price of the US benchmark WTI crude has gained 20% since then to more than $60 a barrel its highest level in 2.5 years. The strength has been driven in large part by the efforts of Organization of the Petroleum Exporting Countries and its allies, including Russia, who have agreed to extend their production freeze agreement through entire 2018. The decline in inventory levels in OECD nations, including the US where commercial crude oil stocks have fallen by 20% from the historic highs seen in March 2016, has also helped push oil prices higher.

At the same time, the Bakken-focused oil producers, such as Continental Resources, have benefited from the improvement in regional prices. In a recent presentation, Continental Resources said that the Bakken oils differential to WTI gradually shrunk from -$8.26 a barrel in 2016 to -$5.54 a barrel in Q3-2017. I believe this is largely driven by the deployment of additional takeaway capacity in the region, particularly the 470,000 barrels per day Dakota Access Pipeline which came online earlier this year and has gradually ramped up. Continental Resources has said that this differential will drop to -$4.98 per barrel in Q4-2017 and will head lower in 2018. That should lift the companys realized prices.

Remember, Continental Resources has no hedges in place. This means that unlike some of its peers, such as Pioneer Natural Resources (PXD) who locked a large chunk of their 2018 production at less than $58 a barrel by Q3-2017, Continental Resources can fully capitalize on oils rise to $60 a barrel. In 9M-2017, Continental Resources swung to an adjusted profit of $37.14 million, or $0.10 per share, from a loss of $299.2 million, or $0.81 per share a year earlier, and also posted 56% increase in operating cash flows to $1.35 billion. That gain was driven in large part by 29.1% increase in average realized sales price for crude oil to $43.26 a barrel. Moving forward, Continental Resources will post higher realized prices which will fuel further earnings and cash flow growth.

On top of this, Continental Resources, which has been keeping a lid on its oil and gas production, will also start targeting strong growth. In fact, I believe in 2018, Continental Resources will report one of the highest levels of production growth rates among large-cap independent oil producers.

So far, Continental Resources has reported a modest 3.8% increase in production in the first nine months of the year, on a year-over-year basis, to almost 227,700 boe per day. The increase was driven by an uptake in drilling activity, mainly at its core Bakken properties. By comparison, its peers Pioneer Natural Resources and EOG Resources (EOG) have posted higher production growth rates of 13% and 7% respectively for the same period.

But Continental Resources production growth has only recently started to kick in as it brought 122 gross wells online in Q3-2017, up from 50 wells in Q3-2016 and 100 wells in Q2-2017, and worked through its inventory of DUCs (drilled but uncompleted or completed but not producing wells). Thats fueled a 14.2% increase in Bakken production (North Dakota and Montana) on a sequential basis and 26.8% on a year-over-year basis to almost 130,000 boe per day in Q3-2017. This drove 7.3% growth in total production on a sequential basis and 16.8% on a year-over-year basis to 242,800 boe per day. Continental Resources will likely continue growing its output at strong double-digit rates in the coming quarters, driven by strong growth from Bakken wells and a drop in DUCs.

Continental Resources has said that following improvement in oil prices to well over $50 a barrel, it is targeting 15% to 20% growth in total production in the coming years. I believe the target is well within the companys reach. Its production briefly touched 300,000 boe per day in October. For the fourth quarter, the company has said that its output will average at around 280,000 boe per day and it will exit 2017 with production of between 280,000 and 290,000 boe per day. This will translate into full year production of a little over 240,000 boe per day. If, in 2018, the companys production climbs slightly from the exit rate to 295,000 boe per day, then that will translate into a strong 23% production growth for the full year. With a production growth rate of over 20%, I think Continental Resources may even surpass EOG Resources and Pioneer Natural Resources whove put some of the strongest growth numbers among large-cap independents in the last few quarters.

I believe that with higher realized prices and ~20% increase in production, Continental Resources will put solid earnings and cash flow growth numbers. Note that although Continental Resources turned a profit in 2017, it actually burned cash flows. The company generated $1.35 billion of cash flow from operations but spent $1.44 billion as capital expenditure and therefore faced negative free cash flows of $97 million. But in 2018, I think it is reasonable to assume that the company will post around 40% increase in operating cash flows (already up 56% in 9M-2017 with little production growth). Continental Resources will also likely increase capital expenditure, though the spending levels likely wont climb as much. If the company grows its capital expenditure by 10%, then it could post positive free cash flows of almost $397 million, as per my rough estimates.

The company will then likely use the excess cash flows to repay debt in order to improve its balance sheet. Continental Resources carried $6.6 billion of debt at the end of Q3-2017, most of which is due after 2021. But the company aims to reduce its debt to $6 billion in the near-term and $5 billion in the long-term. Debt reduction should have a positive impact on the company’s valuation.





















Data source: CLR 10-Q Filing. *Authors estimates.


For these reasons, I believe Continental Resources will deliver a solid performance in 2018, thanks to double-digit production growth, strong earnings growth and will likely report positive free cash flows as opposed to 9M-2017 when it faced a cash flow deficit. The companys shares rose almost 3% last year, easily outperforming its peers whose shares tumbled by 10%, as measured by SPDR S&P Oil & Gas E&P ETF (XOP). I think the stock, which seems reasonably valued with EV/EBITDA (2018e.) multiple of 8.87x, will likely continue to outperform in 2018.

Note from author: Thank you for reading. Do you think Continental Resources will outperform in 2018? Please share your comments below. If you like this article, then please follow me by clicking the ” Follow” link at the top of this page.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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