Industry Leading Cash Flow, Financial and Operational Metrics, 30%+ Diversified Growth Opportunities, Beaten Down Shares Offer Significant Upside
Continental Resources (NYSE: CLR) is an independent producer of oil and the largest leaseholder of Bakken oil fields in Montana and North Dakota. Continental also has significant holdings in the Northwest Cana and SCOOP plays in Oklahoma (Bakken/Three Forks, Red River, Neobrara, Anadarko Woodford and Arkoma Woodford fields). Its operations are focused on organic growth and leveraging technology to increase reservoir productivity.
Beaten Down Shares Offer Compelling Value
On October 10, 2014, shares closed at $56.78, near the low-end of their 52-week range of $50.125 – $80.91, with a price-to-earnings ratio of 34.1x on trailing 12-month earnings per share of $1.703. Continental has a market capitalization of $21.1 billion with about 372.2 million shares outstanding. Shares now trade at 12.5x cash flow and offer compelling value.
Moreover, at 91.77%, Continental’s gross margin is higher than 96% of its peers in the oil and gas operations industry which means it has more cash to spend on business operations than its competitors. Its operating margin of 35.96% is better than 93% of its peers which indicates Continental does a better job at cost and expense controls.
Over the long run, earnings are expected to rise at 23.2% per year, well above the 12.5x cash flow multiple, suggesting shares have significant upside above the $57 level.
Of the 26 Wall Street analysts covering the company, 17 have Strong Buy or Buy recommendations with a mean 12-month price target of $80, a high of $100 and a lot of $63.
Shares Have Soundly Outperformed the Market over the Past Five Years
Over the past five years, Continental shares have delivered a 27.1% annualized return which is almost double the 14.1% annual gain of the S&P 1500 index and almost three-times the 9% annualized gain delivered by its industry peers.
The company does not pay dividends.
Growing, Well Diversified Assets with High Production Yields
As of Q1 2014, the company produced 70% oil and 30% natural gas with 55% of all production from North Dakota Bakken, 19% from SCOOP, 9% each from Montana Bakken and Red River Units and the rest from Northwest Cana, Arkoma Woodford and other fields, with total proved reserves of 1,084 million barrels of oil equivalent (MMBoe as of 12/31/2014), 38% higher than proved reserves of 785 MMBoe in December 2012.
The company’s Proved Reserves have increased steadily from slightly below 150 MMBoe in 2007 to over 1,100 MMBoe at the end of 2013, with increases in crude oil and natural gas reserves. In parallel, average production has steadily increased from about 12.5 MMBoe in 2008 to over 50 MMBoe in 2013, with a 70-30 split between crude oil and natural gas.
Continental is a technology-focused innovator and uses advanced technologies such as ECO-PAD drilling (that enables higher reservoir harvesting while reducing costs and environmental impact), horizontal drilling (to access resource plays in an economically feasible manner) and well stimulation (using high pressure sand and water to crack deep rock oil-bearing formations).
Overall, Continental has an exceptional future from growing assets with potential undrilled net wells up from 11,400 in 2012 to 18,600 as of September 2014, with increases in Bakken and SCOOP, with an almost doubling of net un-risked resource potential and proved reserves to 9,600 MMBoe. Its reserves also provide high rates of return that range from 45% at Bakken to 105% at SCOOP Springer.
Solid Growth in Bakken E&P
Continental has 892,824 net acres in Bakken – North Dakota and 305,060 net acres in Bakken – Montana, and has grown its Bakken real estate through leasing, selective acquisitions and strategic trades.
The Bakken field has orderly development underway with steady industry rig count, new infrastructure and full-field development. Bakken’s recovery factor of 15% can be increased to over 20% with density drilling, and this higher recovery factor could release more recoverable resources (62 – 96 billion Boe). Additionally, enhanced completions can cause 25% uplift in production.
Continental has a solid track record of successful execution at Bakken with net production growth of 58% annually over the past three years and an 11,100 Boe/d gain in quarterly production in the most recent quarter. Continental is an industry leader in natural gas capture and sells 85% of its gas volumes which is well above the industry average of 60% to 70%. Continental is also an industry leader in density pilots and lower bench testing.
At Bakken, Continental has completed detailed geological and reservoir studies, refined and quantified resource potential, ranked and prioritized inventory and conducted density pilots for clarity on full-field development, with very promising enhanced completions and high volume lift installations. As a result, Bakken holds 4.1 billion Boe across 11,800 net undrilled wells and 25% production uplift.
Continental has made significant strides in maximizing Bakken profitability through its initiatives to increase production and optimize combinations of well spacing, completion design and artificial lift.
As a result, Continental has increased wells per rig from 12 to 15 per year with double-digit improvements in cycle times which have contributed to production and revenue growth while reducing average drilling cost per lateral foot by 22% from $398 to $310 to increase returns.
The company has optimized artificial lift and production facilities through the use of longer stroke pumping units (LSU), electric submersible pumps (ESP) and gas lift (GL), optimized water handling and leveraged central tank batteries to serve an increasing number of wells. As a result, Continental has seen an increase in higher capacity artificial lift installations every quarter.
SCOOP Offers Significant Growth Potential Too
Scoop rivals Bakken with 3.6 billion Boe of net un-risked resource potential (up 320% since 2012), 4,744 net unrisked drilling locations (up 326% since 2012), 646,000 of net combined resource leasehold acreage (Woodford/Springer), economics that match or beat Bakken, new oil plays with 118,000 net acres oil and 77,000 net acres condensate/gas, extended lateral wells and a 176% increase in net acreage since 2012.
SCOOP has seen a 217% annual increase in net daily production to approximately 34,300 Boe per day average in 2Q14 of which 46% is oil and 74% is total liquids. The company exited 2Q14 with a rate of 36,300 barrels of oil per day from 112 Continental operated wells with a net addition of 86 wells since 2012.
Continental’s prominent acreage in SCOOP reflects its early entrant advantage and timely recognition of the site’s potential with confirmation through initial delineation success. Continental holds a dominant leasehold position in both the oil and condensate fairways with ongoing leasing and acquisition initiatives.
The company has improved drilling efficiency through a shift to longer laterals with a 50% decrease in drilling cost per lateral foot, and by continuous operational optimization that has steadily reduced average drilling costs.
Recently Announced Springer Shale Has Compelling Economics
Continental recently announced its newest oil discovery at Springer Shale with 447 MMBoe net unrisked resource potential (127 oil, 320 gas/condensate) with 195,000 net acres in the heart of SCOOP, up 540% since 2012. This incremental value was created from in-house exploration without expensive acquisition costs.
Continental is deeply committed to organic growth and continuously adds experienced staff to its exploration programs. The company is currently (as of September 2014) pursuing seven New Ventures projects with over 500,000 net acres of committed leasehold outside of its core areas, with 100% of all new projects as horizontal targets in unconventional reservoirs backed by technical understanding and advanced data analysis.
Experienced, Founder-Led Management Team
Shelly Dean Oil Company, the predecessor company to Continental, was founded in 1967 by current Chairman and CEO Harold Hamm who is also Oklahoma’s richest billionaire. Shelly Dean changed its name to Continental in 1987 after a series of acquisitions, and has since grown into a multi-billion-dollar corporation that is a vital part of America’s energy independence strategy.
Jack Stark was appointed President and Chief Operating Officer in September 2014, and has served the company since 1992 in positions of increasing responsibility.
Jeff Hume serves as Vice Chairman of Strategic Growth Initiatives and has been with the company since 1983, having joined after holding engineering positions with prominent oil companies.
John Hart serves as Chief Financial Officer and Treasurer, and joined the company in November 2005. He is a Certified Public Accountant and earlier served as senior audit manager with Ernst and Young.
Collectively, management has been instrumental in growing the company through multiple industry cycles into a well-established industry leader positioned to capitalize on high-growth opportunities, with strong double-digit returns on equity.
Compelling Financial Metrics
Over the past six years, Continental has steadily increased production from 37,324 Boe per day in 2009 to 167,953 Boe/d in 2014, and steadily increased EBITDA each year to $1.64 billion for the first half of 2014.
The graph below shows Continental’s strong cash flow with a cash margin of 75% per Boe and steadily rising cash contributions since 2012 to $55.84 per Boe.
Continental’s compelling cash flow is also reflected in its Recycle Ratio (cash margin divided by 3-year Finding and Development costs per barrel of oil equivalent) which, at 4.5x, is top-of-class and more than twice the industry average of less than 2.0x.
Continental is on-track to achieve 27% to 30% growth in 2014, well above its 2012 5-y growth plan on achieving 25% compounded annual growth (CAGR). As of mid-year 2014, it’s proved reserves of 1.2 billion BOE were up 31% over mid-year 2013 and its marketing and operational strategy is focused on driving strong cash margins. This is an important milestone and reflects the company’s ability to set and beat realistic targets.
Q2 Results Show Continued Strength
Q2 2014 highlights include adjusted net income of $277 million or $1.50 per diluted share, 10% increase in production by 15,500 Boepd on an 11% production increase at Bakken and a 17% increase at SCOOP over the prior quarter, with enhanced completions promising early production uplift. The company reported net income of $104 million or $0.56 per diluted share.
In its second quarter ended July 30, 2014, Continental had an average realized oil price of $92.31 per barrel on 116,551 barrels of oil per day and average realized natural gas price of $5.43 per thousand cubic feet on 309 MMcfpd, and generated $867.94 million in EBITDAX (earnings before interest, tax, depletion, depreciation, amortization and exploration expenses – a key metric in the oil and gas industry) with cash margin of $55.45 or 75% of the average oil equivalent price of $74.09.
Continental ended the quarter with $777 million in cash, $14.38 billion in total assets, $5.83 billion in long-term debt and $4.3 billion in shareholders’ equity. (Debt/Equity of 1.36x, Debt/Assets of 0.41x)
Looking ahead, Continental expects year-over-year production growth of 26% to 32% in 2015 with a $9 to $11 drop in NYMEX WTI crude prices.
Continental Resources is an industry-leading player with top-of-class operational and profitability metrics, diversified plays, significant proven organic growth and production set to rise at 30%+ rates in 2015 and beyond. The company differentiates itself by leveraging technological innovation to organically uncover high-return opportunities and often finds itself with first-mover positioning due to the originality of its exploration and production approach. Shares are currently near the bottom of their 52-week range, valued significantly below projected growth rates and offer compelling upside over the long run. The company has exceptional cash flow and enjoys investment grade credit rating. Future cash flow generation is, however, susceptible to a potential drop in the price of oil from a global economic slowdown.