U.S. based energy producers Concho Resources is being downgraded to neutral from buy at B of A Securities. Analyst David Zatezalo says that the company has been growing production in the Permian Basin at an almost constant rate in recent years, which has eroded value of the company’s balance sheet.
U.S. producer company, Concho Resources announced the release of its first quarter 2019 results on May 31. The company’s revenue for the quarter grew by more than 50% to $845.5 million from the year ago quarter. However, the company’s net income (which includes the effect of income taxes) plunged by more than 75% to $22.7 million from the year ago quarter, due to higher commodity costs, which increased the company’s working capital requirements. In addition, Concho Resources announced in the quarter that it is also facing a number of high-risk and high-return exploration opportunities in the Permian Basin and East Texas.
Concho Resources has been grappling with low prices in recent years. A supply glut of U.S. crude oil has depressed international oil prices in recent years. Low oil prices triggered energy companies to slash investment and save on expenses, which in turn have led to declines in rig count, and how many oil wells are being drilled per year, resulting in fewer investment projects to replace declining production. Given the lack of investment in the Permian Basin, production capacity is likely to grow.
“We estimate the Permian’s production growth rate will be as high as 12% over the next two years,” writes Zatezalo. This is one reason why he is downgrading Concho Resources to neutral.
Zatezalo is concerned that falling production has been one of the key factors that have led to Concho Resources’ net debt rising from $3.8 billion in March 2015 to $5.4 billion in March 2019. Rising prices in the U.S. will likely lead to a more productive drillers. The producer believes its upcoming discovery in the Culberson County area of the Permian Basin with potential to recover more than 100 million barrels of oil will mitigate oversupply in the U.S. As a result, the average price for the crude production in the Permian Basin is forecast to rise by about $3 a barrel in the coming year and about $4.40 a barrel in 2020. This will provide an opportunity for B of A Securities to sell Concho Resources on the possibility of rising commodity prices.
Concho Resources’ shares have fallen by more than 22% in the last 12 months, due to falling prices for crude oil and the high interest rates.