Rating Update: Stock Rating F-Lowest (9/5/19)-Concho Resources Inc (CXO).

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BUSINESS

Concho Resources Inc., an independent oil and natural gas company, engages in the acquisition, development, and exploration of oil and natural gas properties in the United States. The company’s principal operating areas are located in the Permian Basin of southeast New Mexico and west Texas. As of December 31, 2017, its total estimated proved reserves were 840 million barrels of oil equivalent. Concho Resources Inc. was founded in 2006 and is headquartered in Midland, Texas.
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INVESTMENT RATING

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Reflecting future returns on capital that are forecasted to be in line with the cost of capital, CXO is expected to be Value Creation neutral.

Concho Resources has a current Value Trend Rating of F (Lowest Rating).
The Value Trend Rating reflects inconsistent signals from PTR’s two proprietary measures of a stock’s attractiveness. Concho Resources has a neutral Appreciation Score of 44 but a very low Power Rating of 2, leading to the Lowest Value Trend Rating.

Concho Resources’ stock is selling below targeted value. The current stock price of $70.36 compares to targeted value 12 months forward of $81.
This neutral appreciation potential results in an appreciation score of 44 (56% of the universe has greater appreciation potential.)
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Concho Resources has a Power Rating of 2. (This very low Power Rating indicates that CXO only has a better chance of achieving attractive investment performance over the near to intermediate term than 2% of companies in the universe.)
Factors contributing to this very low Power Rating include: CXO’s earnings estimates have fallen very significantly in recent months; is currently in an unfavorable positi; and recent price action has been unfavorable.

INVESTMENT PROFILE

CXO’s financial strength is above average. Financial strength rating is 62.
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Relative to the S&P 500 Composite, Concho Resources Inc has slightly more Value than Growth characteristics; its appeal is likely to be to investors neutral towards Income; the perception is that CXO is normal risk. Relative weaknesses include: low forecasted profitability, low historical profitability, low financial strength, and high earnings variability. CXO’s valuation is moderate: low dividend yield, moderate P/E ratio, and low price/book ratio. CXO has low market capitalization.

CURRENT SIGNALS

Concho Resources’ current operations are eroding. Return on equity is falling, reflecting: falling asset utilization; declining pretax margin; falling tax keep rate; and falling leverage.

Concho Resources’ current technical position is very weak. The stock price is in a 7.2 month down move. The stock has declined 30.5% from its prior high. The stock price is below its 200 day moving average which is in a downtrend. Concho Resources’ stock price decline is extreme and the stock appears oversold.

ALERTS

Concho Resources Inc (NYSE: CXO) has recently experienced significant negative changes in fundamentals: the consensus estimate for December, 2019 decreased significantly, and the consensus estimate for December, 2020 decreased significantly.
The stock is currently rated F.
Concho Resources Inc (NYSE: CXO) stock enjoyed a major increase of 12.1% on 9/5/19. The shares closed at $0.06. Moreover, trading volume in this advance was above average at 144% of normal. The stock has been extremely weak relative to the market over the last nine months but has risen 1.9% during the last week.

CASH FLOW

In 2018, Concho Resources experienced a very significant reduction in cash of $0 million (). Sources of cash were much lower than uses. Cash generated from 2018 EBITDA totalled +$2,860 million. Non-operating sources contributed +$1,709 million (+60% of EBITDA). Cash taxes contributed +$518 million (+18% of EBITDA). Re-investment in the business amounted to -$14,043 million (-491% of EBITDA). On a net basis, debt investors contributed +$1,389 million (+49% of EBITDA) while equity investors contributed +$7,567 million (+265% of EBITDA).
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Concho Resources’ Non-operating Income, %EBITDA has enjoyed a very strong overall uptrend over the period. This improvement was accompanied by an opposite trend for the Concho Resources Inc Peer Group. In most years, Concho Resources was in the top quartile and third quartile. Currently, Concho Resources is upper quartile at +60% of EBITDA (+$1,709 million).

Concho Resources’ Cash Taxes, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Concho Resources Inc Peer Group. (Since 2016 Cash Taxes, %EBITDA has sharply accelerated.) In most years, Concho Resources was in the top quartile and third quartile. Currently, Concho Resources is upper quartile at +18% of EBITDA (+$518 million).

Concho Resources’ Business Re-investment, %EBITDA has suffered a volatile overall downtrend over the period. This downtrend was accompanied by an opposite trend for the Concho Resources Inc Peer Group. (Since 2016 Business Re-investment, %EBITDA has accelerated very sharply.) In most years, Concho Resources was in the second quartile and third quartile. Currently, Concho Resources is lower quartile at -491% of EBITDA (-$14,043 million).

Concho Resources’ Debt Investors, %EBITDA has experienced a volatile overall downtrend over the period. This downtrend was accompanied by an opposite trend for the Concho Resources Inc Peer Group. In most years, Concho Resources was in the top quartile and second quartile. Currently, Concho Resources is above median at +49% of EBITDA (+$1,389 million).

Concho Resources’ Equity Investors, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Concho Resources Inc Peer Group. (Since 2016 Equity Investors, %EBITDA has accelerated very sharply.) In most years, Concho Resources was in the third quartile and second quartile. Currently, Concho Resources is upper quartile at +265% of EBITDA (+$7,567 million).

Concho Resources’ Change in Cash, %EBITDA has exhibited a volatile overall uptrend over the period. This improvement was accompanied by an opposite trend for the Concho Resources Inc Peer Group. In most years, Concho Resources was in the third quartile and second quartile. Currently, Concho Resources is below median at 0% of EBITDA ( $0 million).
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Concho Resources’ Cash, %Revenue has exhibited little to no overall change over the period. This stability was accompanied by stability for the Concho Resources Inc Peer Group as well. (Since 2015 Cash, %Revenue has experienced a very sharp decline.) In most years, Concho Resources was in the lower quartile. Currently, Concho Resources is lower quartile at 0%.

PROFITABILITY

Concho Resources’ return on equity reached a new post-2010 high in 2019.
This was due to very strong negative trend in pretax operating return and minor negative trend in non-operating factors.
The productivity of Concho Resources’ assets declined over the full period 2009-2019: asset turnover has suffered an downtrend.
Non-operating factors (income taxes and financial leverage) had a small negative influence on return on equity.
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Concho Resources’ return on equity is lower quartile (2.9%) for the four quarters ended June, 2019.
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Operating performance (pretax return on assets) is lower quartile (2.3%) reflecting asset turnover that is at the lower quartile (0.18X) and lower quartile pretax margin (13.0%).
Tax “keep” rate (income tax management) is upper quartile (89.4%) resulting in after tax return on assets that is lower quartile.
Financial leverage (leverage) is lower quartile (1.42X).

GROWTH RATES

There are no significant differences between Concho Resources’ longer term growth and growth in recent years.
Concho Resources’ historical income statement growth and balance sheet growth have diverged. Revenue growth has paralleled asset growth; earnings growth has fallen short of equity growth.

Annual revenue growth has been 7.7% per year.

Total asset growth has been 10.5% per year.

Annual E.P.S. growth has been 8.5% per year.

Equity growth has been 17.6% per year.

Concho Resources’ consensus growth rate forecast (average of Wall Street analysts) is 17.2% — substantially above the average of the historical growth measures.
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Relative to the Concho Resources Inc Peer Group, Concho Resources’ historical growth measures are generally third quartile. Equity growth (17.6%) has been at median. Total asset growth (10.5%) has been below median. Revenue growth (7.7%) has been substantially below median. E.P.S. growth (8.5%) has been slightly below median.

Consistent with this pattern, consensus growth forecast (17.2%) is also at median.
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PRICE HISTORY

Over the full time period, Concho Resources’ stock price performance has been variable and slightly below market. Between November, 2008 and September, 2019, Concho Resources’ stock price rose +198%; relative to the market, this was a -10% loss. Significant price moves during the period: 1) January, 2018 – September, 2019: -55%; and 2) February, 2009 – March, 2011: +438%.
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TOTAL INVESTMENT RETURNS

Current annual total return performance of -32.9% is lower quartile relative to the S&P 500 Composite.
In addition to being lower quartile relative to S&P 500 Composite, current annual total return performance through July, 2019 of -32.9% is slightly above median relative to Concho Resources Inc Peer Group.

Current 5-year total return performance of -7.0% is lower quartile relative to the S&P 500 Composite.
Through July, 2019, with lower quartile current 5-year total return of -7.0% relative to S&P 500 Composite, Concho Resources’ total return performance is substantially below median relative to Concho Resources Inc Peer Group.
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VALUATION BENCHMARKS

Relative to S&P 500 Composite, CXO’s overall valuation is normal. The highest factor, the ratio of enterprise value/earnings before interest and taxes, is near the upper quartile. Price/earnings ratio is above median. Ratio of enterprise value/revenue is above median. Ratio of enterprise value/assets is lower quartile. The lowest factor, the price/equity ratio, is lower quartile.
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Concho Resources has a large value gap compared to the median valuation. For CXO to achieve median valuation, its current ratio of enterprise value/revenue would have to fall from the current level of 4.16X to 3.61X. If CXO’s ratio of enterprise value/revenue were to fall to 3.61X, its stock price would be lower by $-12 to $58.
For CXO to fall to lower quartile valuation relative to the Concho Resources Inc Peer Group, its current ratio of enterprise value/revenue would have to fall from the current level of 4.16X to 2.95X. If CXO’s ratio of enterprise value/revenue were to fall to 2.95X, its stock price would decline by $-27 from the current level of $70.

VALUE TARGETS

Reflecting future returns on capital that are forecasted to be in line with the cost of capital, CXO is expected to be Value Creation neutral.
Concho Resources’ current Price Target of $82 represents a +17% change from the current price of $70.36.
This neutral appreciation potential results in an appreciation score of 44 (56% of the universe has greater appreciation potential.)
With this neutral Appreciation Score of 44, the low Power Rating of 2 results in an Value Trend Rating of F.
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Concho Resources’ current Price Target is $82 (+4% from the 2018 Target of $79 and +17% from the 09/05/19 price of $70.36). This plateau in the Target is the result of a +4% increase in the equity base and a +0% change in the price/equity multiple. The forecasted increase in growth has no impact on the price/equity multiple and the forecasted increase in cost of equity has no impact either. However, the forecasted increase in return on equity has a very large positive impact.
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PTR’s return on equity forecast is 7.7% — in line with our recent forecasts. Forecasted return on equity suffered a dramatic, variable decline between 2010 and 2018. The current forecast is well below the 2011 peak of 16%.

PTR’s growth forecast is 20.0% — substantially above our recent forecasts. Forecasted growth suffered a dramatic, erratic decline between 2010 and 2018. The current forecast is significantly above the 2017 low of 4%.

PTR’s cost of equity forecast is 8.7% — slightly above recent levels. Forecasted cost of equity enjoyed a dramatic, variable decline between 2010 and 2018. The current forecast is below the 2012 peak of 10.8%.
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At Concho Resources’ current price of $70.36, investors are placing a negative value of $-40 on its future investments. This view is consistent with the company’s most recent performance that reflected a growth rate of 8.0% per year, and a return on equity of 5.8% versus a cost of equity of 6.9%.
PTR’s 2020 Price Target of $82 is based on these forecasts and reflects an estimated value of existing assets of $98 and a value of future investments of $-16.

About John Lafferty 57444 Articles
During his career, John has developed valuation and stock rating methodologies, managed institutional portfolios and mutual funds, and provided equity research to institutional investors on thousands of companies. He has been Director of Research at PTR since its inception in 2004.

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