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Another Big-Ticket Oil Shale Play
02/15/2012 11:45 am EST
Back on January 13, I added Pioneer Natural Resources (PXD) to my long-term Jubak Picks 50 portfolio. The logic, I argued in my post on that pick, was that Pioneer Natural Resources was part of the boom in US oil production out of the tight shale formations of the Permian basin.
Unlike wells drilled in natural gas shales, wells drilled in this region produce lots of liquids. And with oil prices stuck north of $100 a barrel and natural gas prices stuck well south of $4 a BTU, investors, I argued, want to buy liquid-rich producers such as Pioneer.
The market apparently agrees. This pick is up 13.5% since I made it on January 13. At today’s price of $110, it’s closing in on the $115 target I set for December 2012. (At this point, I’d say I’m likely to raise that target.)
Today, I’ve got another play on the same story. Concho Resources (CXO) is a little smaller than Pioneer (a market cap of $11.7 billion versus $13.4 billion), a bit faster growing (with production in 2012 projected to climb by 28% at Concho versus 24% at Pioneer), slightly cheaper, and a bit riskier.
For fast-growing stocks like these, current price-to-earnings ratios aren’t a good indicator of expensive or cheap. An investor is buying growth, so the key question is at what price.
The PE to Growth rate ratio (PEG ratio) for Pioneer is a tiny 0.51. (For reference, famed growth-at-a-reasonable-price investor Peter Lynch looked for stocks with PEG ratios below 1. Pioneer is way, way below that valuation target.) The PEG ratio for Concho is 0.38.
Before you buy anything that looks cheap, I think it’s important to understand why. If you’re buying something the market has priced as cheap, you’re essentially saying the market is wrong.
So why is Concho cheap in comparison to Pioneer? It’s mostly a question of higher risk at Concho because more of its operations are in relatively undeveloped parts of the Permian Basin.
So, for example, Pioneer’s Wolf Camp shale resource looks well on its way to proving out reserve estimates. Concho’s positions in the Delaware Basin, in contrast, are still at what Australian investment bank Macquerie called the “Wild West” stage in a recent note.
The process of proving that a hydrocarbon reserve holds as much actual oil and natural gas as the seismic studies have indicated, by drilling lots and lots of wells, is called de-risking. And Pioneer is further along in that process than Concho at this point.
I think the geology of Concho’s positions in the Delaware and other Permian basins looks good. Competitors drilling in those regions have turned in solid results. So I think the odds are that Concho really will produce the oil that management projects that it will.
If that’s the case, then this is a $130 stock (target price for December 2012) selling for $112 on February 14. (Macquarie thinks Concho is also a likely acquisition candidate, and puts the acquisition price at $165.) Concho Resources is scheduled to report fourth-quarter earnings on February 22.
As of February 14, I’m adding this stock to my Jubak’s Picks 12-18 month portfolio with a December 2012 target price of $130.
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