Continental Resources (NYSE: CLR) was an early leader of America’s oil renaissance, because it was one of the first drillers that successfully tapped into the Bakken shale. The company was able to quickly build up and develop a leading position in the region, which fueled fast-paced production growth until oil prices came crashing down in 2014.
While lower oil prices stalled Continental Resources’ growth engine for a few years, the company was able to get back on track last year after turning around its finances. Those factors helped fuel a 75% rally in its stock over the past year, which most oil investors probably missed since their main focus has been on the Permian Basin. However, with the Permian slowing down due to pipeline issues, and Continental shifting its focus toward creating shareholder value, it’s time that investors stop overlooking this oil stock.
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A dramatic transformation
Before the oil-market downturn, Continental Resources was growing its production as fast as it could. The company routinely outspent its cash flow, bridging the gap by borrowing money, which ballooned its debt load to $7.1 billion by the end of 2015. That put it in a precarious position as oil prices crashed, which caused its stock to plunge more than 70% from its peak in 2014 before it bottomed out in early 2016.
The company’s financial concerns forced it to take drastic actions so that it could stay afloat, including slashing capital spending and other costs. Those initiatives enabled it to generate some free cash flow by 2016, which allowed it to begin whittling down its debt. Meanwhile, the company accelerated its debt reduction process by selling more than $1 billion in noncore assets. As a result, Continental Resources’ debt had fallen to around $6 billion at the end of this year’s second quarter, which puts it halfway to its target of getting debt down to $5 billion.
Continental Resources’ efforts to drive out costs have significantly improved its drilling returns. In 2014, for example, wells drilled in the Bakken would earn a 20% rate of return at $70 oil. This year, however, Continental’s wells in the region are delivering a 175% rate of return. The underlying rocks haven’t changed; what has is the company’s ability to get more oil out for less money. The oil driller has also made significant progress on developing its land in the STACK and SCOOP plays of Oklahoma, where returns on new wells targeting the Springer formation are currently delivering a 215% rate of return at $70 oil.
The Continental Resources of tomorrow
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Thanks to those lucrative returns, Continental Resources has restarted its oil growth engine. The company currently expects to increase its production by 20% to 24% this year. What’s most impressive about that forecast is that the company can achieve that high growth rate while generating an estimated $800 million to $900 million in free cash flow for 2018.
Continental Resources has several options for the excess cash. While the bulk of it will likely go toward its debt reduction plan, the company is also considering initiating a dividend. That would mark a stark contrast for a company that had previously spent everything that came in (and then some) on growing its production.
In doing so, it would join fellow shale driller Diamondback Energy (NASDAQ: FANG), which also initiated a dividend this year. That quarterly payment was Diamondback Energy’s “first step toward rewarding shareholders for their support of our growth these last five years,” according to Diamondback’s CEO Travis Stice. Furthermore, Stice noted that his company “is now in a position to generate industry-leading organic growth as well as return capital to shareholders while continuing to reduce leverage.”
That’s also where investors find Continental Resources these days, since it too is now in a position to deliver strong production growth, along with a rising stream of free cash flow that it has the flexibility to use in reducing debt and potentially start paying a dividend.
Focused on growing value, not just production
While Continental Resources’ stock has been red-hot over the past year, the company doesn’t appear to have reached its peak. That’s because its focus will be on creating value for its investors, instead of expanding as fast as it can. This shift is why this oil stock could potentially be an even bigger winner in the coming years.
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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
