CLR is down about -17.5% from its 52-week high – is it a good bargain?

One of the ways that I think a smart investor keeps track of industry and economic trends that can have a carryover effect on broad market activity. One of the sectors that is useful for the purpose is the Energy sector, since energy products such as petroleum and natural gas are used in the production of finished goods across just about every other sector of the market. A sector that has historically been dominated by energy products from the Middle east has seen the United States narrow the gap in large part by the expansion of shale oil exploration and production. The two largest oil-producing regions in the country come from the Permian Basin in the southwestern part of the U.S. and the Bakken Formation, which is located in the northwestern area covering parts of Montana and North Dakota in the U.S. and Manitoba and Saskatchewan in Canada.

For producers focused in the Bakken, part of the challenge is transporting oil to the Gulf of Mexico, where the majority of North American oil is exported to the rest of the world. One of the key pipelines in this process is the Dakota Access Pipeline, a 1,172-mile-long underground oil pipeline running from North Dakota to an oil terminal in Illinois. Over the last few years, this pipeline has seen its share of controversy, prompting protests from environmental activists and Native Americans such as the Sioux and Meskwaki tribes arguing that the pipeline threatened their land, water and way of life. The pipeline was enough of a political hot potato that in 2020 a U.S. District Court ordered the U.S. Army Corps of Engineers to conduct a new environmental review on the pipeline to determine the pipeline’s impact on the environment, raising concerns that the pipeline could be shut down and throttle the flow of oil from the Bakken to the rest of the world and fueling additional lawsuits that have since been dismissed. That dismissal included a judgement the pipeline could remain open even while the environmental review continues.

As one of the major oil-producing regions of the United States, the Bakken is obviously a key piece not only of U.S. oil production capacity, but also for Canada, providing an important counterbalance on the global market to OPEC-driven control and subsequent price manipulations. That’s why companies involved in both the Permian and the Bakken areas are worth paying attention to, and depending on their relative fundamental strength and value proposition may provide useful opportunities for new investments in the future.

Of course, there are lot of players in the Energy sector, large and small alike, which means there is no shortage of candidates worth considering One of those “smaller players” with a specific focus on the Bakken region is Continental Resources Inc (CLR). Over the past year, the company’s fundamentals have seen material improvements in operating margins, liquidity and free cash Flow as U.S. crude prices have rebounded from 2020, pandemic-driven lows. The stock’s price responded in kind, moving from a low in January of 2021 at around $18 to a high in October at around $55.50. From that point, the stock has retraced by about -17.5% to its current level around $45. The company’s fundamental improvements naturally beg the question of whether they have kept pace with the stock’s price performance, and whether the current downward trend might provide a useful new value-based opportunity. Let’s dive in.

Fundamental and Value Profile

Continental Resources, Inc. is a crude oil and natural gas company with properties in the North, South and East regions of the United States. The North region consists of properties north of Kansas and west of the Mississippi River and includes North Dakota Bakken, Montana Bakken and the Red River units. The South region includes properties south of Nebraska and west of the Mississippi River including various plays in the South Central Oklahoma Oil Province (SCOOP), Sooner Trend Anadarko Canadian Kingfisher (STACK), and Arkoma Woodford areas of Oklahoma. The East region is consists of undeveloped leasehold acreage east of the Mississippi River with no drilling or production operations. As of December 31, 2016, its estimated proved reserves were 1,275 million barrels of oil equivalent (MMBoe), with estimated proved developed reserves of 519 MMBoe. As of December 31, 2016, its average daily production from South region properties was 91,088 barrels of oil equivalent (Boe) per day. CLR has a market cap of $16.7 billion.

Earnings and Sales Growth: Over the last twelve months, earnings for CLR increased by about 850%, while rose almost 94%. In the last quarter, earnings grew nearly 32% while revenues increased by 8.6%. CLR’s operating profile is healthy and growing, with Net Income as a percentage of Revenues running at 17.84% over the last year, and increasing impressively to 27.53% in the last quarter.

Free Cash Flow: CLR’s free cash flow is healthy, at about $2.9 billion million over the last twelve months. It should be noted that free cash flow has improved steadily over the last year, from $1.3 billion and $2.2 billion in the quarter prior. It is worth noting that prior to the pandemic, free cash flow was about $3.2 billion, but considering the improvement over the last year, my takeaway is that CLR has clearly turned the corner on the difficult circumstances imposed by the 2020 collapse in oil demand. Its current level translates to an impressive Free Cash Flow Yield of 17.59%.

Debt to Equity: CLR has a debt/equity ratio of .66. This is a conservative number that reflects a conservative approach to leverage. The company’s balance sheet indicates liquidity has been improving measurably; in the last quarter, cash and liquid assets were $693.65 million compared to just $96 million three quarters ago. CLR does also have $4.7 billion in long-term debt; however the company’s operating margins and improving free cash flow are good indications that servicing and reducing debt is not a concern. The company has been aggressive about paying down its debt levels, reducing long-term debt from about $7.2 billion in early 2016 to its current level.

Dividend: CLR pays a dividend of $.80 per share, which translates to an annualized dividend of 1.79% at the stock’s current price. It is also worth noting that after not paying a dividend at any previous point, management instituted its dividend payout in May of this year, reaffirming the company’s fundamental strength and their confidence in their approach moving forward.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at around $49 per share. That suggests that the stock is undervalued right now by just 7%, with a practical discount price at around $39.

Technical Profile

Here’s a look at CLR’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above displays the stock’s price performance over the last year. The diagonal red line traces the trend from its January 2021 low at around $18 to its high in October at about $55.50; it also informs the Fibonacci retracement lines on the right side of the chart. From that high, the stock has been retracing, finding support in mid-December at around $41, inline with the 38.2% retracement line and marking current support. Current resistance is around $47, with the stock approaching that level as of this wring. A push above $47 should have short-term upside to about $50, while a drop below $41 should see the stock fall to about $38 before finding next support a little above the 50% retracement line.

Near-term Keys: CLR is an interesting case where the company’s fundamental strength has fueled the stock’s price performance for most of the past year. However, that increase in price has also outpaced the improvement in fundamental strength, which is why CLR can’t be considered as a useful value-based opportunity right now. That also means that the best probabilities for success with CLR lie in short-term trading strategies; use a push above $47 as a signal to buy the stock or work with call options, with $50 providing a useful profit target on a bullish trade. A drop below $41 would be a good signal to consider shorting the stock or working with put options, with $38 acting as a practical exit target for a bearish trade.