Delaware Basin Drilling Will Boost Output Amid Market Volatility

Key Takeaways

• Accretive M&A and strategic acquisitions are key components of Permian's growth strategy, potentially boosting long-term shareholder value.
  
• The company's focus on achieving investment-grade status could lower borrowing costs and enhance financial stability.
  
• Reliance on volatile commodities and M&A integration risks, alongside competitive and regulatory challenges, could impact growth, margins, and sustainability of free cash flow.

Catalysts

An independent oil and natural gas company, focuses on the development of crude oil and associated liquids-rich natural gas reserves in the United States.

• Permian Resources is planning to enhance its revenue by leveraging its highly capital-efficient Delaware Basin drilling program, which aims to increase oil production by 8% year-over-year.
  
• The company is focused on maintaining low operating costs, which directly supports strong net margins, demonstrated by a reduction in well costs by almost 20% compared to 2023.
  
• A significant portion of Permian's growth strategy involves accretive M&A activities that enhance long-term shareholder value, indicating a potential future uplift in its earnings through strategic acquisitions.
  
• The company is emphasizing on improving its debt position, with a goal to exit 2025 at approximately 0.5x leverage, enhancing financial stability and potentially leading to a rerating of its valuation.
  
• Permian's strategy to achieve investment-grade status by the end of the year may result in lower borrowing costs and improved earnings, further establishing its capacity for growth and shareholder returns.

Permian Resources Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Permian Resources compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Permian Resources's revenue will grow by 1.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 19.7% today to 19.0% in 3 years time.
• The bearish analysts expect earnings to reach $983.7 million (and earnings per share of $1.16) by about April 2028, down from $984.7 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 19.0x on those 2028 earnings, up from 8.4x today. This future PE is greater than the current PE for the US Oil and Gas industry at 11.2x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.32%, as per the Simply Wall St company report.

Permian Resources Future Earnings Per Share Growth

Risks

• There are risks associated with the company's reliance on a volatile commodity market, which could lead to fluctuations in revenues and impact their ability to sustain current free cash flow levels.
  
• The company’s ongoing M&A strategy, while potentially beneficial, carries integration risks that could lead to unexpected costs or challenges in realizing the anticipated synergy benefits, impacting net margins.
  
• While the focus on operational efficiency and cost reduction is positive, any failure to maintain these efficiencies or unexpected increases in service costs could negatively affect earnings.
  
• Capital expenditure, although controlled, remains significant, and any inability to maintain or optimize this spending could strain free cash flow, particularly if market conditions worsen.
  
• Despite ambitious growth plans, the industry's competitive environment and possible regulatory or environmental challenges could hinder production targets, impacting future revenue growth and affecting the overall financial health of the company.

Valuation

• The assumed bearish price target for Permian Resources is $15.41, which represents one standard deviation below the consensus price target of $17.9. This valuation is based on what can be assumed as the expectations of Permian Resources's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $23.0, and the most bearish reporting a price target of just $14.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $5.2 billion, earnings will come to $983.7 million, and it would be trading on a PE ratio of 19.0x, assuming you use a discount rate of 7.3%.
  
• Given the current share price of $11.86, the bearish analyst price target of $15.41 is 23.0% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.