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Leading Independent Investment Research

Morningstar, Inc.

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Equity Bottom-Up

<div class="content-highlight"><h2>The company may not have the best acreage in the Permian, but the current discount is hugely overdone.</h2></div><hr><p><a href="https://www.smartkarma.com/entities/17246" target="_blank" data-smartkarma-citation="entities:17246:1">Laredo Petroleum (LPI US)</a> operates on the eastern fringe of the Midland Basin in an area characterized by an unfavorable oil-gas mix and below-average initial production rates. So, it stands to reason that the market is more lukewarm on the name than it is on most other Permian producers (which tend to have better acreage and therefore, juicer margins). But after a brutal sell-off triggered by a combination of commodity weakness and fixable operating issues, the stock has slumped well below its intrinsic value, becoming one of our most compelling ideas in the upstream segment. Management plans to reverse the recent deterioration in well productivity by reverting to a wider spacing pattern, similar to what it used in 2016 (when well performance was consistently better). The current stock price bakes in no improvement whatsoever, which means even partial success could drive significant upside. Our $6 per share fair value estimate conservatively incorporates management's revised projections for average cumulative oil production (red triangles on Exhibit 1). A full recovery to 2016 performance levels (red line) would justify a higher valuation still. In addition, we note that while meaningfully undervalued, the firm has decent financial health, substantial downside protection via hedging, and can achieve 4% annual production growth within cash flows under our midcycle forecast of $55/bbl for West Texas Intermediate.</p>

The company may not have the best acreage in the Permian, but the current discount is hugely overdone.Laredo Petroleum (LPI US) operates on the eastern fringe of the Midland Basin in an area characterized by an unfavorable oil-gas mix and below-average initial production rates. So, it stands to reason that the market is more lukewarm on the name than it is on most other Permian producers (which tend to have better acreage and therefore, juicer margins). But after a brutal sell-off triggered by a combination of commodity weakness and fixable operating issues, the stock has slumped well below its intrinsic value, becoming one of our most compelling ideas in the upstream segment. Management plans to reverse the recent deterioration in well productivity by reverting to a wider spacing pattern, similar to what it used in 2016 (when well performance was consistently better). The current stock price bakes in no improvement whatsoever, which means even partial success could drive significant upside. Our $6 per share fair value estimate conservatively incorporates management's revised projections for average cumulative oil production (red triangles on Exhibit 1). A full recovery to 2016 performance levels (red line) would justify a higher valuation still. In addition, we note that while meaningfully undervalued, the firm has decent financial health, substantial downside protection via hedging, and can achieve 4% annual production growth within cash flows under our midcycle forecast of $55/bbl for West Texas Intermediate.

Laredo Petroleum Deeply Undervalued After Prolonged Sell-Off

Vital Energy

Laredo Petroleum Deeply Undervalued After Prolonged Sell-Off