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Risk-Reward With Laredo Petroleum

- By Jonathan Poland

Maybe we're on the cusp of a new energy revolution where one big breakthrough will render the use of oil and gas, as we know it, useless. If that happens, all the investments in this sector will go to zero. However, that is not likely in 2019 or 2020, it won't mean the downfall of the petroleum industry, and with that in mind, Laredo Petroleum looks like a massive bargain right now.


America is still discovering new oil reserves. In December, new data from the U.S. Geological Service (pre-shutdown) found that Permian's Delaware Basin, the less drilled part of West Texas and East New Mexico's giant oil field, holds more than twice the amount of crude oil as its sister field, the Midland Basin. This is right in Laredo's sweet spot.

Laredo Petroleum operates exclusively in the Permian Basin, with proven reserves of about 216 million barrels of oil equivalent, and averages close to 60,000 barrels per day at a ratio of 72% oil and natural gas liquids and 28% natural gas.

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In the last 12 months, the company has already generated over $584 million in net income on $1.1 billion in sales, good for earnings per share of $2.46. Next year that number is expected to drop to around $1 per share in earnings, but management is still guiding for production growth of 17% in 2019.

The risk for investors is that it doesn't pay out any dividends to shareholders, so the stock is more of a long-term trade for potential capital gains. That said, by the end of 2019, Phillips 66 Partners will have its pipeline online and Laredo will be able to pipe its oil instead of putting it on trucks and rail. That will lower its costs significantly, paving the way for higher earnings with a rebound in oil prices.

Crude prices fell off a cliff late in 2018, and have only marginally improved early this year. Yet, with global political and economic uncertainty, it's only a matter of time before these prices rise again. The world is still dependent on oil for energy and an entire laundry list of other products. Even if renewables take over on the energy front, petroleum will remain a part of our daily lives, meaning the production of crude will too.

From a valuation standpoint, if Laredo continues to produce earnings at this level, investors will be in for a huge upside swing as markets recover.

Disclosure: I am not long/short Laredo Petroleum.

This article first appeared on GuruFocus.