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Why These 3 Oil Drillers Are Outperforming Their Competition

John Bromels, The Motley Fool

Ouch! The stock market has pulverized most oil-industry stocks this year, sending shares of many independent oil and gas exploration and production companies -- E&Ps for short -- down more than 25% so far this year. But three E&Ps have bucked this trend, and they may not be the ones you're expecting. 

ConocoPhillips (NYSE: COP), the biggest of the bunch, is down just 1% for the year, while the second biggest U.S. E&P, EOG Resources (NYSE: EOG) is down just 4%. This clearly goes beyond size, though, because Concho Resources (NYSE: CXO), which is only about one-third the size of EOG, is up 1.3% for the year. 

Here's what these companies did to keep their shares so steady, and how it will affect them and their competitors.

An onshore oil rig and people in hard hats in silhouette against a sunset.

Transforming the portfolio

Let's start with ConocoPhillips, the largest U.S.-based E&P, which, despite having had a decent 2017 so far, is still down nearly 30% over the past three years. Conoco isn't alone, either. Since the price of oil collapsed in 2014, shares of most E&Ps have had a rocky ride downward. With U.S. oil prices stubbornly stuck around $50 a barrel -- or, for most of this year, just below that level -- and with no lucrative downstream operations to fall back on, E&Ps have paid the price.

However, in late 2016, ConocoPhillips developed an ambitious plan to shore up its operations and its finances: It would sell up to $8 billion in assets over the next three years and cut its capital spending by 4%. Management hoped these moves would free up enough cash to lower its debt load to below $20 billion and buy back $3 billion worth of shares while becoming profitable at $50-per-barrel oil. 

This year, though, Conoco exceeded its own expectations, as it made two big asset sales in March and April for more than $16 billion in cash and stock -- twice as much as it promised. The company jettisoned the bulk of its Canadian assets as well as its assets in the San Juan Basin. Those sales not only provided Conoco with the means to shore up its balance sheet but also adjusted the company's product mix toward higher-value liquids from dry gas, which should pay off for the company by increasing its overall margins. The Canadian asset sale popped the stock price nearly 9%. 

Other companies have been taking pages from Conoco's playbook, selling off Canadian assets to focus on higher-value prospects. What remains to be seen is whether the "cut your way to growth" strategy can work for the company over the long haul. 

Pure Permian

Unlike ConocoPhillips, Concho Resources' success isn't the result of any one single event. Rather, the company has been able to outperform peers by virtue of its status as a pure play in the hot Permian Basin of West Texas and New Mexico. Concho owns about 1 million acres (about 1,500 square miles) in the Basin, primarily in the Delaware and Midland sub-basins. 

That position has been paying off so well for Concho that it has increased the midpoint of its 2017 guidance from 23% year-over-year growth to 25%. For an E&P -- which tend to carry a lot of debt -- its balance sheet is solid, with $662 million in cash on hand and just $2.7 billion in long-term debt. Revenues and profits are also way up year over year. 

The stock would probably be doing even better than it is if not for one thing: Recently, output from the Permian Basin -- particularly the Midland Basin -- has proved to be 'gassier' than expected. That's bad for Midland drillers, as oil commands a higher price than natural gas. Indeed, after Concho reported that it had spent more than $48,000 per acre on land in the Midland Basin during Q2, nervous investors knocked the share price down more than 10% over these concerns. 

Investors should keep an eye on the product mix coming out of the Permian. Because of Concho's complete exposure to the play, if its mix starts to underwhelm, the company's days as an outperformer are probably over.

Premium positions

EOG Resources' holdings are much more diversified than Concho's. And its strategy for growth is similar to both Concho's and Conoco's: Focus on the best, and get rid of the rest. Or, better yet, never buy the rest in the first place.

EOG's strategy has been to avoid acquisition-driven growth, which helps keep debt low. It also focuses on low-cost exploration acreage, as opposed to purchasing higher-cost acreage where oil has already been discovered. This situation has helped EOG keep a sterling balance sheet, with an impressive $1.6 billion in cash versus just $6.4 billion in debt -- a nearly identical ratio to Concho's. 

The company's strategy seems to be paying off, as it reported record production in its most recent Q2 2017 and good if not stellar earnings. As long as management continues to execute well, the stock should continue to outperform its peers. 

Investor takeaway

These three companies may have beaten the pack so far in 2017, but it's worth noting that all are trading lower than their 2014 highs. It's also worth noting that in a cyclical business like oil and gas, these companies' peers -- which have fallen farther, and in some cases, much farther -- may turn out to have much more upside today than Concho, Conoco, or EOG. Indeed, many other E&Ps are similarly buying cheap exploration acreage, selling off underperforming assets, and focusing on the Permian Basin. 

Because of that, investors should think carefully before choosing one of these current outperformers above the beaten-down pack.

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John Bromels 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.