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Analyst darling Concho smarting from harsh Q2 reviews

Concho Resources Inc.'s second-quarter earnings call was a less than enjoyable one for the company as its leadership announced that it would be reducing production in the second half and had made some major mistakes in developing the Permian Basin's Wolfcamp Shale.

"We've made the decision to adjust our drilling and completion schedule in the second half of the year to slow down and not chase incremental production at the expense of capital discipline," CEO Timothy Leach said. The company then watched its stock drop more than 20% as unimpressed shareholders bailed out.

Analysts were also largely unimpressed, saying they believed that Concho's production cutbacks were a result of overspending earlier in the year and a lack of spacing between wells in its Dominator project.

"Concho is prioritizing living within cash flow and meeting its $2.8-$3 billion budget. Unfortunately, given elevated non-op spending, capex overruns earlier in the year and issues with down-spacing tests, for 2019, this means cutting activity and growth to a much greater extent than previously thought," Raymond James said.

Leach said the company's Dominator project in the Delaware Basin had tested wells 50% tighter than its current research assessment, and the plan ended up backfiring.

"While initial rates were solid, current performance data indicates that we developed the Upper Wolfcamp too densely," Leach said.

As the company adjusts its approach in the Delaware, it is also cutting its planned rig count for the second half from 24 to 18. Concho also plans to put fewer wells into production during the second half, leading to reduced production guidance for 2019. The company now expects oil production growth year over year of between 22% and 26%, down from previous guidance of 29%.

"The drop in activity is much higher than the Street was expecting, and the resulting drop-off in oil volumes despite an unchanged capex forecast will be viewed negatively," Raymond James said. It was. Shares plummeted from $97.68 at the close of the New York Stock Exchange on July 31 to $75.97 at the bell Aug. 1, after the company held its earnings call. The last few days have not helped; shares were down to $71.89 early afternoon Aug. 5. In its commentary, CreditSights said Concho's leadership had "dropped the ball."

Other analysts were more subtle but just as pointed. In comments on Concho's admission that it had drilled too tightly in the Dominator project, Williams Capital analyst Gabriele Sorbara said the company should have been prepared for the possibility of negative results.

"The Dominator was an extreme spacing scenario with short laterals (~4,000 ft) on a stranded 1-mile section; thus, it is no surprise the company indicated spacing was too tight," he said. Sorbara and other analysts also noted, however, that the lessons learned from the 23-well program have already been incorporated into Concho's future drilling plans.

Long a darling of analysts, Concho did not see any observers move away from their "buy" rating; it did, however, see their price targets cut significantly. Sorbara and Williams dropped their price target for Concho shares from $171 to $155; Raymond James, which said the company had taken a "big step back," chopped its price target from $155 per share to $130. Still, not everything the analysts had to say was negative. Raymond James praised the company for its emphasis on free cash flow.

"We still project that Concho will achieve consistent FCF over the next five years," Raymond James said. "In 2020, we expect the average FCF yield to reach 4%, rising to over 6% in 2021 (both at strip pricing)."