Looking at profitability is a very important step in understanding a company. Profitability is essentially why the company exists and a key component in deciding whether to invest or to remain invested in a company. There are many metrics involved in calculating profitability, but for this article, I will look at EOG Resources' (EOG) earnings and earnings growth, profit margins, profitability ratios and cash flow.
Over the past 5 years the economy and subsequently energy prices have been hit hard. Through the above-mentioned four main metrics we will get an idea about the company's profitability over past 5 years. We will also get an idea how hard EOG Resources was hit by the crisis and how well the company is recovering.
By comparing this summary to other companies such as Apache Corporation (APA), Chesapeake Energy (CHK) and Devon Energy (DVN) who are in the same sector, you will be able see which has been the most profitable.
Earnings and Earnings Growth
1. Earnings = Sales x Profit Margin
- 2010 - $6.100 billion x 2.64% = $161 million
- 2011 - $10.126 billion x 10.77% = $1.091 billion
EOG Resources' earnings increased from $161 million in 2010 to $1.091 billion in 2011, an increase of 677.64%.
2. Five-year historical look at earnings growth
- 2007 - $1.090 billion, 15.98% decrease over 2006
- 2008 - $2.437 billion, 223.57% increase
- 2009 - $547 million, 445.15% decrease
- 2010 - $161 million, 339.75% decrease
- 2011 - $1.091 billion, 677.64% increase
In looking at EOG Resources' earnings over the past five years, you can see how the economic crisis affected the earnings in 2009. A large impact on the company's earnings is the price of natural gas and oil. Over the past five years the company has reported the average nat gas prices (MCF) and crude oil prices as follows:
|Year||Natural Gas price||Average Crude Oil and Condensate Price|
As you can see from the table above natural gas prices have yet to show any recovery. As natural gas prices has yet to recover this has had a great impact on the company's earnings. These prices are one aspect of the company that has greatly affected the earnings and created volatility in earnings over the past 5 years. As EOG's business is dependent on the economy and energy prices, this has a large effect on the company's earnings.
In 2010, the company hit a low in earnings when it reported earnings of $161 million. In 2011, the earnings have began to recover as the company reported earnings of $1.091 billion.
Even though the price of Crude oil has recovered, a recovery in natural gas will have a great impact on the profits of the company moving forward.
3. Gross Profit = Total Sales - Cost of Sales
In analyzing a company, gross profit is very important because it indicates how efficiently management uses labor and supplies in the production process. More specifically, it can be used to calculate gross profit margin. Here are EOG Resources' gross profits for the past two years:
- 2010 - $6.100 billion - $1.223 billion = $4.877 billion
- 2011 - $10.126 billion - $1.506 billion = $8.620 billion
4. Gross Profit Margin = Gross Income / Sales
The gross profit margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
In reviewing EOG Resources' gross margin over the past five years, we can see that the company's gross margin has been very consistent even through the economic crisis. The 5-year low for the gross margin was reported in 2007 with a margin of 77.32%. The 5-year high for the margin was in 2011 with a margin of 85.13%. The 2011 gross profit margin of 85.13% is above the 5-year average of 80.43%.
- 2007 - $3.122 billion / $4.038 billion = 77.32%
- 2008 - $5.111 billion / $6.387 billion = 80.02%
- 2009 - $3.815 billion / $4.787 billion = 79.70%
- 2010 - $4.877 billion / $6.100 billion = 80.00%
- 2011 - $8.620 billion / $10.126 billion = 85.13%
As the gross margin is above the 5-year average this implies that management has been more efficient in the company's manufacturing and distribution during the production process over the past 5 years.
5. Operating income = Total Sales - Operating Expenses
The amount of profit realized from the operations of a business after taking out operating expenses - such as cost of goods sold (COGS) or wages - and depreciation. Operating income takes the gross income (revenue minus COGS) and subtracts other operating expenses, then removes depreciation. These operating expenses are costs that are incurred from operating activities and include things such as office supplies and heat and power.
- 2010 - $523.32 million
- 2011 - $2.113 billion
6. Operating Margin = Operating Income / Total Sales
Operating margin is a measure of the proportion of a company's revenue that is left over after paying for variable costs of production, such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs such as interest on debt. If a company's margin is increasing, it is earning more per dollar of sales. The higher the margin, the better.
During the economic crisis of 2008 into 2009 EOG Resources' operating margin plummeted. The operating margin fell from 58.98% in 2008 to 8.58% in 2010.
- 2007 - $1.648 billion / $4.038 billion = 40.81%
- 2008 - $3.767 billion / $6.387 billion = 58.98%
- 2009 - $970.84 million / $4.787 billion = 20.28%
- 2010 - $523.32 million / $6.100 billion = 8.58%
- 2011 - $2.113 billion / $10.126 billion = 20.87%
The 2011 operating margin of 20.87% is below the 5-year average of 29.90%. This implies that there has been less of a percentage of the total sales left over after paying for variable costs of production such as wages and raw materials compared to the 5-year average.
7. Net Profit Margin = Net Income / Total Sales
A ratio of profitability calculated as net income divided by revenue, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.
Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.
Like the Operating Margin, EOG Resources' net profit margin revealed a correlation between natural gas prices and the company's net profit margin. The 2011 net profit margin of 10.77% is below the 5-year average of 18.00%.
- 2007 - $1.090 billion / $4.038 billion = 26.99%
- 2008 - $2.437 billion / $6.387 billion = 38.16%
- 2009 - $547 million / $4.787 billion = 11.43%
- 2010 - $161 million / $6.100 billion = 2.64%
- 2011 - $1.091 billion / $10.126 billion = 10.77%
As the 2011 net profit margin of 10.77% is below the 5-year average of 18.00%, this implies that there has been a decrease in the percentage of earnings that the company is able to keep compared to the company's 5-year average. As the prices of natural gas recovers, the company's net profit margin should pick up as well.
The profitability margins are revealing a few different results. They are showing that over the past 5 years the company's profitability has decreased but this has been due to the drastic drop in natural gas prices. As the prices of crude oil and natural gas increase so should the company's profitability margins.
8. ROA - Return on Assets = Net Income / Total Assets
ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."
The 2011 ROA of EOG Resources reveals a decline over the past 5 years. The 2011 ROA of 4.39% is below the 5-year average of 6.49%.
- 2007 - $1.090 billion / $12.089 billion = 9.02%
- 2008 - $2.437 billion / $15.951 billion = 15.28%
- 2009 - $547 million / $18.119 billion = 3.02%
- 2010 - $161 million / $21.624 billion = 0.74%
- 2011 - $1.091 billion / $24.839 billion = 4.39%
As the 2011 ROA of 4.39% is below the 5-year average of 6.49%, this implies that management has been less able to use the company's assets to generate earnings compared to its 5-year average.
9. ROE - Return on Equity = Net Income / Shareholders' Equity
As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.
- 2007 - $1.090 billion / $6.990 billion = 15.59%
- 2008 - $2.437 billion / $9.014 billion = 27.04%
- 2009 - $547 million / $9.998 billion = 5.47%
- 2010 - $161 million / $10.232 billion = 1.57%
- 2011 - $1.091 billion / $12.641 billion = 8.63%
Like the rest of the margins and ratios, EOG Resources' ROE has revealed a strong dip in 2009 and 2010. As the ROE has increased over the past three years, this reveals that there has been an increase in how much profit has been generated compared to the amount that shareholders have invested.
10. Free Cash Flow = Operating Cash Flow - Capital Expenditure
A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base. Free cash flow is important because it allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.
It is important to note that negative free cash flow is not bad in itself. If free cash flow is negative, it could be a sign that a company is making large investments. If these investments earn a high return, the strategy has the potential to pay off in the long run.
All of the past five years, EOG Resources' free cash flow has been negative.
- 2007 - $2.893 billion - $3.679 billion = -$786 billion
- 2008 - $4.633 billion - $5.195 billion = -$562 billion
- 2009 - $2.922 billion - $3.503 billion = -$581 million
- 2010 - $2.709 billion - $5.581 billion = -$2.873 billion
- 2011 - $4.578 billion - $6.951 billion = -$2.372 billion
Over the past 5 years EOG Resources' has had negative cash flow.
11. Cash Flow Margin = Cash Flow from Operating Activities / Total Sales
The higher the percentage, the more cash available from sales.
If a company is generating a negative cash flow, it shows up as a negative number in the numerator in the cash flow margin equation. This means that even as the company is generating sales revenue, it is losing money. The company will have to borrow money or raise money through investors in order to keep on operating.
As EOG Resources' cash flow margin is positive, it does not have to take the above measures to continue operating.
- 2007 - $2.893 billion / $4.038 billion = 71.64%
- 2008 - $4.633 billion / $6.387 billion = 72.53%
- 2009 - $2.922 billion / $4.787 billion = 61.04%
- 2010 - $2.709 billion / $6.100 billion = 44.41%
- 2011 - $4.578 billion / $10.126 billion = 45.21%
In looking at EOG Resources' earnings over the past five years, you can see how the economic crisis and its effect on commodities such as nat gas and crude oil have affected the earnings. Because the commodity prices the economy dropped in 2009, this created volatility in the company's earnings, over the past 5 years.
In 2007 and 2008 when the commodity prices were high the company reported earnings of $1.090 billion in 2007 and $2.437 billion in 2008. As the commodity prices dropped, the company hit a low in 2010 as EOG Resources reported earnings of $161 million. In 2011, the earnings began to recover as EOR Resources' reported earnings of $1.091 billion.
The ROA and ROE indicate similar results as the profitability margins.
The analysis of EOG Resources' profitability indicates a strong company that is recovering from its 2010 lows. Even though the margins have decreased over the past 5 years, the trends show future growth which would be aided by a recovery in natural gas prices and supported as long as crude oil prices don't drop drastically.
Even though the price of crude oil has recovered, a recovery in natural gas will have a great impact on the profits of the company moving forward.
Over the next few years, analysis at Bloomberg Businessweek are predicting growth over the next couple of years. Analysts are estimating EPS for 2012 at $5.37 and a EPS for 2013 at $6.08.
For more information on EOG Resources read my article: EOG Resources: Inside The Numbers
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.