EOG Resources (EOG) is a crude-oil driven exploration company that I have looked into just recently because its portfolio assets piqued my interest. I am already holding a few exploration companies in my portfolio with whom I am quite comfortable. I am a valuation-driven investor looking at peer group valuations as indications of relative over-/undervaluation.
I have previously owned Anadarko Petroleum (APC) which I sold out a few month ago because it had a great share performance and now seems to be running a bit ahead of its fundamentals. Since then Anadarko has continued to increase in value. However, I believe that at some valuation level the odds of increasing valuations are stacked against the investor. In my piece about Anadarko's overvaluation I argued that investors could easily switch to peer firms such as Apache Corp. (APA) or Devon Energy (DVN) which exhibit outstanding production growth rates but trade at substantially lower valuations. It ultimately comes down to whether investors are willing to pay a meaningful growth premium for expected reserve growth.
In my experience high growth premiums indicate low chances of continued outperformance simply because expectations are so high that marginal growth quickly becomes overpriced. No company can outperform forever, just look at Apple (AAPL). This article does not intend to discount EOG's portfolio assets and production achievements. In fact, EOG has increased production by an estimated 38% annually over the last seven years which is respectable and its core assets are located in promising resource regions: Eagle Ford, Bakken and the Delaware Basin. The production history for US horizontal crude oil assets shows that Eagle Ford and Bakken have been the drivers of production growth and contribute about 80% of current crude oil production:
EOG markets itself as a best-in-class growth company. In August EOG raised its FY 2013 production guidance: Crude oil production is now expected to grow 35% compared to a previous full-year estimate of 28% and NGL production is expected to increase 14% compared to a prior estimate of 10%. EOG also increased crude oil production at an average of 40% a year since 2010 (including its FY 2013 production growth estimate). EOG's strong production growth will very likely being driven by deep Bakken and Eagle Ford reservoirs, about which other contributors at SA have written excellent articles.
Growth premium justified?
EOG's and Anadarko's shares run on expected exponential production growth. As a consequence, EOG trades at almost 20 times future earnings. High production growth rates are not limited to EOG Resources alone. I have argued in other articles that the US shale oil- and gas boom has caused a surge in production across the sector and that other companies present investors outstanding growth rates as well but trade at significantly lower premiums.
Marathon Oil (MRO) for instance increased its available-for-sale production by nearly 150% since the third quarter of 2011 but manages to still trade at a forward earnings multiple of 11. BreitBurn Energy Partners (BBEP) also increased its Mboe production markedly at a compound annual growth rate of 31% since 2006. Sandridge Energy (SD) is expected to increase its Mississippian production by 66% y-o-y in the second half of 2013. High growth rates are a reflection of the hydraulic fracturing boom in the US and benefit the majority of players involved in the key US shale plays. Many competitor firms trade at substantially lower valuations than EOG and provide great opportunities for investors not wanting to chase the overvalued sector darling.
Anadarko Petroleum trades at 18 times earnings while the rest of the peer group offers investors much better risk/reward ratios at ratios of around 11-13 times forward earnings. Their underlying portfolio assets are equally attractive but their valuations give investors way more upside potential and also limit downside risk.
EOG Resources has increased dividends 14 times in the last 14 years: From $0.06 per share in 1999 to $0.75 per share in 2013. A premium valuation, on the other hand, makes EOG the least attractive dividend play in the peer group: EOG's dividend yield stands at 0.41% and is even worse than Apache's 0.89%.
EOG Resources trades at a 40% premium to the average peer group P/E ratio of 14.17. Its PEG ratio is also the highest of the peer group at 4.14 and ranks 37% above the peer group average PEG ratio of 3.02. EOG's dividend yield is 70% below the average dividend yield of 1.37%. Highest valuation and lowest dividend yield do not exactly characterize EOG Resources as a bargain among other equally promising oil- and gas plays.
Valuation does matter. EOG Resources trades at nearly twenty times forward earnings. Its earnings and cash flow prospects as well as its portfolio interests in Bakken and Eagle Ford are attractive. But investors can find other oil- and gas companies in the sector that are set to profit from the ongoing oil- and gas bonanza in the US. Many firms present double-digit production growth rates but their valuations are comparatively much more compelling. The peer group table above includes a variety of firms, many with similar market capitalizations, that can be considered viable alternatives to EOG Resources. Chances of multiple expansion are much higher for companies that trade at eleven times earnings. EOG remains expensive and investors need to be aware that they pay a rich growth premium upfront should they consider to add EOG Resources to their portfolios.