EOG Resources Is Focused On Cost Cutting, Profitability, And The Dividend

| About: EOG Resources, (EOG)

Summary

The company has liquidity of about $2.7 billion.

The long term debt to cash flow ratio is less than two-to-one, a very comfortable figure.

The company leads its competitors in well performance on many of its projects.

The company emphasizes profitability in its decision making and the conservative balance sheet tends to validate that statement.

The company has a very conservative acquisition program of small acquisitions of adjoining acreage.

Anytime a company tells investors about its goals and breaks these goals down for the investors, it is time to pay attention and start reviewing the company as an investment opportunity. A management that admits its challenges and presents a concrete action is rare enough, but those type of managements usually meet their goals, and the stockholders benefit a lot.

EOG Resources (NYSE:EOG) started the latest conference call with:

"Our goal this year has been to transition the company to be successful in a low commodity price environment. To achieve this goal, our 2015 game plan is focused on the following objectives; one, maximize return on capital invested; two, improve well performance through technology and innovation; three, achieve significant cost reductions through sustainable efficiency gains; four, take advantage of opportunities to add drilling inventory; and five, maintain a strong balance sheet."

Stockholders don't often hear the company goals stated quite this clearly. It is actually a very clear follow up to the earnings announcement that showed very straight-forward instances of these goals in action. The company stated how its best assets now return 40% after tax when oil is at $50 per barrel. That can give the investors some comfort because there is room for a price decrease and still the company can generate an adequate return. With oil prices now in the thirty price range, if the company is able to continue cutting costs, this company will be viable even with these lower prices. That may well have been the goal from the start as management mentioned a transition to a low price environment, but most observers did not know how low. This is one company that appears to be prepared for very low.

The company may not have that viability immediately, but it is definitely attainable with the returns noted at $50 for oil pricing.

"Year-over-year third quarter per unit lease operating expense was down 17%, per unit transportation was down 11% and total G&A was down 6%."

The company made clear during the conference call that management is bent on attaining more cost decreases in the future. This is exactly what investors and lenders need to hear at a time like this. Later on the company stated that rate of return drives their decisions. So if a longer lateral is not profitable, then they don't do it. Several of their better wells came in with shorter laterals which surprised some analysts. Increased profitability does not always have cookie cutter answers, and the management of this company appeared to be open to that idea. Hopefully the market will warm to that idea also.

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slide, the company has made vertical integration work by reducing the time it takes from the start of drilling until the well is producing. Note the emphasis on innovation and cost reduction on the slide. They are right after great assets. By having its own well servicing basically in house, it can coordinate fracking activities more efficiently and does, all with an objective of lower costs. From this slide the company sets the tone and its clearly to be a low cost operator through any operations improvements it can achieve. The second thing is the emphasis on the returns driven culture. The company examines profitability of each project to constantly increase profitability. In exchange, the costs of each area the company has leases in are very low when compared to the rest of the industry.

In line with this the company is pursing an extremely conservative acquisition strategy. Normally acquisition strategies are hard to execute at the bottom of the market, but this company is having some success. It is making small acquisitions of leases that adjoin its own leases. It has already vetoed the idea of large acquisitions because of the mixture of quality in those acquisitions. Plus larger acquisitions tend to be harder to integrate successfully than smaller acquisitions. If a small acquisition goes bad, the damage is so much easier to repair.

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slide, it should be no surprise that the company is leading with the highest return on capital employed. The model the company uses promotes this, and in a cyclical industry, the company with the leading capital employed should have greater average profitability than other companies in the industry. This slide agrees with the first one in that emphasis on cost cutting and profitability should result in a superior return of capital employed. At the bottom of the slide are the competitors that the company was compared with and those as a group are some formidable competitors. It will be interesting to see how well this slide holds up in the future, but with the emphasis on profitability in decision making this company should continue to be a leader in the future.

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slide, that forty percent return (or greater) should tell investors that there is room for oil prices to drop (since they have dropped) and the company can still drill to have an adequate return on the money it spends. The company has stated that it has several years of prospects using the prices at the time of the conference. From the slide, there will be less prospects with the current lower pricing but still enough to keep the company busy for a few years. It does have some hedging for a little cushion against the current low commodity pricing, but this company appears to have a strategy of making money from operations even when commodity prices are low. That should have the company far more prepared for increasing prices if and when they arrive than many of its peers. For many companies a 20% return is marginal but that is a good distance from the forty percent and more that the top acreage of the company offers for a return. The company should be able to develop its best acreage to maintain production until prices recover somewhat.

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slide, those wells have rates that were unimaginable a little while back. Through its well completion techniques and the ability to target its fracks, the company has completed the Thor 21 #701H well with an initial production rate that is 74% oil. When compared to the circles showing the typical reserves, this well will outperform the average well in the Wolfcamp and probably several other intervals as well. But if that well continues its 74% oil mix for the thirty day oil, it would produce 62,160 barrels of oil. Even if oil price was $30 a barrel, the company would receive nearly $1.9 million from selling the oil in the first thirty days. The gas would probably add another hundred thousand to two hundred thousand dollars.

However, the main idea is that the gross receipts in the first thirty days would be equal to nearly a third of the well costs. With the company working hard to lower the decline rate, and the newer wells not declining as fast as the older wells, clearly these wells are going to be very profitable, even at the current low commodity pricing environment. Since the company has a lot of leases that have this zone in it (with appealing profitability) this is definitely a lease that would allow the company to operate profitability in the current environment, and the company has several more of these prospects as listed on the slide above.

The company shows lease operating expenses per BOE of $5.30 and transportation costs of $3.80. General and Administrative plus some other costs total about $1.20. So the total cost to produce and get the oil to market appears to be about $10.30, one of the lowest costs in the industry. The company shows a depreciation, depletion, and amortization rate of $14.50 so its quite clear that the wells drilled going forward would be profitable at $30 dollar oil, which is what the current prices are approaching. However, the depreciation is a combination of historical costs, including some well types no longer drilled. Therefore the costs per BOE should be lower than that on any future wells drilled and that implies some slack should oil and gas prices drift lower this year (as total costs per BOE shown above are $24.80 without a profit margin). Plus the company gives every indication of focusing on driving those total costs down a lot more.

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slides, the company is showing several ways in which it will reduce costs. The top slide shows how its working on total well costs and total days to drill.

The bottom slide focuses on increasing production. With the wells producing 60,000 barrels of oil in 150 days (on average). The company, with this project the company grosses $1.8 million in 150 days, which is clearly less profitable than the other play but still fairly impressive. The other play could well be emphasized during the current low pricing environment, however, many operators are reporting flow rates increasing 50% or more and much higher recovery rates than imagined a year ago, with more improvements on the way. So this play could still be interesting in a low pricing environment depending upon future improvements. In any event, count on this company to maximize its profitability in the future. So if it needs to put of future drilling here until it establishes a suitable profitability, it does have other leases (like the slides before) to keep it busy until oil prices recover, or the company obtains a sufficient rate of return from these wells (fast enough).

With an estimated recovery of 400,000 (net) barrels of oil and gas, the well could be profitable at these prices, but the decline curve is very important here as the company wants to get its drilling money back as fast as possible (less risk). Plus the company wants a larger oil cut consistently. Nonetheless these slides, as do the ones above, demonstrate the focus of the company on costs and profitability as well as giving investors specific targets.

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slides, the company has some of the best well performances in each play in the industry. It works hard to make vertical integration work to the advantage of its shareholders. The conservative financial strategy actually fits quite well with the conservative operating strategy (emphasizing profitability) and cost reduction.

The successful efforts accounting strategy needs a little bit of adjustment though. The company reported more than $6 billion in impairment charges due to the ceiling cost calculation. While lower commodity prices played a big part in the impairment charges, it also points to more conservative assumptions regarding depreciation, depletion, and amortization in the future, to minimize impairment charges. Those charges cannot be avoided usually when the price changes are as dramatic as they have been in the last twelve months. However, they could definitely be smaller, and conservative assumptions are the key.

Summary

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

From the presentation slides, this company has clearly demonstrated how it is going to achieve its goals. The key is that last headline about extending the lead and not resting on the lead it has now. In case there is any doubt left, the company shows this comparison of its progress over the last few years:

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Source: EOG Resources Third Quarter, 2015 Earnings Conference Call Presentation

The key is that the company managed over three years to maintain its profitability over a three year period. Profitability has admittedly declined, but with the latest costs, the company could still be cash flow positive even with the latest price drops. The cash flow for the latest nine month period was approximately $3 million (vs. $6.5 million the year before). While that drop was a little more than 50% from the year before, I just did an article for Occidental Petroleum (NYSE:OXY) showing a cash flow drop that was far worse because cash flow dropped from $8.9 million for the first nine months of 2014 to $2.4 million in the current year. Plus the company has no hedging program.

So the cost cutting, the emphasis on profitability, and the hedging (among other initiatives) have combined to limit the cash flow decline. Since the cost cutting, hedging, and other initiatives will continue, the investor can bet that over the long run, this company will maintain its cash flow (and profitability) if any company does in this industry. Based upon the above slide, and the news from the latest quarter, this company has been showing substantial cost decreases and significant production increases (as well as an increase in recovery rates etc...) for a long time. There is no indication that trend won't continue for the time being.

The company's long term bank debt is a little more than two times the nine month cash flow. That is an extremely comfortable figure before the cash flow is annualized. Many observers believe that the current low prices are unsustainable, and that may be true, but this company is clearly preparing to wait out an extended period of low commodity prices. The company also has the cash and an unused credit line for total liquidity of approximately $2.7 billion with no credit line redetermination worries, as this company has significantly growing reserves and production at this time (in addition to the generous cash flow).

As of the close of the market, today, the company has a stock market value of $35 billion, and long term bank debt of $6.4 billion. Adding those two together and dividing by the annualized cash flow rate of $4 billion gives a ratio of roughly 10-to-one. While that ratio is a little high, the company has one of the best growth rates and profitability rates (see the slide above on capital employed) in the business. A first rate company such as this is worth paying a little more for, as an investor could get that premium back several times over from the superior execution that management has demonstrated.

That cash flow ratio is a little more than half the cash flow ratio of Occidental Petroleum, where the profitability numbers and historical growth rate is not nearly so robust. Interestingly, EOG is much smaller than Occidental Petroleum, yet EOG Resources now has a larger annualized cash flow by about 30% (depending upon one's assumptions about the fourth quarter cash flow and Oxy with no hedging may not make it to $3 billion annualized). Plus EOG decreased its per unit lease operating expenses 5% from the second quarter. Investors can continue to expect that EOG will lead the way in cost cutting and operational improvements. EOG has a far smaller dividend rate than Occidental Petroleum, but that rate is far more sustainable in the current environment.

The production of EOG did decline about five percent in the third quarter when compared with the second quarter, but investors can expect growth to resume once the company re-establishes its profitability. Given the cost structure of the two companies, EOG could well be profitable enough if oil prices increase past $40 per barrel (given some success of future cost cutting initiatives). Currently, Occidental may need more than that even with its diversification program.

Plus Occidental needed a dividend (from California Resources) of approximately $6 billion to pay its dividends and maintain its capital program. With the large decrease in cash flow (and about $1.7 billion left to pay about 3 quarters of dividends), next year could be very interesting for this company. EOG, by contrast is much closer to maintaining its production and dividend with its current cash flow. It will be interesting to see how 2016 unfolds for these two companies.

Disclaimer: I am not an investment advisor and this is not a recommendation to buy or sell a security. Investors are recommended to read all of the company's filings and press releases as well as do their own research to determine if the company fits their own investment objectives and risk portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.