EOG Resources: Outstanding Business, Rich Valuation

Apr. 1.12 | About: EOG Resources, (EOG)

The energy investment landscape has countless options. Limiting criteria to large independent oil and gas companies with meaningful growth, a long history of financial conservatism and a high quality asset base narrows the list considerably. Consider EOG Resources (EOG) as a leader in the move from natural gas to oil production.

With crude oil prices robust and natural gas prices depressed, industry participants find touting their move to oil from natural gas fashionable. EOG was early in the industry to recognize the fundamentals several years ago and moved in this direction early, while peers like Chesapeake Energy (CHK) and Devon Energy (DVN) have been slower to act. EOG's size in a capital intensive industry allows them to be technological innovators with first mover advantages.

EOG Resources cornerstone asset is their Eagle Ford position. With 572,000 acres in the oil window EOG is having industry leading results in the industry leading play. EOG is still in the steep portion of the learning curve of this resource and is advancing the technology to continue to increase investment returns. Recently EOG revised significantly higher estimates of their Eagle Ford recoverable reserves, sending shares of Magnum Hunter (MHR) stock higher as Magnum Hunter's acreage is surrounded by EOG.

In the Bakken oil shale formation, EOG set off the investment frenzy and continues to be a leader. Continental Resources (CLR) and Whiting Petroleum (WLL) are two large industry Bakken leaders. However, EOG is going in a different direction. EOG Resources is deemphasizing the Bakken. First, EOG is working to optimize recovery techniques. Additionally, EOG is using finite resources of financial and human capital on higher return developments.

EOG's second largest driver of liquids growth is the Barnett Shale Combo play. In using their scale and advanced geologic experience, EOG is pushing ahead into more new oil play territories. Expect new well testing in West Texas, New Mexico and Argentina to continue. If the company finds something on the order of their Eagle Ford position, do not expect to hear about it right away. CEO Mark Papa will keep it quiet so they can acquire as large a position as possible inexpensively. Industry hype would hurt this competitive advantage.

Large independents have advantages in the domestic landscape. When drilling a single well costs $5-10 million and building a scalable acreage position cost tens or hundreds of millions of dollars, this is the big leagues. Scale is also important for technological and geologic advancement. On the other end of the spectrum, the largest supermajors like Exxon Mobil (XOM) and BP (BP) are not nimble enough to compete in a land grab nor are horizontal drilling opportunities large enough to meaningfully affect companies so massive.

Among large independent producers, EOG stands out. As a first mover toward oil production EOG's cash flow is not hurt as much by depressed natural gas pricing. The discipline to avoid outspending cash flow keeps their balance sheet clean and management operationally focused on only the best opportunities. Dislocations occur in booming industries and EOG has stayed ahead of the competition. EOG's leadership in crude by rail facilities allows them to market their Bakken oil well and their self sourced sand for Eagle Ford fracking gives a cost advantage. Management has demonstrated vision and execution.

With a market cap of $30 billion with 2011 sales of $10.1billion and 2011 cash flow under $5 billion the stock carries a rich valuation. Three things may dominate the future stock price. First, the passage of time to allow management to continue to execute well. Second, the possibility of another massive discovery like the Eagle Ford. Thirdly, the future of oil and natural gas prices.

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