Analysts at UBS AG recently upgraded EOG Resources (EOG) from neutral to "buy", with a price target of $120, based largely on EOG's heavy focus on oil. As other E&P stocks falter, EOG is remaining strong due to its focus on select plays with big potential and a leadership team, with CEO Mark Papa at the top, which is showing a true talent for spotting the next opportunities ahead of the rest of the industry.
Texas Supporting Drive for Growth
Many of EOG's successes are based on hunches that run counter to prevailing industry wisdom, and a so-called mini-boom on the Barnett Shale is no exception. The gas heavy Barnett does have pockets of oil, and EOG's hunch that acreage in Wise, Cooke, Montague, and Jack, Texas counties was oil heavy is proving the company's prescience once again. EOG and competitor Devon Energy (DVN) are pivoting towards these counties in exploration efforts, with Devon reporting that it is "pleased with the results" so far - so pleased, in fact, that it is expanding its nearby gas processing plant to a total capacity of 790 mcf per day. Pioneer Natural Resources (PXD) is also following the trend.
EOG is investing heavily in Texas, not just on the Barnett but also in Eagle Ford and the Permian. The company plans to drill 300 wells annually on Eagle Ford over the next decade and is hoping to drive further innovation to increase recovery rates. Papa recently explained that EOG believes there are 26 bboe in EOG's Eagle Ford holdings that are not recoverable with current extraction methods. To put this in perspective, this estimate of 26 bboe in one play is almost half the amount of ConocoPhillips' (NYSE: COP) estimated 43 bboe total resources at the close of 2011.
Elsewhere in North Texas, EOG competitor Chesapeake (CHK) recently reported much higher than average initial production from one of its wells on the Hogshooter, located in the Granite Wash play, which Apache inaugurated in 2010. Nonetheless, EOG is marketing certain of its Oklahoma-based Granite Wash assets through Meagher Energy Advisors, with a deal expected to close in the near future. Though there may be potential in this section, it appears that EOG thinks that there is better potential elsewhere in its holdings, and given its history I think that its competitors would be wise to re-evaluate the average production here as well.
The Permian is a keystone for EOG, and one of the reasons that its St. James crude by rail system is necessary. Its focus on the Permian is in two separate plays, the Wolfcamp and the Leonard, and the company is quickly moving into full scale development on the Wolfcamp, putting its actions behind Papa's belief that the Wolfcamp is only in its "first inning." EOG held about 480,000 acres net in the Permian as of the close of 2011. EOG may have an opportunity to expand its Permian holdings by acquiring a part of Chesapeake's offered Permian acreage, though with just $294,064 in cash and cash equivalents as of the end of the first quarter it will not be a significant purchase without acquiring significant debt, something that EOG's conservative history indicates is unlikely.
McClendon claims that Chesapeake needed to limit the number of interested parties reviewing its Permian Basin data to "a double digit number - we've got the thundering herd coming through." However, few members of this supposed herd are coming forward in public. If the number of interested buyers is as high as McClendon seems to indicate, I think this reluctance towards public discussion on the buyers' behalf is negative for Chesapeake since it points towards a lowball bidding process on the assets. After all, if any of the interested companies are afraid that even a public indication of potential interest would raise the bidding, it can only mean that Chesapeake will be lucky to get its asking price in the Permian, much less a premium. That suggests an opportunity for EOG to at least nominally increase its Permian holdings, since EOG would certainly be a buyer on a budget.
Don't Write Off EOG in Canada Just Yet
EOG's joint venture with Apache (APA) and Encana (ECA) in a Kitimat, British Columbia natural gas processing and exporting plant just received a boost, since Apache announced earlier this month its discovery of what might be "the best shale gas reservoir in the world," according to Apache's Vice President, Worldwide Exploration John Bedingfield. Apache is not estimating reserves for this new field just yet, but did report daily flow rates of 21.3 mcf per day in the first thirty days of a single fracking well on the play. These production rates give the Apache-led Kitimat project a needed boost, since enthusiasm over the project seemed to be flagging as a Royal Dutch Shell (RDS.A) led consortium on another Kitimat processing and export facility pulled ahead on key plant development milestones.
While some areas of the country are less than enthusiastic to have oil independents as neighbors, the city of Chippewa Falls, Wisconsin is happy to have EOG's frac sand processing plant on board, since in addition to generating the frac sand EOG needs for its domestic fracking operations it also generated $1.4 million in tax revenues for the small city's downtown redevelopment efforts. The energy capital of Houston, Texas is also well pleased with EOG, as the Houston Chronicle named EOG "Public Company of the Year" on the strength of its surging profits and continuing innovations in technology and engineering, which CEO Mark Papa calls part of EOG's "rational risk-taking culture." EOG's ability to integrate with the communities surrounding its operations is a skill that many of its competitors lack, and one of the reasons that EOG is a perennial media darling in an industry that receives more than its fair share of negative publicity.
Looking at its value ratios, EOG's many strengths are countered by very few negatives. It has a debt to equity ratio of 0.4, low for a large growth stock, with a $22.7 billion market cap. Corresponding to its risk and debt, EOG is paying a nominal 0.8% dividend supported by net margins of 11.6%, enough of a margin to continue to fuel the company's growth while adding a small incentive for stockholders. Another negative for EOG is that it is heavily weighted in natural gas, so its stock is vulnerable to these price fluctuations. Natural gas made up 61% of the its total reserves in 2011. I think EOG stock could certainly be weighed down by the price volatility of natural gas, especially over the next 6 to 12 month period.
At $84 per share, I think EOG is undervalued, with a price to book of 1.7, while competitors routinely break price to book ratios of 2.3 and up. Given these numbers, EOG is a buy opportunity that is not likely to become much more attractive in the near future.