After increasing its crude oil and condensate production by 52%, EOG Resources (EOG) increased its second-quarter revenues on crude oil and condensate by 42% over the same quarter a year prior, although the impact was dampened by a 19% decrease in natural gas liquids realizations and a 41% decrease in dry natural gas realizations. These decreases came despite an overall 49% increase in liquids production, reflecting that the price environment for natural gas liquids and dry natural gas remains punishing for producers.
As with many other exploration and production companies, including Chesapeake Energy (CHK), EOG took an impairment in the second quarter of $1.5 million net of tax over certain assets, although EOG indicated that these assets were not a part of its core asset group. Chesapeake's hit over impairments was much larger than EOG's, at $243 million, though this number also includes losses on sales of fixed assets that were not broken out. I expect that EOG, Chesapeake, and most other firms with natural gas exposure will be taking these types of impairments over the coming months. But in this area as in many others, I do not think that the loss will be as deep for EOG.
An Outperform in a Struggling Market, Driven by Emerging Plays
The primary reason EOG is outperforming the competition is because it began its shift to oil before many of its competitors saw the need. This early move meant that EOG was able to finance its shift from revenues from natural gas while prices were still strong. The laggards, like Encana (ECA), now face the burden of diversifying production without sufficient cash from operations to finance such moves. In fact, for the second quarter Encana reported a net loss of $1.5 billion, which comes on the heels of the company's June announcement that its capital spending will exceed cash flow through mid-2013 as it tries to navigate its way to increased oil production.
On the strength of its production gains, EOG is now the largest crude oil producer in the Eagle Ford and Bakken shales. EOG Chairman and CEO Mark Papa expects that the company's newly inaugurated St. James crude-by-rail facilities will help the company take advantage of Brent pricing for most of this production. This is a coup for EOG, which combined with its pipeline infrastructure will now have the benefit of higher crude pricing and direct access to the Houston shipping channels. These advantages will help EOG push its revenues higher based on its oil sales even if natural gas prices do not recover in the near term.
On the Wolfcamp formation in West Texas, EOG is operating five rigs, and is indicating that strong results from this position are in large part a driver for its increased growth forecast, recently raised from 7% to 9%. The oil heavy Wolfcamp is quickly becoming a player favorite within the Permian Basin, with an estimated 10 billion barrels of oil and 3 trillion cubic feet of natural gas available for recovery. EOG forecast the growth spurt in the Wolfcamp nearly a year ago, and is once again proven correct.
Pioneer Natural Resources (PXD) is another major Wolfcamp operator. For Pioneer, the step to the Wolfcamp was minor, since the company already claimed a presence on the overlaying Spraberry field. Now Pioneer estimates its ultimate recovery from the Wolfcamp at 575,000 mboe, and is trying to attract a joint venture partner to accelerate development on its 200,000 acres on the play.
Competitor Apache (APA) is taking a more cautious approach to the Wolfcamp. Apache estimates that per well drilling and completion costs on the play will average $7.7 million for the near term, which is on the high side, but what I think is the result of Apache's limited presence on the play. But in its second-quarter earnings call Apache President and COO Rodney Eichler indicated that the Wolfcamp is "emerging as a new development area," with what he called "notable test results" through the Wolfwood and Fusselman targets. Due to this, I expect Apache is likely to expand its presence in this area in the near term.
EOG is currently trading around $110 per share, giving it a price to book of 2.2 and a forward price to earnings of 17.1. This reflects a premium to EOG's underlying value, but it also reflects the firm's strong expectations for growth. Analysts at Raymond James recently upgraded EOG from market perform to outperform, just a few days after researchers at Miller Tabak upgraded the stock from neutral to buy. I believe that these ratings are appropriate for EOG, since it is trading at a discount to its peers and its future earnings potential.
For comparison, Chesapeake is trading around $19 per share with a price-to-book ratio of 0.9 and a forward price-to-earnings ratio of 9.2., better ratios than might be predicted given the expectations that the next few months will present new challenges for Chesapeake, as further impairments and conclusions to several ongoing lawsuits and federal investigations are on the horizon. Encana, in the meantime, is trading around $22 with a price to book of 2.4 and an astronomical forward P/E of 75.7, reflecting its own issues with natural gas pricing.
Pioneer is performing better than its gas weighted peers, trading around $99 with a price to book of 2.2 and a forward price to earnings of 14.3, close on the heels of EOG with a similarly strong performance. Apache is trading around $88 with a price to book of 1.2 and a forward P/E of 7.2, a significant discount to Pioneer and EOG despite the fact that Apache can claim strong growth potential with its projects scheduled to come online within the next two to five years.
EOG exceeded analyst expectations with its second-quarter earnings by a significant margin. According to the Forbes consensus, analysts predicted earnings of $0.93 per share, and EOG reported earnings of $1.48 per share. Although analyst estimates may be raised for the third quarter in light of this, I think that EOG stands a good chance to beat analyst expectations once again, and is a strong buy at its current levels.