EOG Resources - High-Potential American Oil

| About: EOG Resources, (EOG)
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Summary

EOG Resources' stock price is still almost 25% below its pre-crash heights while oil prices are more than 50% below its pre-crash heights.

The company's dividend yield is weak, but the company is plowing large amount of capital back in the form of premium wells.

These premium wells will help EOG Resources generate significant profits in the coming years.

Introduction

EOG Resources (NYSE: EOG) is an American petroleum and natural gas exploration company headquartered in Houston, Texas. The company has a $50 billion market cap making it one of the larger oil companies with oil reserves located in the United States, Canada, Trinidad, United Kingdom and China. Out of these reserves, the vast majority of them are located in the United States making this company primarily an American oil company.

EOG Resources Logo - Niobrara News

EOG Resources has profited greatly from the American oil boom. The company watched its stock price go up almost 500% from its 2008 crash lows to its 2014 pre-crash peak. Since then, the company's security is evident as oil prices are more than 50% below their 2014 highs while the company's stock price is just 25% below its 2014 highs.

Throughout this crash, the company has continued to offer a measly 0.74% dividend as it has continued to plow earnings back into growth rather than giving them out to shareholders. The company's investments into its business during the downturn coupled with its market leading position, strong future growth potential, and the fact that the company's stock price remains 25% below its pre-crash highs makes the company a strong investment at the present time.

Market Crash Changes

Now that we have an overview of EOG Resources, it is now time to dive straight in by discussing the changes the company has made since the start of the oil crash.

EOG Resources What's New - EOG Resources Investor Presentation

In 2Q 2016, EOG Resources increased its petroleum inventory and now has 4,300 net wells. As a result, the company's premium resource potential has increased by 75% to 3.5 billion barrels. Due to these and other developments, the company has changed its 2017-2020 growth outlook to 10-20% CAGR growth, an incredibly impressive growth rate. Achieving the upper end of this growth rate for all four years (18%) will result in the company's oil production roughly doubling.

On top of this impressive inventory growth and new growth outlook, the company has also managed to reduce its well costs by an impressive 23% year over year. The company has managed to increase its 2016 oil production forecast and has sold $0.425 billion of assets so far this year. The company is currently planning on keeping its capex range the same while drilling numerous new wells. The company now has hundreds of uncompleted wells which it could bring online with an uptick in oil prices that should significantly increase its revenue.

EOG Resources Robust Growth - EOG Resources Investor Presentation

Part of the company's accomplishments have come from its shift into only drilling premium wells. By only drilling premium wells, the company will be able to keep capex the same while achieving higher rates of return. The company defines a premium well as a well that generates an ATROR (after tax rate of return) of at least 30% at $40 per barrel oil. With current oil prices at just a hair under $42 per barrel, that means that these premium wells are generating rates of return at more than 30% at present prices, incredibly respectable earnings returns.

More importantly, the company has been cutting its drilling costs. As we saw above in 2Q 2016, the company announced it had cut its per-unit lease and well expenses by 23% year over year. As expenses drop, that means that an increasing number of the company's wells will fall into this definition of a "premium well". These premium wells will significantly help the company's earnings should oil prices recover partially to just $60 per barrel, where they were a year ago already in the midst of the oil crash. The company is continuing to work on increasing its premium inventory of such profitable wells.

EOG Resources Premium Well Shift - EOG Resources Investor Presentation

EOG Resources has roughly 4,300 net locations to explore, amounting to more than a decade of drilling in the present environment. Since oil prices are widely expected to recover in just a few years, having a decade or more of premium drilling locations places EOG Resources in an amazing spot for the long term. And the company realizes that the oil crash might be drawn out. It is shifting to only drilling premium locations, with its % of completed wells that are premium growing from just 14% in 2014 before the oil crash up to 60% for this year and 98% in 2018.

These premium wells are enormously profitable, and when they make up a major portion of EOG Resources' wells, they will provide strong cash flow. The graph above for the ATROR of these premium wells shows a good indication of the minimum return. Since the start of the oil crash, which has been the worst crash in more than a decade, oil prices have only hit less than $30 per barrel once. And these premium drilling wells offer a minimum return of 10% at $30 per barrel. That shows huge potential for EOG Resources in the coming years.

Earnings Potential

Now that we have discussed the very impressive market crash changes EOG has taken, namely its shift to very profitable premium wells, it is now time to discuss the company's earnings potential.

EOG Resources Cash Operating Cost - EOG Resources Investor Presentation

The above image shows the decrease in EOG Resources' cash operating costs per barrel. From 2014 to the 1H 2016, EOG Resources has cut its cash operating costs by 30% from $17 per barrel to just under $12 per barrel. These cuts have come mainly from decreasing tax expenses and LOE (lease operating expenses). This cut will allow EOG Resources to handle a further drop in oil prices or to handle a more drawn out oil crash while generating profits.

EOG Resources Growth Potential - EOG Resources Investor Presentation

This above image shows EOG Resources' oil growth production capabilities at $50-$60 oil. Currently, oil prices are at roughly $40 per barrel, but oil prices are widely expected to recover in a few years. However, let us assume oil prices stay at $50 per barrel a price where they were at earlier this year. That means that in 2020, EOG resources will be producing 400 thousand barrels per day.

Assuming all this production comes from premium wells producing 60% ATROR at $50 per barrel oil, that means that the company is producing 146 million barrels per year at a 60% return. That means the company is earning roughly $19 per barrel from each barrel at $50 per barrel oil, meaning $2.8 billion in annual profits. And that's if oil prices are stuck at $50 per barrel in 2020, noticeably below where anyone things they will be.

Oil Demand and Supply Balance

The above image shows the demand and supply balance in the oil markets until the 4Q 2016. As you can see, the oil supply and demand balance first went out in 3Q 2013 and from there it took roughly three quarters for the oil crash to start. From that point, it took an additional six quarters for oil prices to set what was widely considered as the first bottom in January 2016.

Let us assume it takes the same nine quarters for oil prices to recover after the demand and supply balance recovers. That means that oil prices should recover in early to mid-2019. Seeing oil prices hold at $50 until 2020 would be very surprising indeed in the face of this demand and supply picture. Let us redo the calculations assuming oil prices are at $60 instead.

That means in 2020, EOG Resources will be producing 550 thousand barrels per day. Its new annual production would be 201 million barrels per day from the 146 million barrels per day. And the company's premium wells that were earning a 60% ATROR would now be earning a 100+% minimum ATROR. At $60 per barrel, that means that these wells will now be earning $30+ per barrel in minimum profit up from $19 earlier. For our purposes, we will assume $35 per barrel in after tax earnings.

The numbers here become very impressive. EOG Resources would now be earning an astounding $7 billion per year which assuming a $51 billion market cap means EOG Resources, in 2020, will have a P/E ratio of just 7.3. And here is the core of why EOG Resources is such a good investment.

The company may not have the same dividend as its oil peers, but even if oil prices only recover to $60 per barrel by 2020, it will be trading at an astoundingly low P/E of just over 7. Should oil prices recover even further, to just $80 per barrel, still more than 20% below their pre-crash heights, the profit potential is astounding. That's what happens when a company takes advantage of lower costs in a downturn to invest in its own business and explains why EOG Resources is such a good investment.

Conclusion

EOG Resources has seen its stock price drop by a respectable amount since the start of the oil crash, with the company's stock price still almost 25% below its pre-crash highs. However, in light of oil prices, which are still more than 50% below their pre-crash highs, EOG Resources has done fairly well.

And the company's future potential is astounding. The company is working on shifting to only drilling premium wells and by 2018 more than 98% of its wells should be premium. These are wells that generate an after-tax return of 30% or higher at oil prices of $40 per barrel, and the company has enough of these wells identified to last itself more than another 10 years. More so, the high after tax return of these wells coupled with the potential for growing EOG oil production indicate huge future earnings.

In fact, my calculations show that even if oil prices only recover to $60 per barrel by 2020, which is unlikely given that I expect oil prices to fully recover by 2019 based on the supply and demand balance, EOG's P/E ratio in 2020 will be just a hair over 7. With a larger oil price recovery having the potential to bring down this P/E ratio even further this shows you the potential EOG Resources has.

As a result, I recommend investors open positions or extend existing ones in EOG Resources at the present time.

Disclosure: I am/we are long EOG.

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.