EOG Resources: Perhaps A Good Time To Move On?

Summary

• EOG Resources reported better than expected Q4'17 earnings and revenues. Growth guidance came in low considering the price of oil above $60.
• Capital expenditures for 2018 are expected to range from $5.4 billion to $5.8 billion, and it was not positive news for the market.
• I finally sold out my position at $115, and I do not believe the stock presents a sufficient potential going forward unless the stock retraces under $90.

Image: EOG rig.

Investment Thesis:

EOG Resources (NYSE:EOG) is one of the best top-tier US Shale plays. It is similar in many ways to Occidental Petroleum (OXY) which is the leader in the Permian.

The company presents a rock-solid balance sheet with a tremendous growth potential which makes the stock an excellent long-term candidate, but only at a reasonable price.

However, due to a recent high-valuation and low dividend, it was time to sell (above $115) and wait for a meaningful stock retracement. I think a much higher dividend could eventually help the stock to turn attractive again, but so far the company is not acting forcefully in this domain.

While I think the valuation was too high a few days ago, EOG is still a robust company. The business model is healthy, safe, and very efficient. It is solely a timing issue at the moment.

What makes EOG a good business?

• The company is primarily producing oil and gas from the USA or 91.5% of the total output for 4Q'17.

Production per Region in K Boe/d	4Q'17	3Q'17	2Q'17	1Q'17
United States of America	605.6	539.2	545.6	512.6
Trinidad	51.0	54.6	54.1	55.2
Other International	5.4	4.3	4.2	5.9
TOTAL	662.0	598.1	603.9	573.7

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• The company is constantly growing its reserves and its US premium asset locations. EOG added 18% in net proved reserves in 2017 to now 2,527 MMBoe and replaced 201% of EOG's 2017 production at a finding and development cost of $8.71 per Boe.
• EOG is turning cash flow positive at $60+ per barrel and is resuming dividend growth by increasing dividend 10% starting next quarter to $0.74 annually or 0.7% yield. Unfortunately, it is far from adequate, and hopefully, EOG will reach a more decent dividend with a 3-4% yield minimum.
• EOG's diverse multi-basin portfolio allows the company to grow each asset at the optimum pace to maximize its profitability and long-term value.

William R. Thomas said on the conference call:

In 2017, we grew high return U.S. oil production 20%, paid the dividend, reduced our debt, and generated over $200 million in free cash flow. Remarkably, we delivered those results, while oil prices averaged a modest $50. Throughout the downturn, our goal was to reset the company to be successful in a lower oil price environment.

Quick Presentation

The shale oil revolution has dramatically and positively affected the U.S. oil and gas production. EOG and other producers in this sector unlocked the hydrocarbons trapped in these tight rock formations through using new technics and at a low cost, which allowed them to produce a tremendous new fuel output.

Texas is the No. 1 oil producer in the USA and home to the Permian and Eagle Ford shale reservoirs, some of the more robust basins in the Lower 48, where the company is actively present. As Ezra Yacob said in the conference call:

The Eagle Ford continues to be the workhorse and centerpiece of EOG's oil production portfolio of assets.

EOG owns a multi-basins premium portfolio which is very appealing and growing (Bakken, Eagle Ford, Delaware, and Powder River Basin with the $2.5 billion Yates acquisition).

Source: EOG Presentation 4Q17

The production growth in the Permian will probably increase with the recent expansion in the capacity of the BridgeTex Pipeline, from 300 KBp/d to 400 KBp/d and other current projects.

Pipeline firm EPIC last week said it is going ahead with a 590,000 barrel-per-day (bpd) crude pipeline tying the Permian and Eagle Ford shale basins to Corpus Christi, Texas. The line is expected to begin operation in 2019.

Furthermore, The Permian's drilled but uncompleted wells tally hit a record in January 2018 of 2,880 with the Eagle Ford's reaching 1,511 alone.

Unfortunately, the shale success continually drags oil prices lower at one point, and this time, it will not be different even if they have reached a multi-year high recently.

It is my primary issue that supports a sell strategy above $110.

EOG Resources - Balance sheet: Raw numbers

EOG Resources	1Q'15	2Q'15	3Q'15	4Q'15	1Q'16	2Q'16	3Q'16	4Q'16	1Q'17	2Q'17	3Q'17	4Q'17
Total Revenues in $ Billion	2.319	2.470	2.172	1.797	1.354	1.776	2.119	2.402	2.611	2.612	2.645	3.340
Net Income in $ Million	−170	5	−4,076	−284	−472	−293	−190	−142	29	23	101	2,431
EBITDA $ Million	740	958	−5,501	442	286	553	706	706	927	998	1,061	1,367
Profit margin % (0 if loss)	0	0.2%	0	0	0	0	0	0	1.1%	0.9%	3.8%	72.8%
EPS diluted in $/share	0.04	0.05	−0.24	−0.35	−0.53	−0.86	−0.52	−7.47	0.01	−0.31	0.17	4.20
Operating cash flow in $ Million	961	887	1,131	616	292	503	760	805	898	1,078	961	1,328
Capital Expenditure in $ Million	1,546	1,268	1,357	843	573	615	654	741	947	1,027	1,094	1,057
Free Cash Flow in $ Million	−585.1	−380.5	−225.5	−227.0	−281.6	−111.8	105.8	63.8	−48.5	51.5	−132.7	270.9
Cash and cash equivale.nt $ Billion	2.13	1.37	0.74	0.72	0.67	0.78	1.05	1.60	1.55	1.65	0.85	0.83
Long term Debt in $ Billion	6.90	6.40	6.43	6.66	6.99	6.99	6.99	6.99	6.99	6.99	6.39	6.39
Dividend per share in $	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675	0.1675
Shares outstanding (diluted) in Million	545.0	549.7	545.9	546.4	546.7	547.3	547.8	571.7	578.6	578.6	578.7	579.4

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Source: EOG Resources filings and Morningstar.

Trends and Charts: Revenues, Earnings Details, Debt, Free Cash Flow, and Upstream Production

1 - Revenues.

EOG reported fourth-quarter 2017 net income of $2,430 million or $4.20 per share, compared to a fourth-quarter 2016 net loss of $142 million or $0.25 per share. Revenues were a solid $3,340 million, beating analysts' estimate of $3.03 billion; revenues were up 39.1% from last year.

William R. Thomas, the company chairman, and CEO said in the conference call:

In 2017, we grew high return U.S. oil production 20%, paid the dividend, reduced our debt, and generated over $200 million in free cash flow. Remarkably, we delivered those results, while oil prices averaged a modest $50.

2 - Free cash flow.

Free cash flow for EOG is $141.2 million on a yearly basis. EOG free cash flow for the quarter was $271 million.

Free cash flow is an important clue we should always carefully evaluate when looking at a long-term investment. FCF should be adequate and material if the business model can be considered as satisfactory.

Accordingly, it must be sufficient enough to compensate for the dividend, reduce debt, and pay for eventual shares buyback.

EOG produced steady cash flow in the fourth-quarter and will continue delivering free cash flow as oil prices keep trading above $60 a barrel. EOG had passed the FCF test.

3 - Oil-equivalent production and others.

The fourth-quarter 2017 results benefitted from increased production and higher oil and gas price realizations. Total production was 662K Boep/d, up 13.5% from last year.

EOG rely heavily on the crude oil and condensate which represent 79.5% of the total revenues earned from production.

EOG Resources targets 18% crude oil production growth and 16% total production growth for 2018 with significant free cash flow at $60 oil. The company expects to earn double-digit ROCE in 2018. EOG is now permanently switching to premium drilling with an all-in reserve replacement cost of $8.71/Boe.

Source: EOG presentation 4Q17

4 - Net debt and cash.

Net debt is now $5.56 billion or 3.2% higher than a year ago.

On December 31, 2017, EOG's total debt outstanding was $6.39 billion with a debt-to-total capitalization ratio of 28%.

The company has a debt-to-equity ratio of 0.46, a current ratio of 1.27 and a quick ratio of 1.11.

5 - 2018 Outlook.

Capital expenditures for 2018 are expected to range from $5.4 billion to $5.8 billion, including production facilities and gathering, processing and other expenses, excluding acquisitions. It is a significant increase from 2017 which was $4.125 billion (according to Morningstar). It has been the primary factor for the recent drop in stock price.

EOG expects to complete approximately 690 net wells in 2018, compared to 536 net wells in 2017. Capital will be allocated primarily to EOG's highest rate-of-return oil assets in the Delaware Basin, Eagle Ford, Rockies, Woodford, and the Bakken.

At least 90% of the wells completed in 2018 are expected to be premium. EOG has an inventory of approximately 8,000 such wells, which have a direct after-tax rate of return of at least 30% assuming $40 flat crude oil prices and $2.50 flat natural gas prices. Obviously, EOG is a good cash machine.

6 - Technical analysis.

EOG was forming a rising channel pattern which is bullish short-term but bearish midterm and long-term.

The stock was trading at the pattern resistance late in January at about $118 (strong sell flag) and retraced significantly to the pattern support early February at $102 (buy flag).

EOG is now trading just above its extended trend support at $100 which is paramount for the stock uptrend. Any breakout at this level could create a substantial drop.

Given the fact that future oil prices are weakening, I think EOG may experience a negative breakout soon and finally cross the $100 long-term resistance and re-test the next support at $90 (buy flag) or even re-test $84 (double bottom - strong buy flag).

It is the perfect setup for what I call "selling on the news." It doesn't mean that EOG Resources has reached its top value, but I consider the stock as overbought, with little to no real profit potential remaining.

Thus, it was time to take a substantial profit off the table at $110 and wait until the stock retraces sufficiently or pays a decent dividend which represents 0.73% annually now.

I recommend a sell at $110 and above.

Important note: Do not forget to follow me on EOG and other O&G producers. Thank you for your support, it is appreciated.

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.