EOG Resources: An Unquenchable Need To Grow Production

Summary

• EOG Resources delivered a good 4Q '19, which fell short of expectations. The company announced a fourth-quarter 2019 net income of $636.52 million, or $1.10.
• EOG Resources' oil production exceeded the high end of its guidance range during the fourth quarter. Total production was a record of 850.3K Boep/d, up 11.1% from last year.
• The company got approvals from the board of directors to increase the quarterly dividend by 30% to $0.375 per share.
• EOG Resources offers a rock-solid balance sheet with substantial growth potential.
• Looking for a helping hand in the market? Members of The Gold And Oil Corner get exclusive ideas and guidance to navigate any climate. Get started today »

Image: EOG rig from EOG Resources

Investment Thesis

The Houston-based EOG Resources (NYSE:EOG) is one of the top-tier U.S. shale players that I regularly cover on Seeking Alpha. The company was spun out from Enron in 1999.

I like EOG because of its pragmatic management that has followed a rigorous strategy over the years that resulted in steady growth and a remarkable accomplishment.

EOG Resources offers a rock-solid balance sheet with substantial growth potential. It makes the stock an excellent long-term candidate, especially after the massive correction that the oil sector suffered last week.

This oil company is another perfect example of my basic strategy attached to the entire oil sector. The investment thesis is quite simple.

First, you identify a reliable company with a solid track record producing excellent cash flow, in which you are confident to invest and accumulate for the long term.

A company with a good dividend yield is even better, and the company is progressing in this domain. EOG Resources is paying a lower dividend yield compared to one of its direct competitor Occidental Petroleum (OXY), but seems reasonable and fits what the company can afford to pay. In contrast, OXY is paying a dividend, which is well over what its free cash flow is generating and is likely to cut soon.

Second, you have to be willing to trade about 30% to 40% of your position by using short-term volatility. It is an essential part of the strategy and will provide you with better control of your investment. Furthermore, it will help reduce the loss due to the risk of being caught in a massive correction.

The chart below is showing a 20% differential between EOG and OXY, mostly attributable to the ill-timed Anadarko acquisition.

Data by YCharts

What makes EOG a good business?

The company is primarily producing oil and gas from the U.S. shale or 94.5% of the total output in 4Q '19.

As we can see, production in the USA has been increasing significantly while international production slowly declined.

Production per Region in K Boe/d	2Q'18	3Q'18	4Q'18	1Q'19	2Q'19	3Q'19	4Q'19
United States of America	644.4	695.0	715.5	722.0	760.4	784.2	803.6
Trinidad	47.8	44.1	39.0	45.1	46.1	44.1	40.9
Other International	10.0	9.7	10.0	6.5	6.3	5.8	5.8
TOTAL	702.2	748.8	764.5	773.6	812.8	834.2	850.3

Click to enlarge

Bill Thomas, the CEO, said on the conference call:

"In times of uncertainty, EOG's sustainable business model is well suited to navigate a volatile environment. In fact, we are more confident in EOG's future today than we've ever been in the history of the Company. With our strong balance sheet and flexibility, EOG is better positioned now, both financially and operationally to weather the storms than it's ever been in the past."

Quick Presentation

The U.S. shale has dramatically transformed the U.S. oil and gas production, turning the U.S. into the number one oil producer in the World. A massive oil price correction now threatens this expansion due to the effect of the coronavirus outbreak on the world economy.

EOG holds a multi-basin premium portfolio, which is very appealing and growing fast (e.g., Bakken, Eagle Ford, Delaware basin, Woodford oil, Wyoming, and Powder River Basin).

The company's assets in the Delaware Basin (Permian), which produced 174K Boep/d in 2019, are the fastest-growing assets for the company. Furthermore, the company is active in setting up an oil gathering system and terminal web with ultimately up to five connections to downstream markets.

_{Source: from EOG Presentation}

Ezra Yacob, EVP, Exploration, and Production, said in the conference call:

"We were able to reduce well costs across the Company by approximately 7% and that's really the number one driver of converting those well locations and that's something we've done over the past four years is be able to lower well cost every year through not just reduced contract pricing, but dominantly through our increased operational efficiency and applying innovative technologies and capturing different parts of the value chain."

EOG Resources - 4Q '19 Balance Sheet: The Raw Numbers

EOG Resources	2Q'18	3Q'18	4Q'18	1Q'19	2Q'19	3Q'19	4Q'19
Total Revenues and others in $ Billion	4.238	4.781	4.575	4.059	4.698	4.303	4,320
Net Income in $ Million	697	1,191	893	635	848	615	637
EBITDA $ Million	1,805	2,428	2,064	1,853	2,192	1,887	1,568
EPS diluted in $/share	1.20	2.05	1.54	1.10	1.46	1.06	1.10
cash from operating activities in $ Million	1,942	2,190	2,085	1,608	2,687	2,062	1,807
Capital Expenditure in $ Million	1,684	1,649	1,302	2,000	1,563	1,491	1,368
Free Cash Flow in $ Million	-257.7	540.4	783.1	-392.7	1,123.6	570.8	438.9
Total Cash $ Billion	1.01	1.27	1.56	1.14	1.16	1.58	2.03
Long-term Debt in $ Billion	6.43	6.43	6.08	6.08	5.18	5.18	5.18
Dividend per share in $	0.185	0.22	0.22	0.2875	0.2875	0.2875	0.375
Shares outstanding (diluted) in Million	580.4	581.6	580.4	580.2	580.2	581.3	579.5

Click to enlarge

_{Source: EOG Resources PR and Morningstar}

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

1 - Total Revenues and others were $4.32 billion in 4Q '19

EOG Resources delivered a good 4Q '19, which fell short of expectations. The company announced a fourth-quarter 2019 net income of $636.52 million, or $1.10 per share, compared with the fourth-quarter 2018 net income of $893 million, or $1.54 per share.

• Lease and Well expenses decreased to $334.5 million from $346.4 million a year ago.
• Transportation costs rose to $208.3 million from $196.1 million a year ago.
• Gathering and Processing costs went up to $127.6 million as compared to the year-ago quarter’s $112.4 million.

As of December 31, 2019, EOG Resources announced net proved reserves at 3,329 million barrels of oil equivalent (MMBoE), representing a year-over-year increase of 14%.

2 - Free cash flow

The free cash flow for the fourth quarter of 2019 was a gain of $438.91 million, and for the year 2010, a total of $1.741 billion.

Free Cash Flow to Equity ("FCFE") or FCF is calculated by subtracting Capital Expenditures to Cash from Operating Activities. Free Cash Flow to Equity is the amount of cash available to be eventually distributed to shareholders. It must be sufficient to cover the dividend and allow debt reduction.

The dividend is now $1.50 per share yearly or a yield of 2.7%, which is still low and is way below the industry average. It is the primary weakness of the company and should be around $2.50 per share, at least to attract dividend-oriented investors, which is reasonable after looking at the FCFE.

Note: The company indicates a free cash flow of $1.9 billion.

Tim Driggers, the CFO, said in the conference call:

"The most tangible output of this strategy is the payment of a regular dividend. The payment of a growing sustainable dividend is the best way to return cash to shareholders and is an integral part of our successful business model, high-return reinvestment."

3 - Oil-equivalent production and other

EOG Resources' oil production exceeded the high end of its guidance range during the fourth quarter. Total production was a record of 850.3K Boep/d, up 11.1% from last year, and up 1.9% sequentially. 94.5% of the total output comes from the U.S., as you can see in the chart below.

EOG relies heavily on crude oil, which represents 44.9% of the total output.

The price of oil (composite) realized by the company this quarter was $57.13 a barrel, down 3.9% from a year ago and down less than 1% sequentially. Cash operating costs were standing at $9.37 for 2018 and are expected to go even lower to $8.76 in 2019 and are expected to be $8.60 in 2020.

Source: Presentation

Note: EOG Resources is receiving a premium for its oil and condensate versus peers of $1.81 per barrel in 4Q '19 above the WTI, which is significant.

The primary production driver was the company's position in the Delaware Basin with 51 wells online (gross) and South Texas Eagle Ford with 67 wells online in 4Q '19.

4 - Net debt and cash

Net debt is now $3.6 billion, and the net debt-to-EBITDA is 0.48x. Net debt to total capitalization ratio for 4Q' 19 was 13%. Thus, an excellent debt profile.

Tim Driggers, the CFO, said in the conference call:

"We retired $900 million in debt. Cash on the balance sheet at year end was $2 billion and total debt was $5.2 billion for a net debt-to-total cap ratio of 13%, down from 19% at the end of 2018. Below is indicated the bonds maturities from 2018 to 2021 (presentation)."

5 - EOG 1Q' 20 and full-year 2020 Production/CapEx Guidance

Source: EOG Presentation

The company increased its 2020 spending forecast to between $6.3 billion and $6.7 billion on capital projects, versus $6.2 billion and $6.4 billion in 2019.

The company's U.S. production will be 845.2 to 900.4 K Boep/d.

The company expects production for 2020 between 886.2K Boep/d and 950.1k Boep/d.

Conclusion And Technical analysis

EOG Resources beat its fourth-quarter oil production targets. It is the fourth quarter in a row that the company beat production expectations with a reduced CapEx.

A vast inventory of premium drilling wells in the Bakken and Eagle Ford plays is set to drive oil production in 2020.

The takeaway for 2020 is the company call for 10% to 14% crude oil growth and a capital budget of $6.3-$6.7 billion in 2020.

It is precisely at this detail that I find some weaknesses in the company's business model. I call it an unquenchable need to grow production in a weakening environment run by oversupply and dismal commodity prices.

Why deplete the company's inventory to grow oil & gas production instead of stockpiling the cash on the balance sheet?

In a time of winter, you do not dance bare chest in the snowy storm. Instead, you stay home and keep your energy for better days. Then, time to get a nice nap and stop spending on growth when the World is telling you to downsize for the time being.

Technical Analysis (short term)

EOG has experienced a decisive support breakout of the symmetrical wedge pattern at the end of February. The new trend, in my opinion, is now a descending channel pattern with line support at $48.75 and line resistance at $65 with higher resistances at $74.90 and $86.25 if oil prices can turn very bullish all of a sudden, which is quite unlikely after what happened on Friday between OPEC and Russia.

The strategy is quite simple. First, look at the oil prices like a hawk. Then, if no change next week, expect a retest of the lower resistance at $48.75, where it is a good idea to start accumulating. The first sell target is around $65-$68, where I think selling 30% of your position could work well.

Author's note: If you find value in this article and would like to encourage such continued efforts, please click the "Like" button below as a vote of support. Thanks!

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EOG over 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.

I am trading short term the stock but I may start a long term position at or below $49

Comments

[User 41156665]

Fun Trading,

EOG had cultivated a deserved reputation of having "premium" upstream assets over the past 5+ years. They were in the process of methodically increasing the scale of their 'value-added' -- 'oil/ngl/ng' upstream production of the course of many years, when a replay of 1H2016 struck over the past weekend.

EOG Traded ~$100-130 For Years Until Now:

Today It Rose From $34.89 to $41 After Falling ~75% Past Month from ~$90

So after years of prudent and painstaking management and conservation of Upstream Resources, EOG has a 'Business-Model' that doesn't fit a crude oil price that is ~1/2 of what EOG has thrived under. So are all bets off?

[Fun Trading]

@lwpcolonel

The recent few days are quite humbling. The stock collapsed below $35 and now jumped 10%. It is difficult to try to rationalize the oil sector now and we need some time to think rationally.
What I could recommend is to take advantage of the volatility and trade frequently the stock without committing for the long term. I do not think we are done with the downside and it will be red days and rebound. It is what we can follow right now.

[User 41156665]

Fun Trading,

Yesterday I did more trading than in any day this year. I more than doubled our discretionary BP position at an average 'Cost Basis' of ~$25. selling Con Edison for good capital gain, (a lot of new 💰💲too).

It seemed like the right thing to do yesterday. I also added AES @14-15, CWCO ~$15, BTG (all different prices) EPD for ~$15 (couldn't believe it). I also added a lot of Ford at an average of $5.88 this morning by selling Evolution Petroleum for $4.11 that I bought yesterday for ~$3.95-6. It sounds like pennies but there were a lot of shares.

[Fun Trading]

@lwpcolonel

You did very well. I have been busy as well... Take some profit off the table now if the oil prices continue to firm up a little. Just in case...

[User 21793061]

I think EOG is a bit too costly for most majors' pockets. Yeah, they could potentially swing it. But still cost a lot, almost a merger, not an acquisition. Also, some of the value may be in the going concern and in their exploration. Which would be blown up when forced into the supermajor corporate straightjacket. XOM has already once said "we will leave XTO alone" and then reneged and dragged them all down to Houston.

[Fun Trading]

@21793061

The shale is not attractive, no supermajors would touch it now.

[Maui55]

"An Unquenchable Need To Grow Production" Perfect. How did that work out ? Famous last words. Might want to change it to an unquenchable need to slow production. Try that .

[Fun Trading]

@Maui55

I am not in favor of increasing production. Instead, I would like to see EOG reducing CapEx and hoarding cash if possible.

[EmeraldRun]

EOG is going to present itself as an excellent buy sometime here during this oil price plunge. Perhaps already has.

[Fun Trading]

@EmeraldRun

Yes, It is possible. Do you think the company will take advantage of the situation and will start to go on the acquisition trail?

[EmeraldRun]

I've always figured them more for an acquiree if the price got cheap enough. CVX obviously wants to buy a major shale producer. I don't think EOG as good a fit for them as Anadarko would have been though.

[Nanook1]

Agreed, I don't think CVX wants to grow a lot outside of the Permian so I don't think EOG is a great fit. Plus they are run well so I don't think you will get fire sale prices like some other assets. CVX just got done writing down other shale assets back east. OXY is a friggin mess right now and with that bloated debt and other obligations (Buffett for one) so I don't think anyone can really touch them unless they really start to crumble price wise (which is possible... thank you Hollub). I think a combo of OXY and Chevron assets in the Permian would make a ton of sense. Hard to see it happening though.

[Pentag0]

Thanks for the article, though the title is curious. I have followed and invested in the company from the beginning; what I believe differentiates it is the discipline and realism not to chase targets, but to concentrate on improving long-term metrics. Whilst others have rightly been chastened for chasing growth and making rash and expensive acquisitions, EOG has generally targeted carefully and not overpaid. The balance sheet points are sound, however I fully anticipate the company to sacrifice some growth capital to continue improving Tier 1 inventories - there are few companies out there that are in this position, and I believe credit options will tighten further.

It's a tough space, however I believe, by year-end it will become clear that 6 years of under-investment in global oil projects has destroyed spare capacity (yes even in KSA). Invest now in the space and the Integrateds, E&Ps and refiners should give excellent 12-month returns. Anyone who doubts this should study the impact of stimulus out of previous economic/event driven downturns and the relative inelasticity of downturn demand relative to supply. Yes I agree we need to curb hydrocarbon usage, yet, as I travel globally, I understand how difficult this is to achieve in a timely manner (especially if prices of hydrocarbon fuels are so relatively cheap).

[Fun Trading]

@Pentag0

Thank you, yes the title is explained in my conclusion. I believe EOG is too much focused on producing more and more and I believe it is more a time of hoarding cash, keep production as it is and save CapEx.

Good comment by the way. Waiting for tomorrow to see where oil will be trading?

[User 21793061]

Maybe Putin took EOG seriously about the "we can grow as long as prices are 40+". Thus poking below 50 was not enough. Have to crash it into the 30s. (Retail customer says thank you!)

[Fun Trading]

@21793061

Yes, we may drop below $40 with KSA threatening to flood the market with oil and reclaim market shares.

[User 41156665]

Fun Trading,

As the demand for oil is quashed due to the global pandemic's economic lock-down, WTI $~20 and Brent $~25 seem optimistic as economic activity projects forward into a Depression with most of the 🌎 population confined in quarantines for many months to come. Oil can only maintain the aforementioned prices if production is greatly reduced in the higher cost Non-OPEC nations while the KSA and Russia fight over the small and heavily discounted remaining market. At least 10 million barrels of Demand Destruction has already been set into motion with another 10 million barrels likely to show up during the 2nd quarter - barring a medical miracle.

Since the 1980s when oil production was at 74 million barrels per day I could never envision a 🌎 which could sustain a 100 million barrel balance of Supply/Demand. 'Fracking' was a short term solution which may no longer be either needed or viable in the future.

[User 41156665]

Solution For Low Oil Prices = Low Oil 💲Prices

If we have any sense we won't stay fixated on fossil fuels which aren't 'sustainable' with both the environmental and geopolitical risks which are currently all to obvious.

Why is the solution for Low Oil prices = Low Oil 💲 Prices?

The reduced overall Capex of the past 6 years has created a situation whereby we aren't replacing our 'Recoverable Reserves' as quickly as we are consuming them. Then add our legacy production, which declines overall at 5+% annually with 'Shale Basins' suffering 50-80% declines in just the first 2 years. What we have will be production in the Permian Basin below 1/3 of today's production in 2-3 years, if we have a cessation of drilling continue that's now getting underway. Even Exxon's Capex has been proposed to be cut by ~$50 billion over the next 5 years.

Exxon and Chevron might consider altering their business model to be more like Total's and BP's, which aren't completely dependent on conventional oil and gas as their core energy segments. Why NOT add Renewables, EV Infrastructure + Charging 🌎? Power generation and transmission too. It is becoming more of a mainstream trend rather than just a radical minority who are partially correct.

It would be shrewd for say Chevron or Exxon to acquire AES - a global Multiline Regulated and Unregulated electric and gas utility that's expanding into LNG and has already converted much of their Energy Generation Feedstock from Coal and Oil into Natural Gas and Renewables in both the U.S. and internationally.

[User 21876061]

EOG May emerge from this downturn. Few others (perhaps PXD and CXO) could become moderate value acquisitions for a major assuming anyone can produce cash in shale which is now a pie in the sky proposition. 

IMO, steer clear of all other value trap shale players, even those that were previously viewed as successful. Shale’s reckoning won’t escape the KSA twice.

[Fun Trading]

@kez58

Agree, EOG is quite a bullet proof proposition even if revenues will take a serious hit if oil starts to crash below $40 and it is very possible because KSA got really mad at Russia. However, The USA is the world's biggest producer of oil and has NO mechanism regulated oil production. Do you think it is fair and safe?

[User 47998195]

Fun Trading,

I don't think it's safe at $40, but at that price or below my dad would consider a "Speculative" position because its balance sheet is so much better than Occidental Petroleum.

[User 41156665]

No - $40 would be much too high since it fell to $27 in the past mid-week period. If it returns to that level, I would probably pass on it anyway because I still see a long way down for Energy companies because demand appears to be severely impaired for at least the next year.

Meanwhile there's a growing surplus, compliments of Putin's desire for relative economic growth through the 'chaos' he's creating in the world oil market. The KSA, an American ally has taken the bait and Putin is enjoying a great personal ride to a longer term position at the top for the sake of Russian security, until 2036 when he's 84 years old. He has crashed the EU, East Asian and more importantly, the Chinese economy, while severely damaging the U.S. and the U.K. in the process. His loss of profit, for 'Mother Russia' is less relevant to a former U.S.S.R. Lt. Colonel, in the KGB from 1975-1991, than any real growth, such as he had in his first 8 years in office. Russia's Strategic position rises in this scenario as the stronger aforementioned economies lose their 'capital based' strength, which gives Putin's Russia a relatively more dominant role in steering world events.

[pepe argento]

Toughs times for oil, many medium and small producers will shut down, debt won’t be paid and that’s going to create even more panic. In the long run however, situation will stabilize with only the most efficient producers getting a benefits from this oil war.

[Maui55]

@pepe argento bankruptcies take a lot longer than expected . Hedging and banks who are willing to kick the can down the road can drag this on for years . This experiment failed in 2014 and will again in 2020. Saudi and Russia will regret this . As soon as the shale leeches get a hint of higher prices they will do exactly the same bad behaviour. Who ever thought growing production by 2 million BPD in one year in a market that grows 1 million BPD was a good idea ? And here we are folks. Never underestimate the greed and stupidity of shale producers.

[PT Larry]

Many thanks for the article.

EOG is an excellent company and an excellent take-over target for any of the majors that are willing to pay for quality.

[Fun Trading]

@PT Larry

Thank you, you are a nice fellow and I appreciate it. Not sure about many take-over targets right now.

[PT Larry]

Yeah, things change fast. @Fun Trading

[User 51153147]

What does this mean for refiners, PSX and/or MPC?

[Fun Trading]

@Money_Money

It could be a positive assuming their margins are increasing.

[Me XMan]

Not sure OXY but I would buy XOM though 😀

[Fun Trading]

@Me XMan

In the oil producers's store everything is on sale now. I bought XOM (added) as well.

[Me XMan]

@Fun Trading Let's see how the game of chicken between Russia and Saudi go. Who will blink (cut bpd) first?

[Fun Trading]

@Me XMan

It doesn't look good for oil right now...

finance.yahoo.com/...