Cash-Generator EOG: Shale As It Should Be

Summary

• EOG has positively differentiated itself from its shale peers through its ability to consistently generate free cash flow while simultaneously growing its production and reserves base.
• Higher-quality capex from its “premium well strategy” and a 23% reduction in well operating costs between 2015-2019 have helped EOG achieve this rare feat among shale independents.
• EOG expects to be able to fund its dividend and reduced capex program through operating cash flow at $30 WTI, reaffirming its aversion to debt-funded growth.
• Crude hedging for Q2 and Q3 near $60/bbl should provide around $800 million of revenue at $30 WTI, according to our rough, back-of-the-envelope calculations.
• The shale industry is undergoing a fundamental restructuring which will cull highly-levered, high-cost operators who have placed production growth above financial discipline. Investors should use this period of turmoil as an opportunity to identify disciplined E&Ps with strong balance sheets and track records of value creation for shareholders.

EOG: A Diamond in the Rough

The party is finally over. After a decade-long, credit-fueled production binge, the fiscally reckless US shale industry now finds itself in a battle for survival. Unlike 2016, this is not a temporary setback – it is a fundamental restructuring of the North American upstream landscape. Highly-levered shale independents who have pursued growth at the cost of free cash flow generation and shareholder value will go the way of dinosaurs and the dodo.

Amid the carnage, keep an eye out for diamonds in the rough: the disciplined, low-cost independents who have kept capex and debt in check and generated consistent returns for shareholders from premium acreage. Identifying and investing in these companies with a long-term horizon will be a lucrative venture as the market swings sharply from bust-to-boom once today’s capex cuts bleed through. We continue to believe that a significant structural supply deficit will emerge and push WTI above $70 in 2022.

In our view, EOG Resources has positively differentiated itself over the last several years through its ability to consistently generate free cash while simultaneously increasing both production and its reserves base. Net proved reserves have grown by 55% since 2016. This is no small feat considering the well-documented hyperbolic decline profile of shale wells, with production frequently dropping 70% from peak in the first year of production and a further 50% in the second.

Based on a track record of performance and balance sheet strength, we think EOG is a long-term bargain at 1.0x book value and sub-10x P/E and therefore initiate coverage on the Permian-focused producer with a “buy” rating at $40.00.

That said, let’s be clear: 2020 is going to be a difficult year for any oil producer, especially in the US shale patch. EOG is well-run, but it is not immune to exogenous factors. Depressed

Analyst’s 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.