Same Strategy, Better Result: EOG Resources Laps the Natural Gas Field
Despite the prolonged slump in natural gas prices, the stock of EOG Resources (EOG) sits near multi-year highs, driven by execution success in shifting organic growth production toward more profitable crude oil opportunities. Although this diversification strategy has been capital intensive, further growth of proved developed liquids-rich plays should underpin a strengthening balance sheet and higher share valuation.
Like other U.S. natural gas producers – Chesapeake Energy (CHK), Anadarko Petroleum (APC), Devon Energy (DVN), and Southwestern Energy (SWN) – EOG Resources responded in recent years to slumping natural gas prices by spending heavily to lease unconventional oil plays. Although EOG invested more than $16 billion in just the last three years to acquire and develop shale assets, such as Eagle Ford and Permian Basin in Texas and Bakken acreage in North Dakota, evidence suggests the company hasn’t blown-up its balance sheet to transition its portfolio of natural gas to liquids production.
At September 30, EOG had $1.1 billion of cash on hand, giving the company non-GAAP net debt of $5.2 billion – and a net debt-to-total capitalization ratio of 27%.
That EOG has made demonstrable progress to higher-margin hydrocarbons is evidenced in sales growth and profitability metrics, too: Oil and natural gas liquids will account for approximately 86% of 2012 sales, up from just 29% back in 2008. And, as seen in the following YChart, the company’s return on invested capital is the highest it’s been in years.
EOG's success is based on a simple equation, chairman and chief executive Mark Papp told analysts on the third-quarter 2012 earnings call: “higher crude oil volumes and higher crude oil price realizations combined with lower well and unit cost – and less money-losing North American natural gas volumes – equals more net income.”
Total crude oil and liquids-rich natural gas production is expected to grow year-on-year 38% to about 215 million barrels per day (Mbd) for 2012, up from 35% in 2010. Acknowledging supply/ demand imbalances, however, Papa cautioned at an energy meeting earlier this month that North American gas production would decline another 9% in 2012 – on top of a 7% sequential decline in 2011 – and that the company planned to “pursue minimal natural gas drilling activity in 2013.”
Although EOG has benefited from this early mover advantage position in key resource plays, like Eagle Ford, maintaining one of the best (and aggressive) organic oil growth rates of any of the large capitalization independents doesn’t come without cost. In particular, reserve replacement expenses will remain a critical headwind in coming quarters, as only 39% of EOG’s net proved reserves of 2.05 billion barrels of oil equivalent are crude oil and condensate, according to regulatory filings.
The company has a diversified drilling portfolio -- more than ten years of inventory, according to regulatory filings. Given management’s record of success – and, unless crude prices drop significantly – 2013 should be another good year for EOG stockholders.
David J. Phillips, a contributing editor at YCharts, is a former equity analyst. His journalism has appeared in Bloomberg BusinessWeek, Forbes, and Kiplinger's Personal Finance. From 2008 to 2011, David was a reporter for CBS News Interactive. He can be reached at firstname.lastname@example.org.