EOG Resources Revised To $80 Per Share On Lower Oil Prices, Slower Production Growth

EOG Resources (NYSE:EOG) recently announced its 2014 fourth quarter and full-year earnings. On expected lines, the company posted an impressive growth in crude oil production over last year, primarily driven by increased development of its acreage in the Eagle Ford shale. However, lower oil prices more than offset the impact of higher volumes on its net earnings per share (EPS) adjusted for one-time items, which declined by 21% year-on-year to $0.79.  For the full year, however, the company’s non-GAAP EPS increased by 20% over 2013. This year, EOG Resources plans to slow down its primary growth engine significantly in response to the changed crude oil price environment, as an attempt to maximize its returns in the long term. The company expects its 2015 full-year crude oil production to be flat, as it defers the completion of wells until global crude oil prices recover significantly to reflect the adjusted demand-supply scenario. ^[1]

EOG Resources is an independent oil and gas exploration and production company that explores, develops, produces, and markets crude oil, natural gas liquids, and dry natural gas from major producing basins in the U.S., Trinidad, Canada, and the U.K. A vast majority (around 94%) of the company’s total net proved reserves are located in the U.S., while the remaining are spread across other international markets including Trinidad, U.K., Canada, Argentina, and China. Based on the recent earnings announcement, we have revised our price estimate for EOG Resources to $80/share, which is almost 15% below its current market price.

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Lower Oil Prices To Weigh On Profitability

The global crude oil price environment has changed significantly over the past few months due to slower demand growth, rising supplies from tight oil reserves in the U.S., and OPEC’s (Organization of Petroleum Exporting Countries) decision to not scale back its production just to keep prices afloat. The front-month Brent crude oil futures contract on the ICE has declined by more than 46% since hitting a short-term peak of $115 per barrel in June of last year.  Going forward, we expect oil prices to remain suppressed in the short to medium term on global oversupply, as we do not expect the decline in production growth, relative to the demand growth, to fully offset the oversupply situation anytime soon. Our current 2015 full-year average Brent crude oil price estimate stands at $70 per barrel, which is based on the global demand-supply scenario and the marginal cost of production. Since this would imply a decline of almost 30% from last year’s average, we expect EOG Resources’ price realizations and average profitability to take a big hit this year. However, well productivity improvements and lower service costs are expected to mitigate the negative impact of lower oil prices to some extent. The chart below shows our long-term forecast for EOG Resources’ exploration and production (E&P) EBITDA margin. ^[1]

Lower CapEx To Boost Long-Term Returns

Lower oil prices also result in a sharp decline in operating cash flows of upstream oil and gas companies, which reduces their ability to reinvest in production growth. Therefore, capital expenditure (which is the biggest single cash expense item in this business and the primary driver for future production and earnings growth) plans of independent exploration and production companies largely depend upon the short to medium term outlook for global crude oil prices. EOG Resources announced during the fourth quarter earnings call that it plans to cut its capital spending by 40% this year in order to maximize the long-term shareholder value and sustain its balance sheet for potential acquisition opportunities that generally arise in a commodity down cycle such as this one. Bill Thomas, the company’s Chairman and CEO,  noted during the call that the current demand-supply imbalance in oil markets is not very large and benchmark oil prices should recover to more sustainable levels soon. He also stressed that it makes sense for his company to deliberately slow down production growth in the current oil price environment, as this strategy maximizes the value of its portfolio. The chart below highlights how deferring well completions by six months could increase the company’s after-tax rate of return on investment for various possible oil price outcomes, assuming the average price of oil to be at $45 per barrel for the first six months. ^[2]

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1. EOG Resources Reports Fourth Quarter and Full Year 2014 Results, eogresources.com [↩] [↩]
2. EOG Resources 2014 Q4 Earnings Call Presentation, eogresources.com [↩]