Here’s Why EOG Resources Is A Long Term Bet For Investors

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EOG Resources

EOG Resources (NYSE:EOG), the US-based shale producer, is one of the few companies that have shown resilience and continue to hold a firm ground in the ongoing commodity slump. Although the company faced several hardships due to the plunging oil and gas prices over the last three years, it continued to focus on delivering value rather than achieving growth at the expense of its shareholders. This philosophy, coupled with the company’s strategy to concentrate on premium drilling, has not only allowed it to bring down its break-even price but also maintain its industry-leading returns even in a low price environment. Thus, despite the uncertainty regarding the pace of recovery in the commodity markets, we expect EOG Resources to continue to be an industry leader and deliver solid returns to its shareholders over the long term.

See Our Complete Analysis For EOG Resources Here

Source: Google Finance

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Focus On Premium Locations To Drive Returns

In the wake of the depressed commodity prices, EOG Resources has shifted its complete focus to drilling and exploring only premium drilling locations over the last couple of years. These premium locations produce twice as much gross oil as the non-premium locations, and operate at finding costs of around $7 per boe, which is almost 46% lower than the costs of non-premium locations. Consequently, these locations yield a direct after-tax rate of return (ATROR) of at least 30%, at $40 per barrel of oil and $2.50 per Mcf of gas. In fact, the returns of these locations can exceed 100% at oil prices of $60 per barrel.

In order to leverage on higher returns in a low oil price environment, EOG is constantly working towards either converting its existing locations into premium locations by using longer laterals, and innovative technology, or is increasing its exploring activities in its key basins such as the Delaware Basin and Eagle Ford. At present, the company has roughly 7,200 premium locations, representing a drilling inventory of more than 10 years. An inventory of premium drilling locations of over a decade has placed EOG is a sweet spot to generate higher returns for its shareholders even in a soft price environment. While some investors may view the drilling of premium wells in a low price scenario as a negative for the company, others might consider the improved cash flows and returns in the current downturn a big plus.

In our opinion, a solid inventory of premium locations will not only enable the company to generate a regular return for its shareholders in the short term, but will prove to be a huge upside potential for the company in the long term, when the commodity markets finally recover.

Strong Cash Flows And Balance Sheet

Another competitive edge that EOG Resources enjoys over its peers is its strong financial position. The US-based company had a debt-to-total capitalization ratio of around 33% at the end of the latest quarter as opposed to a leverage of more than 50% held by its peers. This indicates that the company has better chances of obtaining additional debt at attractive rates from the markets compared to its rivals. Further, despite its declining cash flow position, the company has managed its capital spending and other costs efficiently over the last three years. The company restricted its capital expenditure to around $2.6 billion in 2016, versus a capital spend of $8.2 billion in 2014. This has enabled the company to streamline its finances and almost cover all its dividend payment and capital requirements over the last couple of quarters.

That said, EOG has increased its capital investment budget for 2017 to $3.7-$4.1 billion in order to augment its aggressive production targets for the year. This is contrary to the trend witnessed in the second quarter earnings season, where large E&P companies have pulled back their capital investment in the wake of the growing uncertainty in the commodity markets. While some may see this as an aggressive move which could backfire given the volatility in the commodity markets, the company recently reiterated its strategy to focus on returns rather than growth, and highlighted that it would refrain from outspending its cash flows. Thus, we believe that with EOG’s focus on premium locations (described above), along with its low cost structure, will allow it to generate sufficient cash flows that will be enough to meet its dividend as well as capital spending needs in the short term.

Thus, we believe that EOG’s strategy to focus on premium drilling locations to enhance its shareholders’ return will work in its favor both in the short and long term. With a solid inventory of premium locations, its low cost structure, and strong execution skills, we believe that the company will continue to be a safe bet for investors, irrespective of the recovery in commodity prices.

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