In the past, I have maintained my view that the energy sector will have more pain in 2016. At the same time, I have highlighted several stocks that are trading at attractive valuations and have a quality balance sheet. Investors can consider exposure to these names or keep them in their investment radar for buying when there is some stability in energy prices.
EOG Resources (EOG, Financial) is an exploration, development and production company with producing areas in New Mexico, North Dakota, Texas, Utah and Wyoming in the U.S.
Starting with the stock price trend, EOG Resources was trading at $73.2 on July 27, 2015. Five months later, the stock is trading at $70.8. During these five months, oil has trended lower, and there have been plenty of bearish triggers for the oil and gas industry. However, EOG Resources has remained sideways, and this is an indication that the stock has bottomed out.
The reason for strong resilience by EOG Resources in the last five to six months will be clear. In the current oil price environment, the first point I consider is the company’s balance sheet. If the company is overleveraged, I don’t take the analysis beyond that point.
As of Sept. 30, 2015, EOG Resources had a $6.4 billion balance sheet debt but a low debt-to-capitalization of 33%. Further, the company has $743 million in cash along with $2 billion in revolving credit facility (total liquidity of $2.7 billion). Importantly, even in the challenging environment, EOG Resources generated $3 billion in operating cash flow for the first nine months of 2015. This implies annualized OCF of $4 billion.
With these positives related to the company’s balance sheet and cash flow, it is not surprising to see the company rated A3 by Moody’s and A- by S&P. The rating underscores the company’s strong credit profile and partially explains the resilience shown by the stock in the last five months.
For EOG Resources, the positives don’t end with the balance sheet and cash flow. The company’s assets are high quality, and EOG Resources has been focusing on Eagle Ford, Bakken and Delaware Basin as these assets have an attractive IRR. To put things into perspective, even at $50 per barrel oil Western Eagle Ford and Delaware Basin have IRR of 35% and 45% respectively. As long as oil prices remain depressed, EOG Resources will continue to focus on low beak-even assets.
For the long term, EOG Resources has a deep drilling inventory with 12,500 potential locations and resource potential of 7,000mmboe. Therefore, the company’s outlook for the long term also remains robust.
For 2016, EOG Resources is targeting capital investments to be in line with operating cash flows, which will ensure that leverage remains well under control. A strong financial flexibility will allow EOG Resources to significantly expand capital expenditure once oil trends higher. A deep drilling inventory implies 10-plus years of drilling even if the capital expenditure is expanded.
Another point about EOG Resources that is positive from a long-term perspective is the fact that the company has $2.7 billion in available liquidity as of 3Q15. In the third quarter, the company acquired 26,000 net acres in the Delaware Basin for $368 million. With many oil companies looking to divest assets to improve the balance sheet, EOG Resources can potentially acquire quality assets in 2016 at a bargain.
From a shareholder returns perspective, EOG Resources pays 67 cents per share in annualized dividend. No increase in dividends is anticipated in 2016, but current dividend levels are sustainable considering the company’s strong cash flow potential. However, if oil remains in the range of $30 to $40 per barrel through 2016, dividend suspension can be expected to conserve liquidity.
EOG Resources has a solid balance sheet, quality assets, deep drilling inventory, attractive IRR assets and resources to pursue acquisition. These factors make the company attractive from a long-term perspective, and investors can consider some exposure to the stock at current levels. With the stock having traded sideways in the last five months, the phase of consolidation can be used for gradual accumulation.
Disclosure: No positions in the stock
