We initiated a position in EOG Resources (NYSE:EOG), a $56 billion independent Energy and Production company with a North American focus on oil shale drilling. EOG is a high quality compounder and has industry leading acreage positions in the most prolific, lowest cost and geographically desirable basins--the Permian, the Eagle Ford and the Sanish/Parshall in the Bakken. As a leader in shale drilling, EOG has foreseen the problems facing the industry in fracking sand availability (it owns its own sand company) and take-away and processing (the Company is invested in core areas and is a leader in oil by rail, which today is a call option on tight markets). EOG has low cost acreage as it has grown organically, with the exception of the Yates acquisition in 2016, where it paid "for the best" and accumulated core acreage in the Delaware Permian at a time of distress in the industry. This deal should pay off for EOG as it develops deeper zones, which is in line with our thesis that "big fields get bigger". Additionally, EOG's timing on the deal looks prescient, near the end of recent oil price declines and just ahead of OPEC cutbacks.
EOG has a highly visible path to continue its strong book value growth. EOG is only allocating drilling capital to wells that produce at least a 30% return at $40 per barrel for oil, where it has 10+ years of drilling inventory, a figure that is likely to grow with further delineation of its acreage and continued drilling efficiencies. While every E&P company will be subject to oil price volatility, we feel EOG is best positioned to add value in the strong times and survive the lean times as it has a strong balance sheet and industry leading returns.
EOG's 2017-2020 production growth target of 15%-25% compound annual growth rate (CAGR) is highly visible and supported by a strong balance sheet and within cash flows. EOG did not raise equity in the oil bust of 2014-2016, and continues to budget capital expenditures within operating Cash Flow with a target $40 per barrel price. EOG's strong balance sheet has allowed it to raise its 2016 capital expenditures by $200 million, to $2.6-$2.8 billion.
We initiated our position in EOG at over a 20% discount to our estimate of EOG's NAV, which conservatively does not assume a significant increase in oil prices over $50-$55 per barrel, and we will look to increase the position opportunistically as the oil sector has been and likely will continue to be volatile. Aside from continued upside from production growth and strong operational execution, we see a likely path to added value for EOG from resource conversion of assets that do not meet their strict "core" criteria, but would be very attractive for less well positioned peers. EOG has over 30 years of reserve life at current production rates, and they have indicated they would look to sell some of their 1 million non-core acres opportunistically.
From Third Avenue Management (Trades, Portfolio)'s Value Fund first quarter 2017 commentary.
