As OPEC’s compliance with production cut improves, Brent has been trending higher. Further, as China’s growth stabilizes and global economic growth remains steady, the outlook for oil remains positive. I have recently discussed a few names in the exploration sector as well as in the offshore drilling sector. This article will discuss another stock that is likely to provide strong returns as oil trends higher.
EOG Resources (EOG, Financial) is one of the largest independent oil and gas companies in the U.S. with proved reserves in the U.S., Trinidad, the United Kingdom and China. Year to date, EOG Resources touched a low of $83.15 on Aug. 29. The stock has moved higher by 24% and trades at $103.
The upside momentum is likely to continue, and this article will discuss the factors that can take EOG Resources higher in the future.
Shift to premium wells
One of the key upside triggering factors for the near term and long term is the company’s continued shift to premium wells and its potential implication for the company’s cash flows.
Just to put things into perspective EOG Resources had 14% premium wells completed in 2014, and this is likely to increase to 80% by the end of 2017 and above 90% by 2018.
To elaborate further on the premium wells, EOG Resources expects after-tax rate of return (ATROR) of 30% from premium wells even at realized oil price of $40 per barrel. At $50 per barrel, the ATROR increases to 60% and at $60 per barrel, it is likely to be over 100%.
While oil was trading around $40 to $50 per barrel, the company’s focus shifted to premium wells. As oil trends higher, the deep inventory of premium wells will deliver healthy returns for EOG Resources in the next two to three years.
Further, EOG Resources has 8,000 net undrilled premium locations with resource potential of 7.3BnBoe. In the coming years, Eagle Ford and Delaware Basin are likely to be game changers with 2,425 undrilled premium locations at Eagle Ford and 4,690 undrilled premium locations at the Delaware Basin.
As a result of this attractive ATROR, the key point to note is that even at $50 to $60 per barrel oil, EOG Resources expects oil production growth at a CAGR of 15% to 25% through 2020.
Another aspect that is likely to improve the company’s EBITDA and cash flow is sustained reduction in cash operating cost. This declined from $13.53 per barrel in 2014 to $10.52 per barrel in 2017.
Strong fundamentals for growth
EOG Resources has a deep drilling inventory that can translate into sustained production growth. At the same time, the company’s financial resources need to be discussed to underscore the point that the company can deliver on robust growth.
The following points are worth noting from a financial perspective:
For the first nine months of fiscal 2017, EOG Resources reported operating cash flow of $2.9 billion and for the same period, the company’s investments were also $2.9 billion. With the company investing within means, I see financial health remaining stable.
As of Sept. 30, EOG Resources had cash and equivalents of $846 million, and this provides ample cash buffer. With target of investment within cash flows, I don’t see cash burn or increase in debt in the foreseeable future.
EOG Resources reported total debt of $6.4 billion as of the third quarter. But I don’t see that as a concern with strong EBITDA and cash flows. Debt servicing is likely to remain smooth and as oil trends higher, the attractive IRR assets will deliver higher EBITDA. I expect the company’s credit metrics to improve in the next three to four quarters –Â in particular, if Brent sustains around $60 per barrel.
Conclusion
It is important to note that EOG Resources expects capital expenditure of $3.7 billion to $4.1 billion for fiscal 2017 and for fiscal 2018; I expect capital expenditure to remain in the range of $4.0 billion to $4.5 billion.
With a deep drilling inventory, premium wells swelling and strong financial flexibility, I expect the company’s target of U.S. production growth forecast of 20% to continue in fiscal 2018 as well.
Further, as oil moves higher, I expect capital expenditure of $4.0 billion to $5.0 billion being largely covered by internal cash flows. EOG Resources is therefore interesting and the current rally is likely to sustain in the next 12 to 24 months.
Disclosure: No position in the stock.
