Early last year, EOG stepped up its efficiency game, targeting “double premium” wells capable of at least 60% after-tax returns assuming oil at $40 per barrel and natural gas at $2.50 per thousand cubic feet. For context, oil currently sells for $83 per barrel and natural gas for $5.53 per thousand cubic feet.
At the end of 2021, EOG controlled about 6,000 untapped locations for double-premium wells, equating to more than a decade’s worth of production at current levels. In July, the company said it expected to replace these sites faster than it would drill. In other words, if EOG wants to increase production at a pace faster than the 11% it managed over the last year, the company has levers to pull.
But with revenue up at an annualized rate of 22% over the past five years, supporting annualized growth of 18% in operating cash flow and 22% in free cash flow, EOG has done just fine without gunning the engine. EOG expects to complete 520 wells this year, similar to its 2021 pace.
EOG’s concentration on cost controls has paid off handsomely over the last eight years. EOG expects cash operating costs of $10.30 per barrel of oil equivalent this year, down 24% from $13.53 at the start of 2014. Over that same period, EOG sees declines of 56% in finding and development costs and 41% in depreciation, depletion, and amortization. Not surprisingly,
EOG’s operating profit margins have risen to 42.7% from 37.3% since the start of 2016, when the company began targeting premium wells.
In 2014, EOG needed oil prices of $83 per barrel to earn a return of 10% on capital. Last year, it only needed $44. The combination of increasingly efficient production and rising prices generated explosive growth in recent quarters.
The benefits of that efficiency will become more apparent, however, when energy prices fall, as they inevitably do. Analysts project profit growth of 7% in 2023 and a decline of 11% in 2024, reflecting a normalization of prices. EOG trades at nine times the 2024 estimate.
A Special Case for Income
The indicated year-ahead yield of 2.3% understates EOG’s true income potential. In addition to the base annual dividend of $3 per share, EOG has paid four special dividends totaling $6.30 per share over the last year. We can’t build those special dividends into the indicated yield, but the combination of regular and special dividends equates to a trailing yield of 9.0%.
Going forward, EOG has pledged a minimum of 60% of free cash flow to shareholder return. The consensus calls for free cash flow of just over $7 billion, or $12.01 per share, this year, then $7.5 billion ($12.75 per share) in 2023 and $6.2 billion ($10.66 per share) in 2024.
Compare these numbers to the base annual dividend of $3.00 per share, and we see a high chance for aggressive dividend growth, additional special dividends, or both. The oil and natural gas producer is a Focus List Buy.