EOG: Conservative Approach to E&P

03/24/2015 7:00 am EST

Focus: STOCKS

Our latest focus stock is one of the leading oil and gas exploration and production (E&P) companies in our coverage universe, suggests Stewart Glickman, S&P Capital IQ Equity Analyst in S&P The Outlook.

With above-average projected returns and strong exposure to crude oil production, by our analysis, EOG Resources (EOG) should outperform peers.

Its early forays into the Bakken Shale and Eagle Ford Shale plays, two of the most prolific shale plays in the country, lend it a competitive advantage versus peers in generating profitable production growth.

The US has seen a significant renaissance in domestic energy production in the last ten years, first with natural gas and more recently with crude oil and natural gas liquids.

Notwithstanding the recent and dramatic decline in crude oil prices, we have a preference for liquids exposure, relative to gas exposure, as we see better internal rates of return for crude oil-directed plays.

Based on data from Bentek Energy, a unit of McGraw Hill Financial, we see crude oil prices averaging about $51 per barrel in 2015 and natural gas prices averaging $3.15 per million BTU.

EOG has also commented publicly in recent months that it can achieve economically viable returns in some of its plays even at $40 oil.

Looking forward to 2015, we see EPS of $0.34, which compares with 2014 normalized EPS of $4.95 and reflects the sizable drop in prices.

For 2016, however, we see a strong recovery to $2.50 per share. Capital IQ consensus estimates suggest that production volumes will be flat in 2015, but rise 5.8% in 2016.

In our view, 2015 represents an anomaly for E&P companies; many are in the stages of major pullbacks in capital spending, but there are varying degrees of such pullbacks.

EOG, in our view, is taking a more conservative approach, slashing capital spending by about 40% and not aiming to produce as much as possible, if maximizing near-term production might adversely affect future production.

Finally, we think EOG is likely to have better financial flexibility than peers: Capital IQ consensus datapoint to 2016 operating cash flows amounting to 121% of its capital spending needs, versus just 93% for the peer median.

Based on these factors, we think EOG should trade at a premium to peers. The stock carries S&P Capital IQ's highest investment recommendation of 5-STARS or strong buy.

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