Is EOG A Good Stock to Buy?

  • The chart below shows the performance of natural gas and crude oil exploration and production firm EOG Resources over the last 3 years
  • Since the stock’s trough in October of 2020, it has risen over 250%, triggering behavioral errors that often give investors the feeling that they “missed” a stock after it rises that much
  • Our last piece on oil stocks explained how the ESG crowd was driving the world into a famine
  • That piece also explained that at $75 oil, many of the energy stocks at the top of our stock screeners have double-digit FCF yields and noted that so far in Q1 2022, oil had an average price of $92
  • KCR expects Q1 results of our favorite stocks to produce prodigious free cash flows making the market’s cheapest sector even cheaper

We believe the need for hydrocarbons sourced from North American producers is severe, and supply will be forthcoming as this view begins to take hold in the West. EOG’s remarkable management team, superb assets, commitment to shareholders, and disciplined approach to capital allocation make it an excellent investment in our view. As we have explained, we are not deniers of climate science.

But between geopolitical stresses and shortages of energy that pre-dated the tragic situation in Ukraine, KCR has faith that ESG advocates will realize there is a moral imperative to emphasizing SOCIAL needs. Part of this conviction stems from the belief that ESG advocates bring good intentions to the world. Once they realize that the current situation puts the world’s poorest citizens at dire risk, we believe they will come around. And this is particularly true on a stock like EOG Resources, which plans to be a net-zero company by 2040[1].

EOG Resources’ Stock Chart: Absolute Return

To see why our proprietary ranking model likes the stock click here. Below the EOG stock chart, find some simple reasons why, despite its recent run, the company may be a solid long-term investment.

EOG Absolute Performance over the Last Three Years

EOG’s Stock Price Relative to the Market: The Case for Investigation

The chart below shows EOG’s price performance relative to the S&P500 over the last three years. Despite the massive run since October 2020, it has lagged the S&P500 badly.

EOG Relative Performance to the SP500 over the Last Three Years

Our models seek to exploit the behavioral errors that turn investors into their own worst enemies. As we explained in our piece introducing KCR’s “Glamor Stock Index,” we believe that low-quality stocks propelled by narratives but lacking fundamental merit have created uncommon opportunities like EOG today.

KCR’s EOG Price Target: “Higher”

Long-time readers know that KCR follows Buffett’s belief that it is better to be “roughly right” than to be “precisely wrong.” Wall Street analysts offering specific price forecasts do so to satisfy the human desire for certainty. Unencumbered by such constraints, our research team is more than happy with bold proclamations like “history tells us it should go higher.” And higher is precisely what history suggests for EOG’s share price.

In a recent missive from his newsletter, The Daily Dirtnap, Jared Dillian observed that:

Remember, we want the prices of things we need to go down, and the prices of things we want to go up. We need corn, oil, and copper. … For years, stocks and bonds went up and commodities went down. This is known as ‘progress.’ Now it is happening in reverse.[2]

KCR agrees. At the same time, as our research over the last few years has explained, we believe the financialization of the world has run too far. Our work has highlighted the risks from the horrendous trio of record equity duration, record equity valuation, and negative real-yields in fixed income.

KCR believes capital allocators have been starving the makers of things humanity needs creating an incredible opportunity for investors. These exact stocks also happen to be some of the cheapest in the market and display a level of capital discipline that seems to have escaped investor attention.

KCR believes EOG is a stellar example of a company that makes what the world desperately needs and is allocating capital with a level of discipline that once eluded the industry. The slides below are from the company’s Q4 presentation to investors. The notes and annotations are obviously KCR’s.

EOG Resources

Summary of Key Concepts In 4 Slides: This Is Not Complicated

  • EOG requires an after-tax rate of return to be a minimum of 60% using $40 oil & $2.50 natural gas
  • In 2014 the company set a firm record earning $5.32 per share with oil at $93[3]
  • In 2021 the company shattered that record earning $7.09 per share with oil at only $68
  • In 2021 with $68 oil, the company generated $5.5 billion in FCF (the market cap today is ~$65bn)
  • The company doubled its regular dividend, which has never been cut in 20 years, moved its balance sheet to net-cash, and returned a total of $2.7bn in cash to shareholders

For Long-Term Investors EOG Has Removed a Vast Amount of the Commodity Risk

  1. At $80 oil, the company will generate $6.4bn in FCF with a minimum of $2.3bn being paid to shareholders, which equates to a minimum 3.4% yield in 2022 ($1.7bn in regular dividend and $0.6bn in special)
  2. EOG can fund all their capex needs and continue to pay their $1.7bn regular dividend, a 2.5% yield today, with oil at $44
  3. The company breaks even at $32 oil…..so far in Q1 oil has averaged $92……

EOG 2022 Plan Low Breakeven and Significant FCF

Pretty Powerful Slide….with ZERO Net Debt, EOG Authorized a $5 Billion Stock Buyback

EOG delivering on our long term fcf priorities

Despite Prodigious Cash Flows, EOG is GROWING Reserves & Reducing Costs

  1. EOG replaced 170% of the high quality (“double premium”) wells drilled in 2021
  2. New hurdle rate requires wells to be able to generate a 60% return at $40 oil & $2.5 natural gas
  3. EOG replaced over 2x of total 2021 production while reducing F&D costs by 17% to $5.81 per BOE[4], and double Premium well inventory would last 11 years at current drilling rates[5]

EOG double premium higher returns plush higher cash flow

CONCLUSION – In KCR’s View:

  • the managerial acumen, capital discipline, reserve replacement rate, and focus on getting to net zero a decade ahead of the IEA’s own goals makes EOG a phenomenal stock[6]
  • 99% of EOG’s proven reserves are in the United States[7], making it a strategic geopolitical asset
  • With the stock trading at a ~10% FCF Yield assuming $68 oil, when oil prices are ~$100, the stock is significantly undervalued and offers investors both a margin of safety and growth at a reasonable price.

[1] Ezra Yacob, President, Q4 Presentation to Investors

[2] The Daily Dirtnap, March 15, 2022

[3] Ezra Yacob, President, Q4 Presentation to Investors

[4] Ken Boedeker, Executive Vice President, Exploration & Production, Q4 Presentation to Investors

[5] Ken Boedeker, Executive Vice President, Exploration & Production, Q4 Presentation to Investors

[6] Please see page 36 of EOG’s 10-K for details on management’s view of the company’s superb and improving asset composition

[7] 10-K, December 31, 2021, page 1

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

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