2016 was not kind to EOG Resources Inc. (NYSE:EOG). After reporting $4.5 billion in losses last year, EOG looks likely to book another losing year when 2016 draws to a close. Already, the company has reported $954 million in losses for its first nine months -- and OPEC's production cut announcement probably didn't come in time to save the year for EOG.
And yet, this morning, analysts at Argus Research announced they are doubling down on their buy rating for EOG stock, and raising their price target from $105 a share to $119. Why?
As explained in a write-up on StreetInsider.com, Argus thinks that "Despite volatile crude oil prices, EOG management has continued to focus on improving returns on invested capital, strengthening well performance, reducing costs, and maintaining a strong balance sheet." Is the analyst right?
Let's take those assertions one at a time. Here are three things you need to know about EOG.
1. Returns on invested capital
After peaking at 23.9% in 2008, EOG's return on invested capital (ROIC) plummeted into the single digits during the financial crisis -- and stayed there for four long years. S&P Global Market Intelligence data showed a brief return to healthy, double-digit returns in 2013 and 2014, followed by a collapse into downright unprofitability during the oil market crash of 2015 to 2016. So far this year, EOG has averaged a ROIC of negative 5% -- so where are these "improving returns on invested capital" that Argus is talking about?
The simple answer is that they're not here yet -- but may arrive soon. EOG's ROIC for the past couple quarters has been above the average for the year -- negative 3.5% and negative 4%, respectively. More importantly, fellow Fool and oil industry expert Matt DiLallo notes that "last quarter the company raised its guidance from an initial outlook for 10%-20% compound annual oil production growth through 2020 up to the current 15%-25% rate thanks to continued efficiency gains." The company believes that at oil prices of $50 a barrel, it will be able to grow oil production by 15% a year (i.e., more oil produced at better profit per barrel). Should OPEC's production cuts push oil toward $60 a barrel, EOG thinks it can manage 25% annual production growth (i.e., even more profit, and on even more barrels).
That should work out to a very nice ROIC indeed.
2. Reducing costs
EOG spent $8.25 billion on capital investment in 2014, the last year before the oil market crash. Since oil prices plunged, though, the company has ratcheted back capital investment sharply, spending only $5 billion last year, and is now on track to cut that spending by about half in 2016.
Granted, that spending will have to ramp back up if EOG intends to grow production at the levels it has promised -- but only if oil prices justify the increase.
3. Balance sheet strength
Despite cutting capex, EOG remains free cash flow negative at present -- a consequence of cash from operations diminishing with the falling value of oil. Currently, the company is burning cash at the rate of $515 million annually -- and as you might expect, this has resulted in higher debt at EOG.
Since 2014, the company's long term debt has surged by $1.1 billion, and now stands just shy of $7 billion. That said, management has added cash to its reserves to help deal with debt obligations as they come due. Cash on hand is now over $1 billion, leaving the company with less than $6 billion net debt on its balance sheet.
Bonus thing: Is EOG as good as it looks?
With only modest debt on its balance sheet -- roughly one-tenth of the company's $59.1 billion market capitalization -- EOG looks well positioned to benefit from its prediction of 15% to 25% production growth over the coming years. But how profitable will that growth be?
Maybe more profitable than you think. As Matt points out, EOG is the "leading shale producer" in America, and has "among the lowest costs in the industry as well." According to StreetInsider, Argus is forecasting $0.58 per share in profit in 2017 -- $0.12 ahead of consensus estimates on Wall Street. Farther out, though, as oil prices recover, analysts agree that EOG will benefit greatly from a more normalized oil market. With a breakeven cost of production of about $30 a barrel, consensus expectations call for EOG to earn nearly $2 in profit per share in 2018, more than $6 a share in 2019, and more than $7 a share in 2020.
At $102 a share, EOG stock is currently selling for 177 times Argus' expectations for the coming year, and more than 220 times consensus predictions, but only about 13.8 times 2020 profit estimates -- if they come true. Sure, 13.8 times earnings could be an attractive valuation for a stock growing at 15% to 25%. But it's going to be a long wait before EOG gets there, and there's no guarantee it ever will.
Personally, I fear that after gaining 45% in 2016, EOG stock has already had its run. No matter how bright 2017 (and 2018, 2019, and 2020) may look, the stock is simply too expensive for my taste.