When oil prices start falling, it's important to recognize the oil and gas companies with the greatest risk/reward offering. EOG Resources (NYSE:EOG) is one of the largest exploration and production (E&P) companies in the United States but has seen its stock decline by more than 50% in 2019, a new three-year low. Yet the investment thesis for EOG remains strong. The company is lead by forward-thinking management that has spent the last five years positioning the company to operate profitably despite market cycles. With companywide breakeven levels around or below $50 a barrel and the commitment to paying down debt, EOG has proved to be a good steward of shareholder capital.

The business

Ever since selling its offshore assets in the United Kingdom in September 2018, EOG has become a pure-play U.S. onshore oil and gas investment. The company has nearly 3 billion barrels of oil equivalent in estimated proved reserves, of which 52% is petroleum, 21% is natural gas liquids, and 27% is natural gas. As of the end of 2018, EOG is now the largest petroleum producer in the Eagle Ford shale.

EOG continues to make moves in the natural gas space, most recently landing long-term gas supply agreements (GSAs) with liquefied natural gas (LNG) titan Cheniere Energy. "Under the GSAs, EOG has agreed to sell natural gas to Cheniere over a period of approximately 15 years beginning in early 2020, with the quantity starting at 140,000 MMBtu per day and increasing to 440,000 MMBtu per day," said the company in a recent press release.  

Oil derricks at sunset.

Image source: Getty Images.

Driving efficiency

In the five years since the oil downturn of 2014, EOG has committed itself to lowering the oil price required for a 10% return on capital employed (ROCE). ROCE is a good metric to determine the profitability of a company after factoring in the amount of capital used. In 2014, EOG achieved a 10% ROCE at $83 a barrel, creating immense pressure on management to increase efficiencies if EOG was to survive the new world of $40-to-$80 oil.

In response, EOG implemented its premium drilling program, which lowered the price required to achieve a 10% ROCE from $81 in 2016 to $55 in 2018. EOG plans to be able to return a 10% ROCE at below-$50 oil by 2022 and breakeven at $40 oil and $2.50 dollars per million Btu for natural gas.

Asset performance

EOG Financial Information (in Thousands)

Operating Revenue & Other

Six Months Ended June 2019

Six Months Ended June 2018

Crude oil and condensate

$4,729,269

$4,478,836

Natural gas liquids

$405,012

$507,769

Natural gas

$604,864

$600,611

Gains (losses) on mark-to-market commodity derivative contracts

$156,720

($245,654)

Gathering, processing, and marketing

$2,787,040

$2,538,258

Gains (losses) on asset dispositions, net

$4,171

($21,286)

Other, net

$69,194

$60,705

Total revenue

$8,756,272

$7,919,239

Data source: EOG Resources Second Quarter 2019 Investor Presentation. 

The above chart tells you EOG's revenue by segment for the first six months of 2018 and 2019. Yet what matters as much as the numbers themselves is the environment in which EOG was able to achieve these solid results.

The first main takeaway is that most of EOG's revenue comes from its crude oil assets which include a dozen shale plays across the United States and Canada, adding up to 243 million barrels of oil equivalent (MMBoe) of domestic production. The second takeaway is that EOG grew both revenue and earnings by over 10% year-over-year despite the fact that oil prices were actually lower in the first six months of 2019, averaging $62.78 compared to $68.01 in the first six months of 2018.

EOG's stellar performance despite low oil prices proves that management knows how to grow the business despite mediocre oil prices. Note that oil prices averaged $59.73 between July and September 2019 and currently sit at less than $55 a barrel, meaning the coming quarterly report will be a true test to whether EOG can continue to grow when oil is less than $60 a barrel. Regardless, EOG's focus on decreasing break-even prices per barrel will bode well for top- and bottom-line growth even in the current price environment.

Financial discipline

EOG management is committed to strengthening the company's financial position. According to a company statement, during the second quarter of 2019:

[EOG] repaid a $900 million bond that reached maturity in June 2019 with cash on hand. At June 30, 2019, EOG's total debt outstanding was $5.2 billion for a debt-to-total capitalization ratio of 20 percent. Considering cash on the balance sheet at the end of the second quarter, EOG's net debt was $4.0 billion for a net debt-to-total capitalization ratio of 16 percent. This is down significantly from 24 percent at the end of the same prior year period. 

Takeaways

EOG is not your typical E&P company. Management continues to pay down debt and grow the top and bottom line despite market cycles. The stock's trailing P/E ratio of around 11.5 looks even more attractive once you realize it excludes the high oil prices from the first half of 2018 and instead includes EOG's earnings misses in Q4 2018 and Q2 2019.

The company reports Q3 2019 results on Nov. 6, with analysts already expecting a mere $1.17 earnings per share (EPS) which would be the lowest EPS in over a year. EOG will likely suffer from the below-$60 oil prices in Q3, and even more so if oil stays where it is today. That being said, EOG benefits from tailwinds including the growing LNG export market and efficient operations that have lowered breakeven production prices.