While the unabated and unprecedented rise in EOG Resources' stock over the past five years has been a bonanza for growth investors, it has also inspired the notion that the independent oil and gas company's rally must ultimately hit a snag. This is because some investors have never seen anything like it before: The stock has gained consistently since 2009, when it was trading below $40 a share. Out of the natural fear of the unknown, these investors have fastened their purse strings in anticipation of the next pullback.
Are you also waiting for a pullback? Best not hold your breath -- there is still tremendous upside ahead for EOG Resources.
"EOG's business strategy is to maximize the rate of return on investment of capital by controlling operating and capital costs and maximizing reserve recoveries," according to EOG Resources' 10-K report, filed with the SEC on Feb 24, 2014.
The only way the company can maximize its rate of return on investment is by continually increasing production while containing costs. In this regard, it expects to grow overall production in 2014 by 12%, according to EOG investor presentations.
This is possible because EOG Resources is the top producer and leaseholder in the Eagle Ford, the world's biggest shale formation. It also has significant exposure in other key shale plays such as the Bakken and Permian Basin. The only issue is how it will mobilize sufficient and affordable financing to support its planned increase in production. The answer to this is not only impressive, but also revealing of the cogent reasons why EOG Resources' stock will continue tracking upward for the foreseeable future.
No debt, please
EOG Resources deliberately avoids debt. The table below is telling.
When compared with the broader industry, EOG has considerably lower debt as a proportion of overall assets and equity. This is something I have stressed before in previous articles, including outlining that EOG Resources' debt levels as of March 2014 were relatively unchanged when compared with historical debt levels as far back as March 2011.
EOG Resources' deliberate avoidance of debt means it must turn to the equity market for financing, something that it has done successfully in the past with help from its operational strategy. That strategy emphasizes developing cost advantages, which in turn allows it to provide a return on equity that is comparatively higher than the broader industry. According to investor presentations, EOG Resources' return on equity in 2013 was 15.6%. This was the highest in the industry and well above the industry average of 9.5%.This relatively higher return on equity has allowed EOG Resources to rope in a host of deep-pocketed growth investors, who have provided financing for its massive expansion.
EOG's operational strategy also enables it to save costs in areas where competitors can't. As an example, the company has its own midstream assets, including crude-by-rail infrastructure such as loading and off-loading facilities. Besides reducing its logistics costs relative to the broader market, these midstream assets allow EOG Resources to access markets such as the Gulf of Mexico, where crude oil is generally priced at a premium relative to other inland markets. Moreover, EOG has its own sand mines in states including Wisconsin and Texas. Unlike other producers that have to source sand used for extraction of oil from shale oil at a premium, EOG Resources can self-source the sands at a fraction of the cost. The company also pays a paltry dividend that yields only 0.4%, keeping its capital costs significantly constrained.
The unique combination of low capital costs and strategic cost advantages enable EOG Resources to make higher net income for every unit of equity invested. EOG's comparatively high rate of return on equity has made its stock increasingly attractive among growth investors. Accordingly, the company has successively raised more financing on the equity market over the past several years. As represented in EOG's balance sheet, its capital surplus, which is the amount of capital raised over and above a stock's par value, increased by $2.2 billion in 2011, $2.5 billion in 2012, and $2.6 billion in 2013. The fact that each successive increase is higher than the one before reflects the gains in EOG Resources' stock on the secondary market over the years.
As equity financing is a key part of EOG Resources' strategy, it is highly likely that it will continue modeling itself as a pure growth play in order to prompt the share price appreciation needed to comfortably finance continued expansion in areas such as the Eagle Ford and the Bakken. There is still more upside ahead.
Lennox Yieke has no position in any stocks mentioned. The Motley Fool owns shares of EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.