Why EOG Resources Has Excellent Growth Prospects

Martin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In this post I would like to analyze EOG Resources (NYSE: EOG) in terms of its current valuation, financials and potential risks to the stock price going forwardAnd based on this analysis, I would like to conclude whether EOG Resources is a good long-term or short-term stock pick at current prices.

EOG Resources, Inc is one of the largest independent Oil & Gas companies in the United States with proved reserves of 1.8 billion BOE in the United States, Canada, Trinidad, the United Kingdom and China. Approximately 94% of these proved reserves and 86% of production is located in the United States and Canada.

EOG's reserves and production

<img alt="" height="764" src="http://g.fool.com/editorial/images/46820/operations_large.png" width="536" />

Dividend

Obviously, with a 0.57% dividend yield, EOG is not a compelling choice for income investors focused on high dividend yielding stocks with growing dividend. EOG has been increasing its dividend, but the yield remains too low for serious income investors to even include this company in initial stock screening.

<img alt="" src="http://g.fool.com/editorial/images/46820/dividend_large.png" />

However, if you look at EOG's past sales and earnings growth and future EPS predictions, you will surely see the reason why EOG pays such a low dividend. It has much more lucrative use for the cash it generates.

Past sales and earnings

Sales grew 22.48% annually, on average, in the last five years. Although earnings fell by 13% p.a., this was predominantly caused by growing 2010-2012 "unusual" expenses. However, this new habit of regular and growing "unusual" expenses is quite worrisome, and raises questions regarding future sustainability of profit margins despite rising revenue volumes.

Annual sales and income:

<img alt="" src="http://g.fool.com/editorial/images/46820/annual-income_large.png" />

Future earnings growth prospects

After the fall in 2012 by 48% year-over-year, EOG's earnings are expected to increase by 21.13% annually in the next five years. Given the low base created by the rapid fall in company earnings in 2012, I believe this target is very easily achievable.

Quarterly sales and income:

<img alt="" src="http://g.fool.com/editorial/images/46820/quarterly-income_large.png" />

EOG valuation

The current trailing P/E of 48.78 is distorted by the unusually large earnings drop in Q4 of 2012. The more revealing forward P/E currently stands at 16.40.

Using a Discounted Cash Flow formula, plugging the current EOG numbers in and using a 10% discount rate, we come to the conclusion that the market currently prices in EOG's growth of 6% per year after the initial 5-year period of 21.13% annual growth.

I believe that such expectations are reasonable, given the past sales increases and future expected sales growth estimates. However, the stock is definitely not undervalued.

Major risks

1. Price of natural resources

EOG's earnings are volatile, and if the price of oil and gas falls, it could quickly get into trouble.

2. Regional dependency on the U.S.

Being much less regionally diversified than other major and independent Oil & Gas companies creates a concern if the U.S. oil and gas boom shows signs of slowing down.

3. Dependency on the upstream

Being just an upstream company makes EOG quite vulnerable and less resilient to changing relative business conditions in the upstream versus mid- and downstream operations.

Key takeaways

In conclusion, EOG Resources is a pure play on the U.S. Oil & Gas boom, making it potentially a high performer with excellent earnings prospects. On the other hand, due to being predominantly focused on the U.S. and on the upstream operations makes EOG very vulnerable, because its earnings and price tag are more prone to wild fluctuations.

Although I am of the opinion that EOG is fairly priced, given its 5-year and longer-term earnings growth forecasts, I will not be adding this stock to my portfolio because it is too volatile for my appetite. Compared to major integrated Oil & Gas companies as well as to some of the independent players, such as Anadarko, EOG is less balanced, more dependent on the U.S. market in general and the upstream business in particular, and vulnerable to potential fluctuations in the price of oil and gas.

Nevertheless, I am of the opinion that EOG is an excellent pick for investors with higher risk appetites, as EOG's returns could potentially be much higher than those from holding even the riskier major integrated companies with attractive valuations and high dividend yields, such as Statoil or Total.


Martin Vlcek has long positions in Statoil and Total SA. The Motley Fool recommends Statoil (ADR) and Total SA. (ADR). 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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