EOG Resources (IL/A): Delivering exceptional results, but relative valuation pricing in a lot of good news - Goldman Sachs - February 02, 2006
EOG's fundamental performance in terms of organic production growth, reserve replacement, returns on tangible capital employed, and balance sheet health has been outstanding and is expected to remain sector-leading in coming years. Our only issue with the shares today is that relative valuation also appears to reflect a lot of the good news. On an absolute basis, we would expect EOG shares to continue to perform well in light of our bullish commodity macro outlook and Attractive coverage view. However, we rate the shares In-Line as we see greater upside potential in its large- cap North America gas E&P peer XTO Energy (XTO; OP/A), which is also delivering excellent results but at a less expensive valuation.
EOG'S OUTSTANDING FUNDAMENTALS REFLECTED IN RELATIVE VALUATION
EOG shares currently trade at 6.7X 2006E EV/DACF and 6.1X 2007E EV/DACF, well above the large-cap North America gas E&P peer group averages of 5.6X 2006E and 4.9X 2007E. Some premium is clearly deserved, in our view, as EOG has been significantly outperforming most of its peers on a variety of key fundamental metrics over the past 18-24 months. However, we do not see the rationale for a valuation disparity with XTO Energy, which has also been delivering and is expected to continue to show excellent fundamental results. XTO trades at just 5.9X 2006E EV/DACF and 5.4X 2007E EV/DACF. Our cash flow-based valuation comparisons are consistent with a net asset value analysis that considers unbooked resources for both companies. At the moment we see EOG as trading very close to our $83 "traditional" peak value, though it still has 21% upside to a $100 "super-spike"-adjusted peak value. By way of comparison, XTO has 33% upside to a $63 traditional peak and 55% upside to a $74 "super-spike"-adjusted peak value. Hence our preference for XTO among large-cap, "visible growth" onshore North America gas E&Ps.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Delivery of 10.5% production growth objective in 2006. As part of its 4Q 2005 earnings release, EOG raised its forecast for full-year 2006 production growth to 10.5% from 9.5%--all of which is from the drillbit. EOG's new forecast is consistent with our expectations. We note that EOG's year-over-year US gas production growth is expected to accelerate over the course of 2006 from low-double digit growth in 1Q to what we think will be a mid-20s% growth rate in 3Q and 4Q. The second half growth rates, if achieved, would almost certainly be considerably above any other large-cap E&Ps in terms of US gas production and would set the stage for further upward revisions to production growth forecasts in 2007 relative to the current 9% per annum long-term expectation (total company).
(2) Ramp-up/execution of Barnett Shale drilling program. EOG is looking to meaningfully expand its Barnett Shale drilling activity in 2006 to 210 wells from 93 wells drilled in 2005. The company expressed confidence that it was well on-track to secure the necessary equipment and services to execute its program. Given EOG's premium valuation, we believe there is not meaningful room for slippage in its program, though the company's history of exceeding original guidance suggests it has been appropriately conservative in outlining its targets to the Street.
(3) Results from West Texas Barnett look-alike. Initial drilling results from EOG's formerly stealth West Texas Barnett look-alike prospect are encouraging, though it is still early days. The company is awaiting a mid-year pipeline hook-up to better determine production rates from its first well. On its earnings call, management indicated that it could drill 1-2 additional horizontal wells in order to be able to flow 3 wells into the pipeline. We believe delivering on new shale opportunities like this West Texas play is key to further increasing our estimated net asset value for EOG.
(4) Increasing cash returned to shareholders. With a 7% net debt-to-tangible capital, EOG's balance sheet is exceptionally healthy. With 4Q earnings results, the company announced a 50% increase to its quarterly dividend to $0.06/share from $0.04/share. While a nice bump, we see room for EOG to return additional cash to investors via a combination of dividends and share repurchase. We in fact have modeled a $500 million stock buyback program for EOG in 2006.
4Q 2005 RESULTS AHEAD OF CONSENSUS, IN-LINE WITH US
EOG reported 4Q 2005 clean EPS of $1.97 ($1.88 on a reported basis including one-time items), which was ahead of the $1.88 First Call consensus projection and essentially in-line with our $1.95 estimate. 4Q 2005 E&P production of 255 MBOE/d (thousands of barrels of oil equivalent per day) represented a strong 12.6% y-o-y growth. Importantly, growth did not lead to excessive cost inflation. In fact, we believe that EOG's full-year "all-in" cost structure of $18.69 per BOE, which was up less than 9% y-o-y, will compare favorably with its E&P peer group once all results have been reported.
INTRODUCING 2006 QUARTERLY EPS ESTIMATES
We are introducing 2006 quarterly EPS estimates for EOG as follows: $1.59 (1Q), $1.48 (2Q), $1.69 (3Q), and $2.13 (4Q). There is no change to our full-year 2006-2010 EPS forecasts. Exhibit 1 shows our summary financial model for EOG.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
