EOG Resources (IL/A): Analyst meeting highlights attractive growth and returns - Goldman Sachs - September 14, 2005
We came away from EOG Resources' annual analyst meeting believing that it remains on-track for top quartile growth and returns on capital among E&P- oriented companies. The company's new 9% average annual production growth projection through 2010 was in line with our existing expectations. The key catalysts for the shares aside from continued commodity strength include continued success in the Barnett Shale as well as results from impact exploration drilling programs both onshore the United States and offshore Trinidad and Tobago. We believe it is a close call between the three 'growthy' large-cap North America gas E&Ps XTO Energy, EnCana, and EOG. Of the three, we see the most upside at this time for the shares of XTO (OP/A), with EnCana (OP/A) and EOG (IL/A) showing virtually the same upside.
* Leading growth and returns already reflected in our estimates. There is no change to our EPS projections following the analyst meeting. Our models had already reflected the roughly 9% average annual production growth through 2010 that EOG projected for the first time at this meeting. Capital spending guidance to achieve its volume growth objectives were also in line with our forecasts.
* Use of free cash flow becomes a more pressing question in 2006. In terms of use of free cash flow, EOG expressed a strong preference to finding attractive reinvestment opportunities versus stock buyback or a special dividend. However, the company left the door open for an expanded stock buyback program, while indicating that it had little interest in a special dividend. We expect EOG to be essentially net debt free some time in 2006. We think the issue of how to spend free cash flow becomes a more critical question for EOG and industry more broadly in 2006, as industry overall (and EOG specifically) essentially moves to a zero net debt position.
* EOG, EnCana, and XTO show differential organic growth potential onshore North America. We believe the trio of EOG, EnCana and XTO Energy stand apart from other large-cap E&Ps in terms of being able to demonstrate multi-year, visible production growth at attractive rates of return from North America natural gas. Most of the other larger E&Ps are struggling just to maintain production volumes in North America. We note that unlike EnCana or XTO, almost none of EOG's opportunity set came through a large property or corporate acquisition-the key reason EOG's returns on capital appear better today. However, in fairness to EnCana and XTO, both appear to have better project diversity than EOG.
* EOG shares have upside given our Attractive coverage view. We believe EOG shares continue to have meaningful upside potential in the context of our very bullish commodity macro outlook, with 32% upside potential to a $93 super-spike-adjusted peak valuation. We note that our super-spike-adjusted peak valuations do not give credit for the potential for sustained higher commodity prices beyond this decade, which to some degree penalizes companies with long-term visible growth like EOG. On the other hand, we think it is illogical to forecast both a super spike and sustained high commodity prices beyond the next several years as we see long-term sustained high prices as unlikely to be compatible with a super spike.
* Relative valuation appropriate considering current relative growth expectations. In terms of valuation, EOG trades at a 5.7X 2006E EV/DACF valuation, right in line with XTO (5.6X) and EnCana (5.8X) and well ahead of the large-cap E&P peer group at 5.0X. Our 2006 forecasts reflect our recently updated commodity price forecasts of $68/bbl for WTI oil and $9/MMBtu for Henry Hub spot natural gas. We believe the trio of growthy large-cap E&Ps will continue to trade at a premium valuation of about this magnitude versus the peer group, given current expectations for the period of advantaged growth. A wider (or narrower) valuation we think would require a further change in view in relative growth rates.
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.
=====
Previous Report
EOG Resources (IL/A): Confidence in sustainability of growth and returns advantage key to further relative upside Goldman Sachs July 27, 2005
Message 21547981 |
