EOG Resources (IL/A): Continued strong results justify premium valuation _ Goldman Sachs - May 07, 2006
EOG Resources continues to deliver leading organic production growth and returns on capital among large-cap E&Ps, and we believe a premium valuation is appropriate. In addition, we believe Devon Energy's (DVN; IL/A) recent acquisition of additional Barnett Shale acreage points to significant potential upside in the performance of Barnett assets from technological developments and fine-tuning operating techniques that may raise recoverable resource estimates. But with EOG trading at about a 20% premium to other large-cap gas E&Ps on an EV/DACF basis, we believe continued strong execution in the Barnett and elsewhere is already priced into the shares, such that further outperformance would likely require sanctioning of a new "Barnett look-alike" unconventional gas play or exploration success in one or more other key prospects. We rate EOG In-Line relative to an Attractive coverage view. KEY
COMPANY-SPECIFIC CATALYSTS
(1) Meeting or exceeding 10.5% year-over-year organic growth target. Thus far EOG appears well on track towards delivering on its 10.5% growth target for 2006, with 1Q 2006 growth tracking at 10.6% versus 1Q 2005 in spite of some unexpected lingering hurricane-related delays in the Gulf of Mexico. Over the balance of the year, we believe investor focus will remain on results in the Barnett Shale, where EOG is meaningfully ramping up production with a 214 well program in 2006. We are forecasting over 100% growth both this year and again in 2007 from the Barnett. As we believe investors are increasingly growing comfortable that EOG will deliver on this year's growth target, focus will likely begin to shift, in our view, towards where within the 2007-2010 estimated range of 7%-11% EOG will target for 2007. With a high bar set in 2006, we believe investors will be looking for double digit growth in 2007 as well.
(2) Potential sanctioning of a new large-scale unconventional gas play. EOG has accumulated a significant acreage position in several areas which the company characterizes as having attributes similar to the Barnett Shale. On its 1Q 2006 earnings conference call, management specifically mentioned Culberson County, in which EOG has accumulated a substantial 126,000 acre position. A horizontal well was drilled with an IP rate of 2.25 MMcf/d and is exhibiting after three months what management characterized as a similar initial decline profile to a Western Johnson County short lateral well. A second well drilled elsewhere on the Culberson County acreage was a dry hole. Management expects it will know whether the play is commercial by year-end, in addition to having evaluated two other yet to be identified plays. While we believe a high level of success in the Barnett Shale is already discounted in EOG's shares, sanctioning of one -- let alone several -- of these new gas plays would, in our view, be a significant positive catalyst for EOG. News flow is expected in late 2006 and early 2007.
(3) Use of balance sheet and returning cash to shareholders. Strong free cash flow has left EOG essentially debt-free, with net debt/tangible capital down to 2% at the end of 1Q 2006. While EOG has among the most attractive reinvestment opportunities of any company we cover, we believe investors would view it favorably if EOG used some of its ultra-healthy balance sheet strength to return cash to shareholders via share buybacks or further dividend increases. As EOG is far from being capital constrained, it would be possible to return significant amounts of cash while also retaining relatively low leverage and funding almost any conceivable capital program. We are forecasting a $500 million share repurchase program in 2007, though we believe EOG may begin even earlier, especially if commodity prices remain firm.
PREMIUM VALUATION DESERVED
At 7.2X 2006E and 5.8X 2007E enterprise value/debt-adjusted cash flow, EOG trades at a substantial premium to the large-cap gas-levered E&P average of 6.2X and 4.9X, respectively. We believe this premium is appropriate given EOG's top-tier organic production growth and leading profitability. We believe EOG's shares will continue to perform well on an absolute basis due to our bullish view of commodity prices, but we see more favorable risk/reward in our Outperform rated stocks at this time, which among large-cap gas E&Ps include XTO Energy (XTO; OP/A) and EnCana (ECA; OP/A). That said, outperformance could be catalyzed by sanctioning of a new unconventional gas play, exploration success, or better than expected results in the Barnett Shale.
1Q 2006 RESULTS GENERALLY IN LINE WITH EXPECTATIONS
EOG reported 1Q 2006 operating and financial results in line with our expectations. Adjusted EPS of $1.53 was above our estimate of $1.35 and the First Call consensus of $1.24, benefiting from a larger than expected realized hedging gain of $30 million. Production of 1.53 Bcfe/d was in line with our estimate, as were all-in unit costs of $19.93 per BOE.
UPDATING ESTIMATES
We are adjusting our 2Q and 3Q, and full-year 2006 EPS estimates to reflect revised assumptions for production, unit costs, new hedges, and minor other adjustments. Our 2Q, 3Q and 4Q 2006 EPS estimates are now $0.97, $1.31 and $1.66 versus $1.17, $1.44 and $1.67 before, respectively. Our full-year 2006 EPS estimate is now $5.47 versus $5.64 before. There are no changes to our 2007-2010 EPS estimates.
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. |
