How Disciplined Cost Cutting Made EOG Resources (NYSE:EOG) the Main Beneficiary of Rising Energy Prices

0

When evaluating large companies in the energy sector, we find that EOG resources’ (NYSE:EOG) meets certain essential criteria. The company is focused on providing shareholders with cash returns, has increased the efficiency of its operations and has significantly increased the return on capital employed. In this article, we’ll connect these factors and see why investors may want to put this stock on their watch list.

Overview

EOG produces and distributes oil and gas. Its main production areas are located in New Mexico and Texas in the United States; and the Republic of Trinidad and Tobago.

EOG has a low and efficient equilibrium price of US$32 for WTI and estimates to generate a ROCE of 10% at the WTI price level of US$44. Of course, recent events have shattered all expectations, and with oil prices trading above US$120, EOG has the ability to generate much larger returns.

It’s also great to see EOG increasing efficiency over the years by increasing the double-premium sinks and reducing the equilibrium price.

Many factors affect increased efficiency, and the company highlights the following: reduction in cash operating costs from $13.5 in 2014 to $10.1 in 2021, development costs from $13.2 $ to $5.81 over the same period, reducing depreciation costs by 42% to $10.7 per boe. All of these factors have significantly pushed the company to maximize returns in 2022.

In the table below, EOG outlines the increase in efficiency resulting from its dual prime drilling operations:

NYSE: Historic EOG Effectiveness, March 8, 2022

Return on capital employed (ROCE)

When it comes to finances, it looks like 2021 has been a pretty good year, with 2022 set to be even better due to rising energy prices. The company generated $5.5 billion in free cash flow. This allowed EOG to return $2.7 billion to shareholders, increase the regular dividend by 100% from $1.65 per share to $3 per share, and repay a $750 million bond.

Dividend investors may also find the stock attractive. You can view our dividend analysis for EOG here.

In order to understand the company’s ROCE, we will first assess its current performance and then see how it can potentially perform in the future.

If you’ve never worked with ROCE before, it measures the “yield” (pre-tax profit) a company generates from the capital used in its business. The formula for this calculation on EOG Resources is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

0.18 = $6.1 billion ÷ ($38 billion – $4.0 billion) (Based on the last twelve months to December 2021).

Thereby, EOG Resources posted a ROCE of 18%. In absolute terms, that’s a decent return, but compared to the oil and gas industry average of 9.5%, it’s much better.

An 18% ROCE is also arguably higher than the company’s cost of capital, which means that EOG is creating value and share price increases have a fundamental justification, and not just because of rising energy prices.

See our latest analysis for EOG Resources

rock
NYSE: Return on capital employed EOG March 8, 2022

The fact that EOG Resources has turned around returns from a loss five years ago to an 18% return is quite encouraging. In addition to that, EOG Resources employs 25% more capital than before. This may indicate that there are many opportunities to invest capital internally and at ever higher rates.

If you want to see what analysts are predicting for the future, you should check out our free report for EOG Resources.

Looking ahead, the company estimates that it can generate $6.4 billion in free cash flow at an average price of $80 WTI, depending on how events unfold in the future, this could be on the lower end of profitability estimates.

Conclusion

It’s great to see EOG increasing returns on capital employed, while maintaining its commitment to value and cash returns for investors. The stock is in a good position to take advantage of the current market turmoil, and investors who are bullish on energy prices may find this stock very attractive.

On a separate note, we found 2 warning signs for EOG Resources you will probably want to know more.

If you want to look for strong companies with excellent earnings, check out this free list of companies with strong balance sheets and impressive returns on equity.

Simply Wall St analyst Goran Damchevski and Simply Wall St have no position at any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials.

Share.

About Author

Comments are closed.