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EOG Resources (NYSE: EOG) has committed to returning 60% of its free cash flow to shareholders in 2022.
Oil has become increasingly nervous since my previous article last month. Additionally, the potential for oil prices to fall and dampen the overall EOG payout is much more relevant now than it was then.
As recently as May, investors were unsure of the extent to which the Fed would hike rates. Will it be 25 or 50 basis points? It turned out to be 75 basis points.
This caused the EOG share price to fall by more than 20%. The biggest drop in the last 12 months. A step that no one who invested in stocks missed.
In this article, I offer new perspectives to show that despite the recent sell-off in oil prices, oil prices will remain high for longer.
We are now in the middle of 2022 and there is no reason to believe that the second half of 2022 will not match the first half.
For that reason, paying around 7x free cash flow for EOG makes a lot of sense. Additionally, the bull case is supported by EOG’s commitment to a 60% return on free cash flow, which is close to the 8% return on investment for shareholders in 2022.
That’s why I rate this action as a purchase.
EOG Resources near term outlook
Oil prices have been a sell-off for the past few days. Investors are concerned that the economy is entering a significant and long-term slowdown, which will lead to a fall in oil demand.
What is the current oil price? The price of oil is around $109 WTI at the time of writing. So I need to remind you that the price of oil averaged $100 WTI in April?
This means that while investors are genuinely trembling that the “oil party” is over and dusty, I contend that it is not. It’s about perspective. At the moment, oil prices are almost as high as they have been in 5 years.
And the momentum that has brought us here over the past 18 months continues. We live in an oil based economy. Here is a small example: Agriculture consumes 17% of all fossil fuels (oil, coal and natural gas). And then, heating, electricity and buildings, everything needs oil, lots of oil and gas.
And while there’s plenty of news about a slowdown in the global economy, it’s not just “new news.” And although these considerations are now reflected in the WTI price on the spot market, WTI prices are still around 5% to 10% higher than in April. Again, it’s all about perspective.
And given that framework, I’ll discuss why investors would do well to get behind EOG Resources.
Capital allocation strategy, +60% tied return
EOG plans to return at least 60% of its free cash flow to shareholders. My guess is that EOG could have $9 billion to $9.5 billion in free cash flow over the next 12 months. See the next section for more details on this estimate.
If my estimates prove correct, EOG would return about $5.5 billion to shareholders over the next 12 months. That means shareholders should expect a return on investment of around 8% at the current EOG valuation.
EOG Inventory Valuation – 7x Free Cash Flow
There are many moving parts when evaluating EOG stocks.
The most pressing of these is how high will oil prices be for the rest of 2022? I have no idea. And yet it’s the biggest driving force behind my cop case.
Analysts still expect EOG’s free cash flow to hit $9 billion in 2022. And that EOG’s free cash flow will decline to about $8 billion in 2023.
For my part, I believe that the free cash flows of the EOG will be significantly higher in 2022. EOG states that its goal is to achieve free cash flow of $8 billion to $95 WTI. However, as mentioned, WTI is currently priced at $109.
Additionally, we know from EOG’s $10,000 filing that every $1 in WTI results in a net gain of $107 million. As a result, all the numbers show convincingly that EOG will report free cash flow of around $9.0 billion to $9.5 billion over the next twelve months.
Here’s the math:
- $109 WTI – $95 WTI previous estimate = $14 WTI
- $14 WTI * $107 million = $1.5 billion
- $8 billion free cash flow + $1.5 billion upward revised estimate = $9.5 billion free cash flow as new rate.
Therefore, despite various possible guesses, I believe paying 7x free cash flow for EOG is an attractive valuation.
EOG isn’t the cheapest oil and gas. As already mentioned, one aspect that makes the EOG particularly attractive is its clear capital allocation strategy. With EOG, investors don’t have to worry about EOG wasting valuable capital by reinvesting it back into the company.
The aim of the EOG is to return capital to the shareholders. I estimate that EOG will return 8% of capital to shareholders over the next 12 months.