Here’s Why EOG Resources Shares Are Flying

Source: Thinkstock

One of the best-performing stocks in the oil and gas exploration and production space in both the short- and long-term has been EOG Resources (NYSE:EOG). In the past 10 years, the shares have risen more than 700 percent. While there was a correction toward the end of 2013, the shares have risen a whopping 18 percent so far in 2014, and they sit a hair below their all-time high at $99.

But despite this stellar performance, I think there could be more room to run in shares of EOG Resources.

EOG Resources is among the fastest-growing large cap oil and gas producers. Over the past three years, crude oil production has grown at an astonishing annualized rate of more than 40 percent. Total revenues have soared 37 percent per year despite a tepid natural gas market. Furthermore, the company plans on growing its crude production at 27 percent this year, and its total production at 11 percent — not as fast as in prior years, but certainly commendable. Despite this rapid growth, the stock only trades at 20 times this year’s earnings estimates and at 17 times 2015 estimates.

Production growth is not all that makes EOG Resources attractive. As a resource company, it is imperative that EOG Resources find more oil and gas. If it doesn’t, then once it produces the resources it has, it is essentially out of business. But EOG Resources has done a phenomenal job of replacing its reserves. The company had a 264 percent reserve replacement rate in 2013.

This means that it was able to find 264 percent more oil and gas reserves than it produced. Furthermore, net developed reserves (i.e., reserves that are ready for production) increased by 19 percent. A lot of this is in the Eagle Ford region in Texas, where there is an oil and gas boom. The company’s Eagle Ford reserves grew at an incredible 45 percent.

All of these numbers essentially point to one thing: EOG Resources is an inexpensive, rapidly growing company that is securing its future growth.

It follows that EOG Resources is a compelling investment if you are bullish on the prices of oil and gas, and if you are willing to pay a premium for a company that is growing its production. What I mean by this last point is that investors who are more comfortable buying stocks with lower earnings multiples and larger dividends might be more comfortable buying shares in a lower-risk oil and gas producer such as Conoco Philips (NYSE:COP). Since there is a risk that EOG Resources will not be able to maintain its growth, it is not a stock for everybody.

In addition, there are a couple of risks that investors should consider. First, in addition to trading at a high earnings multiple, EOG Resources trades at more than 3 times its book value, whereas many of its lower-risk peers trade at less than 2 times book value. Investors are confident that management will be able to continue to grow its reserves and hence its book value at a fast rate. If it can’t, then EOG shares could underperform the sector.

Second, this may be obvious, but there is the risk that oil and gas prices can fall. Gas prices in particular fell violently about a month ago, after soaring in the prior months. While the trend is still upward, we have to keep in mind that speculators can drive commodity markets to extremes, and even if the market is fundamentally wrong, in some cases these synthetic prices have a real impact on companies such as EOG Resources.

Finally, a lot of environmental groups have expressed concerns over the impact hydraulic fracturing (fracking) has, and if they are successful in slowing down or stopping this method of extracting oil and gas, then EOG Resources will lose a lot of value.

But despite these concerns for a growing company, EOG Resources is relatively inexpensive, and I think enterprising investors should consider taking a position. With the stock just below its all-time high, it might be worth waiting for a pullback toward the $93 per share to $95 per share level. Investors who like the company but who want to wait for a more meaningful correction should consider buying in the mid-$80 range. However, given the strength in oil prices and given the value in EOG shares, I’m not so sure we will see the stock go down that much.

Disclosure: Ben Kramer-Miller has no positions in the stocks mentioned in this article.

More From Wall St. Cheat Sheet: