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By Peter Staas on Feb. 28, 2018

Industry bellwether EOG Resources (NYSE: EOG) posted fourth-quarter earnings per share that handily beat the consensus estimate and delivered a 20 percent increase in US oil production relative to year-ago levels.

The company also increased its quarterly dividend by 10 percent—the stock yields about 0.7 percent—and called for an impressive $1.5 billion in free cash flow next year if West Texas Intermediate hovers around $60 per barrel. Management indicated that much of this cash would go toward further reducing its leverage from an already low 1.28 times operating cash flow, a move that would provide further flexibility.

On the earnings call, management emphasized the company’s efforts to control costs by locking in services and consumables at below-market rates. The company also highlighted its efficiency gains, including expectations that its pressure-pumping fleet would produce 5 to 10 percent more wells per crew despite longer lateral lengths.

EOG Resources also continues to expand its so-called premium inventory of wells that can generate at least a 30 percent rate of return with oil prices at $40 per barrel. Over the past 12 months, the company has added about 2,000 additional locations to this club, including 540 net locations targeting the first Bone Spring in the Delaware Basin and 700 in the Wolfcamp, second Bone Spring and the Leonard Shale.

Two factors prompted the selloff in EOG Resources’ stock today: A capital-spending budget of $5.4 billion to $5.8 billion that represents a 36 percent increase over year-ago levels and conservative guidance calling for an 18 to 20 percent increase in hydrocarbon output. This capital budget dwarfed Wall Street’s consensus estimate, while the production guidance fell short of expectations.

EOG Resources’ spending plans for exploration and development amount to about $6.7 million per well, compared to about $5.9 million per well last year. Management attributed this increase expense to stepped-up drilling activity in the Delaware Basin, where the company continues to do a great deal of testing to hone its drilling and completion techniques. EOG Resources also allocated more capital to its exploratory efforts this year.

We would view this outsized capital spending as a show of strength, particularly when you consider EOG Resources’ guidance for free cash flow and a double-digit return on capital employed.

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