EOG Resources Inc. (EOG), a major independent oil and gas exploration and production company, reported weaker-than-expected third-quarter results. Quarterly earnings were 18 cents per share, below both the Zacks Consensus Estimate of 20 cents and the year-ago profit of 81 cents.

Despite an increase in production volumes and higher commodity prices, earnings missed mainly due to higher operating expenses. While EOG’s results came in below our expectations, the company maintained its quarterly dividend of 15.5 cents per share (62 cents annualized).

Total revenue increased approximately 57% year over year to $1.58 billion, and exceeded the Zacks Consensus Estimate of $1.39 billion. EOG is gaining momentum by building a large North American shale acreage position.

Operational Performance

During the quarter, total volumes increased 11.7% from the year-earlier level to 218.8 billion cubic feet equivalent (Bcfe), or 2,378 million cubic feet equivalent per day (MMcfe/d), 72.4% of which was natural gas and 27.6% liquids.

Crude oil and condensate production during the quarter was 77.4 thousand barrels per day (MBbl/d), up approximately 30% from the year-ago level. This was primarily driven by a significant growth in North American volumes, specially the North Dakota Bakken play. Natural gas liquids (NGL) volumes increased almost 32% from the year-ago quarter to 31.9 MBbl/d.

Average realized natural gas prices increased roughly 26% year over year to $3.80 per Mcf. Domestic price realizations increased nearly 29% year over year to $4.21 per Mcf. Average realized prices for crude oil and condensates increased 17% year over year $70.96. Quarterly NGL prices increased 18% to $36.66 per barrel.

Liquidity Position

At the end of the quarter, EOG had cash and cash equivalents of $28 million and long-term debt of $3.8 billion, representing a debt-to-capitalization ratio of 27%. During the quarter, EOG generated approximately $755 million ($2.97 per share) in discretionary cash flow (DCF), compared with a DCF of $819 million ($3.25 per share) in the year-ago quarter.

Outlook

EOG’s growing emphasis on liquids is reflected through its growth in production volume, which increased 30% for the first time in the company’s history. However, the company has reduced its 2010 organic production growth forecast to 9% from 13% due to fracture equipment delays and lower cash flows resulting from weak natural gas prices.

For 2011 and 2012, EOG set an initial organic production growth target of 10% and 12%, respectively. The company also expects liquids production to grow at the rate of 53% and 30% in 2011 and 2012, respectively.

EOG’s increasing interest in oil is appreciable in a favorable price environment. Management said that about two-thirds of the North American revenue in 2011 will be derived from liquids.

The company plans to sell more non-core natural gas properties (about $600 million to $1 billion) in North America to fund oil-related activity. However, the company has set a new limit for its debt-to-capitalization range of 30% to 35%, up from the previous target of 25%. 

Although we view EOG as a favorable long-term story, risk-reward pay-off for the company is still uncertain over the near term, due to its natural gas weighted production and reserves base as well as cost overruns. We currently have an Underperform rating for EOG shares for the long term. The stock carries a Zacks #4 Rank (Sell) for the short term.

 
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