EOG Resources Dividend Increase: Never Mind The Pennies

(Bloomberg Gadfly) -- Try to contain your excitement, but the dividend yield on EOG Resources Inc.'s stock just spiked:

Even after the 10 percent increase announced late on Tuesday, EOG's dividend isn't going to feed too many widows and orphans. But, without wishing to seem callous, who cares?

In the great debate around growth versus returns in the shale patch, EOG's token dividend increase underlines why things are a bit more complicated than that simple dichotomy suggests. As I wrote here, what really sets exploration and production companies apart is how efficiently they can deploy capital to grow.

While the still-minimal dividend and higher capital expenditure guidance for 2018 disappointed some investors -- EOG's stock was down about 4 percent in early trading on Wednesday -- the bigger picture is more positive.

Cash from operations last year covered capital expenditure and about a third of the dividend, leaving free cash flow after dividends negative, but only to the tune of $245 million, at an average oil price of less than $51 a barrel.

While capex is expected to rise by 36 percent this year (at the midpoint of the guidance range), EOG is guiding for free cash flow after dividends of $1.5 billion, assuming an average oil price of $60 a barrel, which is slightly below what futures imply today.

Importantly, the company still aims to raise its crude oil production by 17 percent (at the midpoint) and says it can break even at less than $50.

If EOG can deliver that sort of free cash flow while still growing its crude oil production by 17 percent this year, that is some operating leverage and the dividend is largely irrelevant. Net debt, which peaked at $6.3 billion in the E&P sector's existential first quarter of 2016, would drop to a pro-forma $4 billion, the lowest since the end of 2014, just as oil prices were tipping into the crash. That would give EOG room to either ramp up production further, if conditions warranted, raise the dividend substantially or announce a buyback.

There is, of course, no guarantee EOG delivers. On the other hand, it mostly has thus far. Besides a distinctly tech-savvy approach to drilling and completing wells, EOG has done some basic blocking and tackling on cost inflation, securing 85 percent of this year's rigs at last year's lower prices and taking similar steps with regards to fracking fleets, well-casings and sand. And remember, unlike many of its peers, EOG neither cut its dividend nor put out its hand for more equity capital during the downturn.

Holding the company to its bold claims combining high free cash flow and growth is the critical test for EOG in 2018, not the pennies scattered around today.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

To contact the author of this story: Liam Denning in New York at ldenning1@bloomberg.net.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net.

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