Relative Valuation

Relative valuation methods try and determine how a firm is priced relative to its peers. The critical aspects of relative valuation involve choosing comparable companies and controlling for differences between firms. In this section, we analyze EOG based on its P/E, EV/EBITDA, and EV/BOEPD ratios. EOG is also valued using a hybrid intrinsic/relative valuation model that involves choosing a target P/E ratio.

Price to Earnings Ratio

EOG is currently trading at 41x earnings which its above its median P/E of 20.21x. This means its relatively expensive when compared to their past. In Chart 1, theres a visible spike in their P/E during February of this year due to their in EPS dropping from $4.10 in 2011 to $2.51 in 2012. Their reduced income during the fourth quarter of 2012 was due to the large write-down of a Canadian natural gas play. Since then their P/E has been trending downwards, but investors are still paying more than double what they have historically paid for earnings. Chart 1: EOG's P/E trending lower
200.00x 180.00x 160.00x 140.00x 120.00x 100.00x 80.00x 60.00x 40.00x 20.00x 0.00x
P/E-Earnings fom trailing LTM
EOG P/ELTM Median

14 12 10 8

Chart 2: EOG is expensive relative to EPX index

-EOG Relative P/E to Median P/E of EPX EOG Relative P/E EOG's Median Relative P/E

Source:Capital IQ

6 4 2 0
Source: Capital IQ

Chart 2 shows that when compared to the EPX index, EOG is more expensive relative to its industry/peers. The EPX index is relatively small and Chart 3: EOG expensive when contains EOGs entire peer group, so I feel it is a fair to compared to the market substitute it in lieu of peer comparisons. EOGs mean 12 -EOG Relative P/E to Median S&P500 P/E relative P/E ratio of 1.25 means that at its current EOG P/E Relative to 10 S&P 500 relative P/E ratio of 1.08 its trading at a 16.8% discount 8 Median Relative P/E to the industry. Chart 3 shows that EOG is currently 6 Source: Capital expensive when compared to the S&P 500. Its current 4 relative P/E ratio of 2.29% is trading at a premium of 2
0

115.2% when compared to its median relative ratio of 1.139. Thoughts on the P/E Ratio I feel the P/E ratio is a poor valuation metric for this industry. E&Ps have a huge capex requirement which means that EPS are extremely volatile. EOG is one of the only companies in the industry not to have significant gaps in its P/E ratio history due to negative earnings.

EV/EBITDA
One of the main advantages of the EV/EBITDA model is that its further up the income statement than EPS. This means that the E&Ps large capex requirements wont play havoc with the multiple. In his book Investment Valuation, Damodaran says that the EV/EBITDA multiple is determined by five components: Tax rates, DD&A, reinvestment requirements, cost of capital, and expected growth. Knowing the components of a multiple allow us to run a regression based on these predictors in order to predict a firms multiple. The predicted multiple allows us to compare firms after accounting for differences between firms. To calculate a predicted EV/EBITDA multiple for EOG, we first have to compile a group of comparable firms. I used the constituents of the EPX index for this analysis. After that, I ran a multiple regression using the following as my predictors: DD&A/EBITDA, Capex/EBITDA, effective tax rate, ROC, and expected revenue growth for the next two years. The results of the regression analysis can be seen in Table 1.
Table 1: Results of Multiple Regression Expected Growth in Revenues-2yr 27.47

R Square 0.45

Intercept 18.14

Tax Rate 0.03

ROC -73.04

Net Capex/EBITDA -0.30

DD&A/EBITDA -17.77

The most important thing to note in the table is the R-square (RSQ). The RSQ of a regression measures how good its predictors are at actually predicting the variable. An RSQ of 0.45 may be considered horrible for textbook problems, but in the real world this is actually pretty high. Solving for EOGs predicted multiple using the coefficients and actual values gives us a predicted EV/EBITDA of 6.37. EOGs actual EV/EBITDA is 7.44, which means EOG is relatively expensive.
19 17 15

Chart 4: Points above the line are relatively expensive after accounting for differences between firms
RRC PXD COG

Predicted

13 11 9 7 5 3 3 5 7
APA WTI NBL SWN EOG TSO APC WLL XEC DNR :SM

The real power of regressing a multiples components is the ability to quickly visualize which companies are overvalued (or undervalued) based on the multiple. Chart 4 is a plot of predicted versus actual multiples for every company in the sample. The trend line allows us to quickly see which

CHK

Actual

11

13

15

companies are undervalued by simply noting which are under the trend line!

EV/BOEPD
The EV/BOEPD ratio is also known as the price per flowing barrel. This is one of the most commonly used valuation multiples in the E&P industry. Price per flowing barrel compares a firms enterprise value to its daily oil-equivalent production rate. Natural gas production rates are usually reported in thousands of cubic feet per day (Mcf/d). Standard Chart 5: EOG's price per flowing barrel practice is to multiply this by 6 in order to convert it to is cheaper than that of its peers. bbl/day. Companies with a multiple thats higher -EV/Kboe/day (lower) than their peer average are considered Source: Capital IQ CHK expensive (cheap) relative to their peers. PXD
CLR CXO EV/Kboe-d 150 EOG APC APA 50 MRO TLM NBL MUR RRC INE XEC

250

200

100

Chart 5 shows that EOGs price per flowing barrel is less than the peer average. EOGs price per flowing barrel of production is $100.66M compared to the peer average of $115.95M. This means that EOG is relatively cheap when compared to its peers. One of the main problems with this metric is that it doesnt account for differences between the weighting of a BOEs components. This means that a company that appears cheap could have production heavily weighted towards natural gas. To account for this, companies can be compared based on their price per flowing barrel of liquids. This is calculated by dividing a companys enterprise value by their average daily liquids production (Liquids=Oil + NGL). Chart 6 shows that EOG even cheaper than its peers after adjusting for gas production. EOGs price per flowing barrel of liquids is $180.85M compared to a peer average of $257.96M. EOGs liquids production is discounted by approximately 30% compared to the peer average.

900 800 EV/Kbbl Liquids per Day 700 600 500 400 300 200 100 0

Chart 6: EOG's is cheaper than peers based on price per barrel of fowing liquids CHK
-EV/Kbbl of liquids per day Source: Capital IQ

RRC PXD APC APA NBL TLM EOG MRO MUR INE

CLRCXO XEC

10

15

Other problems still exist with this metric even after accounting for differences in the weighting of the components that make up a companys production profile. One of the primary issues is that price per flowing barrel doesnt account for differences between undeveloped reserves (either proven or unproven). This means that a high multiple could just be the result of a company having higher EV due to a large number of undeveloped reserves.

Target P/E
Valuing a firm using a target P/E ratio is a hybrid relative/DCF valuation method. This technique requires you to first forecast a firms dividends five years into the future and then sum their present values. You then multiply a target P/E by the firms forecasted EPS in the fifth year, calculate its present value and add it to the present value of the dividends. All forecasts were made using the FCFF model used in the intrinsic value section of this paper. The 10.17% cost of equity calculated in the section on discount rates was also used. I chose to use EOGs average P/E of 31 as the target P/E. I could have also used the firms median P/E of 20.6, but I feel that this was too representative of the past characteristics of the firm. Going back to Chart 1, you can see that EOGs P/E was steady prior to around 2007. It has been much more volatile since then. I feel this is due to the switch from conventional resources to unconventional resources. Tight oil/gas plays have large decline rates and require firms to develop plays at faster rates to keep their overall production rate from declining which requires a lot more capex. As previously discussed, large capex requirements can cause EPS to be quite volatile. I calculated EOGs share price to be 97.34 using the target P/E of 31. Table XX lists a range of P/E around my target as well as the target P/E required to equal the share price today. The target P/E calculated is approximately 42.5% less than the value of todays P/E. To get to a price of $169 requires using a P/E of 54, which is higher than todays. I feel that this is due to the same reasons why none of the DDM models would give anywhere close to a reasonable value. The value of EOGs dividend is tiny when compared to its price. Dividend yields are currently around .04%, which is extremely low.
Table 2: Value using Target P/E of 31
Target P/E Value 30 94.2

25 78.5

26 81.64

27 84.78

28 87.92

29 91.06

31 97.34

32 100.48

33 103.62

34 106.76

35 109.9

54 169.56

Final Thoughts on Relative Valuation

EOG is more expensive on a relative basis when comparing their P/E ratio against their historical ratio, their peer/industrys ratio and the S&P500s ratio. Regressing the components that determine the EV/EBITDA allowed me to come up with an equation to calculate a predicted multiple using EOGs components. Their actual multiple was higher than what was predicted by the equation, which meant they were expensive relative to their peers. EOG is cheaper relative to peers when compared on both price per flowing barrel and price per flowing barrel of liquids. The results of EOGs relative valuation are mixed. While EOG is more expensive relative to its peers when compared using the P/E and EV/EBITDA ratios, its relatively cheaper than its peers when compared on a basis of price per flowing barrel of production and price per flowing barrel of liquids. This leads to recommend EOG as a hold based on its relative valuation.

Technical Analysis
Technical Analysis is the process of analyzing historical data for patterns that could be used to predict the future direction of prices. There are many different types of patterns and indicators that investors use to forecast future price movements. In this section I will be analyzing EOG using two of the most common indicators: Moving Averages (MA) and the Relative Strength Index (RSI).

Moving Averages
A stocks moving average is just a time series of its simple average calculated over a certain period. In this section I will use EOGs 50-day, 100-day and 200-day MA in order to make observations regarding EOGs past and future price history. This summer marked the start of a steep uptrend that ended on 11/05 when EOG broke through the support level at the trend line (circled area on Chart 5). Momentum has begun to slow considerably. While their 200-day MA is still sloping up, their 100-day MA is starting to level off and their 50-day MA has been sloping downward since 11/25. The 50-day MA appears to be about to cross the 100-day MA which is a bearish indicator.
Figure 1: EOG's Technicals Source: Yahoo Finance

RSI
The RSI indicator is a momentum oscillator that estimates a stocks momentum by comparing recent gains to recent losses. The RSI ranges between 0 and 100. Looking at EOGs RSI we can see that it started diverging prior to the peak of its trend on 11/05. The line across the top of the RSI indicator marks a series of lower highs which indicate that the RSI is diverging from price. Their RSI started swinging sharply upwards starting on 12/12 as EOGs price increased from $156.26 on 12/11 to $168.52 on 12/20. This large increase in momentum is a bullish indicator and could mean EOGs price will climb higher.

Final Thoughts on EOGs Technicals

These two indicators are contradicting, which means theres a lot of uncertainty in EOGs price right now. As it stands currently, EOGs technicals reinforce my opinion that they are a definite hold. I would need to see their price moving in a clear direction on strong volume for me to change my recommendation to a buy or sell.