Wait for EOG Resources Shares to Pull Back Before Buying

Within the oil sector, EOG Resources has been faring better than its peers, but it's also priced too optimistically.
By Richard Saintvilus ,

The recent rally in oil prices, which has sent the Energy Select Sector SPDR Fund (XLE) - Get Report soaring 8% in the span of a week, has sparked optimism about a sector that has sputtered in negative territory for the more than a year. And with industry experts hinting that they foresee a sustained recovery in both WTI and Brent crude prices, it's become harder to ignore the potential value in EOG Resources (EOG) - Get Report , which reports its third-quarter results after the closing bell Thursday.

But buying EOG stock too early would be a mistake, especially now that the shares have already surged some 8% in the past month.

Like most its peers, the Houston-based energy company has found revenue and profits hard to come by lately. But EOG stock is only down 5% on the year and 6% over the past twelve months, a far more lenient punishment than the rest of the sector has suffered, as evidenced by how EOG crushed the XLE over those periods.

At this moment, EOG stock -- despite its consensus buy rating -- is not cheap. The shares trade at a price-to-earnings ratio of 34. Not only is that 13 points higher than the S&P 500 (SPX) index, it's 20 points higher than the XLE -- home to prominent energy giants like ExxonMobil (XOM) - Get Report and Chevron (CVX) - Get Report , which both trade at P/Es of 14.

Moreover, at around $87 per share, EOG is priced at a forward P/E of over 500, based on consensus fiscal 2016 earnings per share estimates of 17 cents. And this is assuming EOG, which is projected to lose 26 cents a share for fiscal 2015, doesn't guide downward.

True, EOG management -- driven by aggressive cost cutting and various divestments -- has kept the company's balance sheet in good health. Its net debt position of around $5 billion is more than manageable, given that the company generates more than $6 billion annually in operating cash flow. That's an important factor to consider at a time when most energy companies are continuing to suffer due to a global oil glut.

At the same time, EOG continues to reduce oil production levels, and says it is confident it can make money even if crude prices remain  around $50 per barrel -- hence the potential value I referred to at the top of this article. Its competitors have not been as bold.

The oversupply of oil that exists in the market today isn't going away soon, however. This means, EOG -- despite its confidence -- must significantly outperform the market to send its shares higher. Not to mention, they are already expensive, implying that the company's optimism is already priced into the stock. Accordingly, I would advise investors to wait for the stock to pull back by 10% or so,  to around $80, before buying.

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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