Oil prices have been scorching hot over the past year, up nearly 50% and recently reaching into the $70s. Because of that, oil companies are flush with cash. However, after getting burned by plowing all their money into more wells in the past, they're holding back these days. That leaves them with an interesting dilemma of what to do with the gusher of free cash flow they're generating at current prices.
One thing a couple of oil company CEOs made clear on their first-quarter conference calls is that they have no desire to use that money for large-scale acquisitions. Instead, they're focusing on a variety of other options for their windfalls that they believe will create more value for investors over the long term.
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We have no interest in M&A
EOG Resources (NYSE: EOG) is cashing in on higher oil prices. The company repositioned its business to deliver strong oil growth along with some free cash flow, as long as oil was around $50 a barrel. Meanwhile, with crude well above that level now, the company is in the position to generate substantial free cash flow this year, which gives it lots of financial flexibility.
However, on the company's first-quarter conference call, CEO Bill Thomas had this to say concerning its flexibility: "Let me be clear on one point. We have no interest in expensive corporate M&A; [mergers and acquisitions] in any commodity price environment." That's because "EOG is an organic exploration company" and as such, it only plans to expand its opportunity set through "low-cost organic leasing and low-cost tactical property additions," not by paying up to buy other companies.
Instead of making deals, the company plans to use its growing excess cash flow to "reduce total debt outstanding by $3 billion over the next several years," which would cut it about 50%. In addition to that, EOG "will target dividend growth above our historical 19% compounded annual rate." The company firmly believes that by allocating its excess cash to shoring up its balance sheet, boosting the dividend, and leasing land in compelling locations, it will create more value for shareholders over the long term than it could by acquiring another company.
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We're not considering M&A either
Marathon Oil (NYSE: MRO) CEO Lee Tillman feels the same way. He stated on the company's first-quarter call that: "Our financial flexibility is at the top of our peer group and was further strengthened by receipt of proceeds from Libya and our final Canadian oil sands payment. This flexibility allows us to pursue multiple high-return uses of free cash, but we are taking a disciplined approach and we are not considering large-scale M&A."
Instead of pursuing an acquisition, the company could repurchase shares, since it already has a $1.5 billion authorization in place. In addition to that, it could look to boost its "already competitive $170 million annual dividend."
Meanwhile, like EOG, Marathon plans to organically grow its opportunity set by leasing land in compelling new plays. Tillman pointed out that, "We have successfully added quality operated locations in the Northern Delaware through trades and a small bolt-on and have captured over 250,000 acres across multiple onshore exploration plays, including a material position in the emerging Louisiana Chalk at less than $900 an acre."
The company plans to continue going down this route because it "offer[s] the potential to generate outsized full cycle returns."
A better way to create value
The reason a growing number of CEOs in the oil patch are choosing to avoid M&A is that those transactions tend to destroy more value than they create because companies need to pay a high premium to buy competitors. EOG Resources, on the other hand, has found that it can generate higher returns by investing its capital into finding new resource plays early in their lifecycle rather than paying up to buy those properties after others have de-risked them.
It's an approach that Marathon and others are now starting to follow given EOG's success. That growing focus on generating returns for investors instead of empire building could enable these oil stocks to outperform their acquisitive peers over the long term.
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