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This Oil Stock's Ambition Is to Become an Attractive Dividend Stock

Matthew DiLallo, The Motley Fool

Oil companies have a poor reputation when it comes to paying dividends. Many oil producers have only paid their investors a pittance over the years, instead opting to reinvest all their cash flow to chase production growth. Others, meanwhile, slashed their higher-yielding dividends when crude prices crashed in 2014 so that they could stay afloat. Most income-focused investors have simply chosen to avoid the sector.

For many years, EOG Resources (NYSE: EOG) had been part of the industry's problem, having paid a paltry dividend that often yielded less than 1%. The shale driller, however, has put a priority on increasing its payout in recent years. CEO Bill Thomas laid out the company's vision for its dividend on the second-quarter conference call, which is part of an ambitious plan to become an elite value creator.

The word dividends with a hand drawing an upward sloping line.

Image source: Getty Images.

We're becoming a low-cost, free cash flow-producing machine

Thomas led off the call by saying:

EOG does not need high oil prices to create significant value for our shareholders. During the second quarter, despite a 12% decline in WTI oil prices, EOG generated more than $350 million of free cash flow, lowered our long-term debt by $900 million and paid a substantially larger dividend than last year, all while organically growing U.S. oil production by 20%. The EOG culture of consistently making improvements throughout the company year-after-year has propelled EOG to compete financially with a very best in the S&P 500, all with oil prices averaging below $60 per barrel.

As EOG's CEO points out, the company has repositioned its business in recent years so that it can produce significant cash flow at lower oil prices. The success of that strategy was apparent during the second quarter. Even though oil prices slumped by double digits, EOG produced enough cash to invest in the new wells needed to grow its oil production 20% with $350 million left over. That gave it the funds to reduce debt and pay a much higher dividend.

Generating a growing stream of free cash flow continues to be a top priority at EOG Resources. It remains focused on ways to reduce costs so that it can produce a gusher of free cash at even lower oil prices in the future.

Two oil barrels on top of U.S. currency.

Image source: Getty Images.

We have an ambitious plan for our dividend

Thomas then drilled down into EOG's dividend growth strategy: "Our commitment to strong free cash flow is enabling us to rapidly grow the dividend. We've increased the dividend 72% in the last two years, and our ambition is to target a yield that is competitive in the S&P 500, which stands around 2%." 

While EOG Resources has a long history of increasing its dividend, it has accelerated its growth rate over the past two years. As a result, the company's yield has risen from less than 0.8% a few years ago to around 1.5% in recent weeks. More high-octane dividend growth appears to be ahead, given its target to boost the yield up to the S&P 500's average. To reach that level, the company would need to increase its dividend another 35%, given its current stock price.

EOG, however, isn't expecting to give investors only one more big boost and call it a day. Instead, Thomas said:

Our goal is to continue to aggressively increase the dividend, certainly at 20% or better every year and... we believe we can do that or better. And so our focus is just to have a sustainable strong dividend growth every year and get the dividend up through the yield of the 2% level. We don't have a specific timeline to give you because we need to manage the business according to our view of the business environment. ... But directionally, we want to be competitive with the S&P 500 companies and the dividend yield.

In other words, EOG wants to be known as a dividend growth stock instead of a company that pays an average yield. So while it's targeting to pay 2%, it aims to continue increasing its dividend at an above-average rate in the coming years. As a result, its yield could rise above that level. Though the overarching goal is to increase the dividend so that the stock price also grows, enabling it to produce total returns that outpace the S&P 500's by a wide margin.

A big part of the total return package

EOG Resources wants to be one of the best-performing stocks in the S&P 500. One way it intends on reaching that goal is by increasing its dividend at an accelerated rate in the coming years. That ambitious plan makes EOG an ideal stock for dividend growth investors to consider buying.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

This article was originally published on Fool.com