Apache (APA) recently reported fourth quarter and 2012 annual earnings. Fourth quarter revenues were flat at $4.4 billion versus revenues of $4.3 billion in the fourth quarter of 2011. Net income was $668 million, lower by 78% from last year. Apache blamed most of the decrease in earnings on lower oil and gas prices. The price that Apache received for oil dropped by nearly 4%, while natural gas realizations were fully 26% lower. While things look bad for Apache right now, I believe that the company's long-term future looks bright.
Evaluating Apache as an investment
When a prospective investor evaluates Apache their first thought might well be that this company is a loser, and definitely not worth investing in. There are at least eight reasons why an investor might come to that conclusion.
1. Over the last 52 weeks Apache's stock price has decreased by 29%.
2. The company's fourth quarter year-over-year revenue growth was only 3.6%.
3. The company's fourth quarter year-over-year earnings growth decreased by -43.8%.
4. As of December 31st the company's balance sheet had a cash balance of $160 million but a debt balance of $12.34.6 billion.
5. The company has had a number of unexpected weather related work stoppages in just the last few months.
6. The company's progress in the Kitimat project has slowed, and it could be years before it turns a profit.
7. It now appears that the company's Australian natural gas project will not begin until 2014.
8. Over the last 52 weeks almost all of the stocks of companies in the oil and gas exploration industry have slumped.
It is clear that 2012 was not a good year for Apache, or for most of the companies in the oil and gas exploration industry. For many investors, any one of the above problems would be a reason to shun Apache's stock. However, it can sometimes be a good strategy to take a contrarian view when evaluating a stock. Often times buying the stock of a strong company that has had some temporary setbacks, can be a winning strategy. Right now Apache's stock is undervalued, and I would categorize it as being a strong company that has had some temporary setbacks. Currently Apache's stock is cheap, and could be considered undervalued. Its price to earnings ratio is 15.7 and its price to book ratio is 0.96. Its forward price to earnings ratio is 7.06. These valuations make it cheaper than competitors, such as:
- Anadarko Petroleum (APC), which has a PE ratio of 17.7, a FPE ratio of 16.5 and a PB ratio of 2.05.
- EOG Resources (EOG), which has a PE ratio of 62, a FPE ratio of 17 and a PB ratio of 2.7.
It appears that Apache's stock is undervalued for the following reasons:
1. With a forward price to earnings ratio of 7.06 its stock is trading at a discount to its five year average of 10.5.
2. Apache's stock is currently trading at book value versus a median price of two times book value.
3. The consensus median price target of 27 analysts who covered the stock is $104.72.
Apache's Prospects Moving Forward
Apache has changed its focus from drilling for natural gas to drilling for higher margin oil products. As a result of new horizontal drilling techniques Apache's projects in the Anadarko and Permian Basins have increased in oil production by 30%. Additionally as a result of its change of focus, it is estimated that Apache's revenues will increase by 8% in 2013 despite being flat in 2012. The increased oil production from the Anadarko and Permian Basins will increase Apache's North American production from 46% in 2010 to 55% in 2012.
Apache has done a good job of increasing its oil production. Unfortunately, other oil and gas exploration companies have also utilized the new advanced drilling techniques to their advantage. Two examples are EOG Resources, which increased its fourth quarter U.S. crude oil production by 37.5%, and Chesapeake Energy (CHK), which increased its U.S. crude oil production by 15%. Both of these companies along with Devon Energy and Anadarko Petroleum predict that their 2013 U.S. oil production will be higher than in 2012. This trend was highlighted in November when the International Energy Agency forecast that "U.S. oil output would continue to rise and could exceed the production from Saudi Arabia or Russia by 2017". The West Texas Intermediate (WTI) oil that is extracted from the newly productive U.S. oil fields currently sells for about $93 per barrel as opposed to Brent crude oil, which sells for about $109 a barrel. WTI oil sells for a discount because of the oil glut that has been created by oversupply as a result of improved extraction methods and increased competition. With so many energy companies changing their focus to the production of oil the oversupply of WTI oil is likely to be a long term problem, which could hurt Apache's future earnings.
Apache, like its other oil and gas producers, had a rough year in 2012 mainly due to natural gas prices, which approached near ten year lows. However, since the company changed its focus towards drilling for liquid products (OIL) rather than natural gas, its earnings have improved. In the fourth quarter its earnings were higher than the third. However, due to intense competition, low oil and gas prices and a flat U.S. economy I do not foresee much of a near term boost in Apache's stock price. The good news for patient investors is that oil and gas prices will not remain low forever, and when they increase Apache's stock price could take off.
Additional disclosure: I am currently trading APA call options.