I would like to begin by publicly apologizing to G. Steven Farris, Apache's (NYSE:APA) CEO. Mr. Farris did not receive my previous requests for communication, and I erroneously wrote in the last article, Apache: Calling Out The CEO that Mr. Farris failed to respond to these requests. I did not follow the proper channels of communication, and I accept responsibility for my mistake. As a result, I inaccurately portrayed Mr. Farris pertaining to this incident. I regret the error, and I apologize to him for it. Being new to the process of using the media to facilitate investment research, I chalk it up as a lesson learned.
Following the article, I received an immediate response from Apache's Investor Relations Department, and we began a constructive dialogue.
The 2013 corporate performance goals have not been publicly announced to shareholders, so we will work from 2012. For 2012, Apache had five corporate performance goals:
1) Production Growth 6%
2) EPS $4.5 billion
3) Reserve Growth 5%
4) Cash Flow $10.2 billion
5) Cost Objective Per BOE $9.54
As a result of the discussion with Apache, a couple of ideas were generated that could make helpful additions to the list of corporate performance goals.
1) Maintaining the current Moody's A3 credit rating
2) Adding a Shareholder Consideration Alternative when reviewing the annual capital budget for a defined percentage of the capital budget
Shareholder Consideration Alternative: For cash flow beyond the reserve replacement requirement; Is the highest and best use of capital at this point in time growing production and reserves via acquisitions or capital projects? Is the highest and best use of capital at this point in time buying back shares? Is the highest and best use of capital at this point in time increasing the dividend? Is the highest and best use of capital at this point in time repaying debts?
In a constant commodity price environment, Apache has a fully committed capital budget for 2013 and 2014. The company's primary focus is on exploiting production from $16 billion in acquisitions completed during the past three years while simultaneously building out two large scale LNG projects. The company plans to sell $2 billion in unspecified assets and will use these proceeds to pay down debt.
APA has two large scale LNG projects underway, both joint ventures with Chevron. The Wheatstone in Australia, which is expected to be online in late 2016, and the even more massive Kitimat in Canada, which will not be online for at least five years.
These two projects require significant upfront costs, but once they come online, they are expected to generate considerable cash flow without the reinvestment costs associated with traditional energy reserve replacement activity.
In a period without unforeseen negative developments or execution failures, given constant commodity prices, the company expects to see a significant increase in discretionary free cash flow beginning in 2016 from the two LNG projects.
Apache has shown a willingness to increase dividends, growing the payment 13% in 2012 and 18% in 2013. The $2 billion in expected debt reduction during 2013 will strengthen the balance sheet. Management is open to buying back shares at attractive prices. Or, the company could deploy the cash flow into acquisitions and/or capital projects depending on the expected rates of return from the projects versus the expected rates of return from the buybacks or debt repayments.
The market is expecting APA to earn $9.11 during 2013, $10.14 during 2014 and to grow earnings at 6.62% over the next five years. That takes earnings to roughly $12.30 in 2017.
If energy prices remain constant, and using a 10 PE multiple, the stock could reasonably go from $80 to $120 over the next five years which would provide investors with 10% annual equity returns plus the 1% dividends and any dividend increases.
If the company just reinvested in replacing reserves and plowed $2 billion per year into buybacks at $80 per share, they could buy 100 million shares over the next four years reducing the share count to 307 million. At constant earnings, the $4 billion net income would be $13 EPS in 2016 or $130 per share at 10 PE, up 62.5% from $80 over 4 years, or 15.6% annual return on shareholders' equity plus the dividend and any dividend increases.
The solution is probably an all of the above strategy:
1) Strengthen the Balance Sheet
2) Grow EPS
3) Grow Reserves
4) Grow Dividends
5) Stock Buybacks within predefined price limits
and will vary depending on the pricing of the alternatives at the point in time when the capital is available.
If energy prices spike, you could get higher than the expected returns. If energy prices plummet, the stock could go significantly lower from here. You are also taking on all of the risks associated with energy investing, plus greater than typical geopolitical risks, given that 25% of Apache's cash flow comes from Egypt. In addition, you have execution risks associated with bringing all of the projects online on time and on budget.
Apache only met one of its five corporate performance goals during 2012.
Four insiders purchased APA stock during March 2013. Mr. Farris purchased an additional 2,500 shares at $75.24, after an initial 2,500 share purchase at $72.92 bringing his total recent purchases to 5,000 shares. Director Randolph Ferlic purchased 10,000 shares at $74.47, Director William Montgomery purchased 2000 shares at $73.10 and former CEO Roger Plank purchased 2000 shares at $72.97.
The stock closed Q1 2013 at $77.16 with a book value of $76.87, or very near book value. WTI May crude was trading at $97.23, Brent crude at $109.18 and NYMEX natural gas at $4.05.
Disclosure: I am long APA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.