Anadarko: Helped by Oil's Rebound

Company Description:

Anadarko Petroleum (APC) is current one of the largest independent oil and gas exploration and production companies in the world. Headquartered in Houston, Texas, Anadarko's major areas of operation are located onshore in the United States, the deepwater of the Gulf of Mexico, and Algeria. Anadarko also has production in China and a development project in Brazil and is executing strategic exploration programs in several other countries. As of year-end 2008, the company had 2.3 billion barrels-equivalent of proved reserves. In August 2006, Anadarko acquired Kerr-McGee Corporation and Western Gas Resources, Inc. in separate transactions totaling $23.3 billion, including the assumption of debt.

Investment Thesis:

Exploration provides shareholders upside potential, and significant cash generation provides ample flexibility in funding the company's budget allowing continued growth in the future, despite sliding commodity prices. The asset base at present time is strong and I believe in management's ability to execute.

Amongst analysts, APC shares are expected to continue to outperform their peer average and the S&P 500 in the next 12 months. Although APC gained more than 25% YTD, the upside potential remains greater than the downside risk from lower oil and gas prices. In response to low gas prices, APC reduced Capex, increased borrowing, while reducing cost and expenses. APC reported 1Q09 loss of $0.53/share, $0.07 better than consensus estimate loss of $0.60. Earnings benefited from increased production and lower cost, which were no match to the impact from lower oil and gas prices.

Guidance:

Despite a planned 30% drop in capital spending in near-term projects this year, mainly due the sharp reduction in US onshore drilling activity, APC expects sales volume growth of 1-3%. APC continues to be cautious on the US natural gas market and has a pessimistic view of prices well into 2010, but indicated that it may use hedges to protect natural gas drilling economics. The company expects gas prices to continue to reflect the gas supply/demand outlook. On the supply side, improving efficiency and lower drilling cost will contrast the impact from the sharp decline in rig count. In addition, increased LNG supply from newly completed plants in the Middle East and Russia and weak demand in Asia and Europe could increase LNG shipments to the US as the last resort because of a lack of underground storage capacity elsewhere.

Exploration Potential:

APC plans to drill 12 deepwater wells this year that have more than 100 mmboe resource potential. It has already achieved 1, with 4 currently drilling. APC sees a huge potential in West Africa and the additional acreage obtained recently expands this potential. APC also made a discovery last year in Brazil and sees huge potential there. In addition, APC expects to drill a well in China on a very promising prospect.

The company's reserve additions in the last three years averaged 30% from the drillbit and 70% purchases, compared with 51% and 49%, respectively, in the last five years. APC spent almost $5 billion on reserve additions last year, an increase of 81% from 2007 level, and was the highest in seven years, excluding acquisitions. Total spending exceeded $40 billion in the last three years and $46 billion in the last five years. Exploration and development activities accounted for 40% of the company's spending in the last five years and 33% in the last three years, and acquisitions accounted for 60% and 67%, respectively, in the two periods.

Valuation:

APC shares are trading at a higher P/E but a lower P/CF multiple than most peer large E&P companies, based on 2010 consensus estimates. APC's dividend yield and return on average capital employed are below those of its peers, and its debt ratio is above the peer average. However, its calculated implied reserve value ((IRV)) of $18/boe, which does not take into account its significant upside potential, is below the peer average of $22/boe. At parity with the peer average, APC shares would be trading close to $60/share.

The 12-18-month price target for APC is $60/share or 4.0x 2010 EBITDA estimate, compared with 4.8x for the peer average. This 17% discount reflects APC higher debt ratio than the 25% for the peers.

Valuation range can also be based on NAV estimates, which include value for both proven and unproven reserves, as well as other net assets and liabilities. The NAV estimate for APC is $47. Risks to the NAV include: sustained oil and gas price weakness, and the ability of the company to deliver on stated production targets.

Other valuation parameters for Anadarko are attractive, at 5.6x 2009 CFPS as compared to the E&P group average of 6.5x. The company has a sizeable portfolio of assets which provide the company with a solid production growth profile of 8% this year. The company has had favorable developments in its mega discoveries and the deepwater exploration and development queue positions the company well for the intermediate term. The stock is currently trading 22% below the estimated target price.

Key Risks:

Factors that could hinder the stock from achieving the price target include earnings correlation to volatility in global commodities prices, changes in inventory levels, production disruptions, OPEC’s governing systems and reactions, competing fuel prices, price speculation which is ramping up once again, changes in consumption patterns (most likely possible due to seasonality factors), as well as weather and geophysical and technical limitations.

Disclosure: I hold APC long in my stock portfolio on kaChing. The portfolio is publicly available for anyone to view or follow.

Comments

[Mad Hedge F...:]

It's a great gas play. Those who missed the last 50% move in natural gas got a second chance to visit the trough this week, with the pull back to $3.50 from $4.59. Buying above an industry wide “cap in” price of $3.50 seems a no brainer to me, but is controversial nonetheless. This is a fraction of the $13.50 peak seen last year. You can bet that every electric power utility in the country is scampering to acquire advance supplies, many mandated by new environmental regulations to use the clean burning fuel, taking advantage of a rare opportunity to buy at the cost of production. Natural gas is still a steal at these levels for the long term. They don’t call this the widow maker for nothing, and if the volatility seems daunting, play in smaller size through the CME Emini contract, which only has $10,000 worth of underlying (2,500 MM BTU).

May 31 12:34 PM

[Charles Pet...:]

I think this type of mid to large mid cap energy plays are the way to go over the course of the short, intermediate, and long term. I'm not positive I would pick Anadarko over all of their competitiors (namely Apache if you want a natural gas play with less geopolitical risk) but it is definitely not a bad company. Good write up.

May 31 06:01 PM