I am looking at three major companies in the oil and gas sector in this article. The Hong Kong-headquartered CNOOC Ltd. (NYSE:CEO) engages in up streaming activities and also does exploration, development, production, and sales of crude oil and natural gas and other petroleum products through its subsidiaries. Anadarko Petroleum (NYSE:APC) is primarily an exploration and production company that, apart from operations in southern United States, has interests in East and West Africa, Algeria, China, Alaska, and New Zealand. Apache (NYSE:APA) explores, develops, and produces natural gas and crude oil and has interests in U.S., Canada, Egypt, Australia, the United Kingdom, and Argentina.
All the three companies have a highly leveraged structure. CNOOC has the lowest debt-to-equity ratio at 18.69 vs. 64.32 for Anadarko and 41.01 for Apache. The high amount of leverage in the capital structure of Anadarko poses a risk for potential investors, although earnings to shareholders are enhanced at the same time. Anadarko posted losses in 2009 and most recently in 2011. The high leverage is one of the reasons why, as the interest expense -- which has been consistently above $700 million -- has had a huge effect on the company's earnings. In 2012 Anadarko had a significant profit of 2.39 billion, but the losses in 2011 of $2.65 billion caused a great setback to the company.
Apache also has a high leverage, but the positive effect of leverage can be seen in the earnings of its last three years. While the interest expense was $190 million in 2008, net earnings were $712 million. But the increased leverage, which is visible by the increase in interest expense to $414 million in 2012, has enabled it to significantly enhance earnings to $2 billion by 2012. The interest coverage ratio of 11.7 calculated from the pre-tax income of $4.88 billion in 2012 shows that the company has been able to earn significant profits in order to pay off its liabilities. CNOOC, the largest of the three organizations, has the lowest leverage of the three companies. It issued debt in 2010 that increased its interest expenses from $77 million in 2009 to $528 million in 2010. But the company doesn't have to be concerned about paying off its debt due to the huge amount of cash flows and an interest coverage ratio of 320.
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Although CNOOC has had huge profit margins historically, the net profit margin has been declining for the past four quarters even though the revenues have increased over that period. Even after the recent decline, the net profit margin stands at 25.6 for the quarter ended March 2013. Anadarko has been an inconsistent performer in terms of profits. It has been posting losses every alternate year in the last five-year period. But there has been a rise in the net profit margin in the recent period. Anadarko reported losses in the second quarter of 2012, but has recovered since and has reported increasing profits for the last three quarters. Apache has had net profit margins of more than 15% and has recovered after a sudden dip in profits for the quarter ended September 2012.
At current prices, CNOOC has a P/E ratio of 7.97 whereas the other two companies are valued much higher -- Anadarko is at 18.35 and Apache is at 16.6. The P/E of CNOOC is lower even after having the highest net margins. Not only does it have higher net margins, but it also provides better return to its shareholders with a ROE of 22.06% while Anadarko's ROE is 12.35% and Apache's is 6.63%. CNOOC has a revenues/employee ratio that is more than 10 times the ratio for the other two companies. An interesting aspect to look at is the P/B ratio of Apache, which stands at 1.02. At a ratio so close to 1, the assets of the company are undervalued when compared to the P/B ratios of the other two companies, which are close to 1.8.
CNOOC seems to be undervalued when compared to the other two stocks. It has been a consistent performer in the past and hasn't posted losses like the other two companies. The falling net margins in the previous two quarters have forced the stock price to decline, but even at current levels of profit, the company should be priced higher. I would recommend taking a long position in this stock. As far as Apache is concerned, the assets are undervalued at a P/B of 1.02 and the company has reported good results in the past. With a moderate debt-to-equity ratio, the company is a good one to put your money in. I would recommend staying away from Anadarko. The company has been inconsistent in its performance, reporting losses in two of the last four years and is found to be overvalued when we compare the price multiples.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.