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Penalty may not be so high

In December, the U.S. Bankruptcy Court for the Southern District of New York issued an unfavorable ruling against Anadarko Petroleum (NYSE:APC)'s Kerr-Mcgee unit regarding the Tronox (NYSE:TROX) litigation.

The final pay out depends on how much Anadarko can claim as a creditor of Tronox from the latter's bankruptcy, under the Section 502(h). To calculate the penalty range, the judge considered two factors. One is the maximum amount Anadarko can claim from Tronox bankruptcy as a creditor, and second is percentage recovery of claim.

The table below shows the court's calculation:

Total liability

$14.459 billion

Maximum claim

$10.459 billion

% recovery permitted

2.8% to 89%

Penalty with 2.8% recovery

$14.166 billion

Penalty with 89% recovery

$5.15 billion

However, Anadarko disagreed with the ruling and filed a response against the court's instruction. The company objects the court's instructions on both maximum claim as well as percentage recovery. The company has given the following arguments to support its point:

  1. Maximum claim:

Factors considered to decide maximum claim

Value

Tronox IPO Value (In 2005)

$14.459 billion

Environmental liability as of date of IPO in 2005

$1.757 billion

Environmental liability post-petition in 2010

$4 billion

To calculate maximum claim, the bankruptcy court used the post-petition for Tronox's environmental liability estimation, and after subtracting it from IPO's value, it has limited maximum claim amount to $10.459 billion.

However, the company has argued that the court should use the environmental liability estimates at the date of IPO in 2005 instead of the post-petition estimate. In addition, the company has stated that at the time of IPO, the value of Tronox's available assets was $850 million less than the company's total liability, which includes $1.757 billion of environmental liability.

Hence, the company believes that its maximum claim should be $13.609 billion if the court accepts its $850 million argument, and in case the court rejects it, the maximum claim should amount to $12.702 billion, which comes after subtracting $1.757 billion from the IPO's value.

  1. Percentage recovery:

Anadarko also disagreed regarding percentage recovery range for the claim decision by the court. The company has given an argument that under bankruptcy laws, Anadarko is a class 3 unsecured creditor of Tronox, and Class 3 creditors generally receive full claim. So, the company believes that it is entitled to recover 100% of its maximum claim.

Based on its arguments on maximum claim and percentage recovery, Anadarko believes the penalty amount will be $850 million or $1.757 billion. In the worst-case scenario, the company expects it may not have to pay more than $5.15 billion.

Final ruling only few months away:

The company's stock price has remained range bound between $78 and $82 after the lawsuit ruling on December 12th last year due to the uncertainty regarding the lawsuit. After the final ruling, Anadarko will know how much cash is required to pay the penalty. If it meets Anadarko's expectation of less than $5.15 billion, the company has enough cash holdings to clear it. At the end of last year, the company's cash on hand was $3.7 billion, and by end of the current quarter, the company is expecting to add $2.64 billion from selling part of its Mozambique assets and $580 million from divesting its non-operated Pinedale position.

With these cash flows, the company will be in a good position to pay out anything close to $6 billion. However, if the company has to pay something higher than $6 billion, then analysts believe the company has low cash generating assets worth $18 billion, and selling off some of these assets will provide the company liquidity for a potential adverse litigation judgment. Overall, the company is in a good position to handle all possible judgments.

No doubt in operational performance

Tronox is the only worry for Anadarko, and as the company is expecting the final ruling to come in a few months, it will end all uncertainty regarding the potential pay out. If we study the company with an operational perspective, several potential upsides can boost the company's top line. A few of them are as follows:

  • US assets doing good

Last year, the company's oil volumes in the U.S. onshore operating areas increased 25% year over year, and the sales volume increased 12% year over year. This growth was the result of a rise in production in its major assets, Colorado's Wattenberg field and its shale basins. In Wattenberg, the company's average production was 56,000 barrels of oil equivalent per day (boepd), which is 34,000 boepd more than its 2012 volume. In the last quarter, Anadarko exchanged about 50,000 acres of its property with Noble Energy (NYSE:NBL) in the Wattenberg region. By doing so, Anadarko's development planning and infrastructure utilization improved, which helped the company increase its fourth quarter production by about 6,500 boepd. This signifies that the company is focusing on improving its operational efficiency.

The company has also shown an increase in production in the U.S. shale gas regions as well. Last year, the company's Eagle Ford shale, East Texas shale, and Marcellus shale gas assets together have shown incremental production of 59,000 boepd more than 2012 production. With improving performance, I expect the company's U.S. assets will continue delivering good performance this year as well.

  • Mozambique an emerging prospect

In Mozambique, the company is operating in the offshore area, from where it expects to sell liquefied natural gas to its Asian customers. Last year, the company has discovered two new wells and has successfully appraised six wells.

The LNG demand in the Asia-Pacific region is expected to grow 2.7% annually from 2014 to 2035. Anadarko is expecting to deliver the first cargo of LNG from the region in 2018, and it is expecting to sell about 5 million metric tons per annum. The company has already signed a long-term supply contract for two-thirds of the expected volume with buyers in the Asian market. Since demand is expected to increase, I expect the company will be able to increase its sales in the coming years.

With growth in existing assets like U.S. Wattenberg and the shale basins, and potential growth in developing assets like in Mozambique, Anadarko's operational performance will continue to improve in the coming years, which will positively impact the company's revenue.

Conclusion

Anadarko is showing strong operational performance, which is expected to continue in the coming years as well. In addition, the penalty of the Tronox lawsuit is expected to be on the lower side, which will reduce its impact on the company's cash flow. Considering an overall perspective, I recommend a buy for this stock.

Source: Anadarko: Positive Outlook On Tronox Issue And Strong Operational Performance