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Summary

  • I don't believe there is another company that is better positioned to play the recovery in energy.
  • Consider, even after the recent 14% run-up in the stock, shares are only trading where they were last December, and the stock is still down 7% from its 52-week high.
  • With the shares trading at around $88, I project Apache's fair value to reach $100 on the basis of growing free cash flow and debt-adjusted production growth.

Since reaching a year-low of $77.31 on February 5, there hasn't been a hotter stock in the energy sector than Apache (NYSE:APA), whose shares have soared 14% in the past three months.

Unlike 2013, it seems investors have moved on from prior fears about energy volatility and weak demand for companies like Chesapeake Energy (NYSE:CHK) and Anadarko Petroleum (NYSE:APC) that deal in exploration and production of oil and gas.

In the case of Apache, which has struggled to outperform Chesapeake, it seems management's recent focus on strategic drilling programs and timely acquisitions is beginning to pay off. And with improved conditions in areas like Egypt, where Apache has some strong, albeit risky, assets, the future suddenly looks brighter for one of the best, and at times underrated, names in energy.

On Thursday, Apache affirmed investors' confidence by reporting better-than-expected first-quarter earnings results, helped by higher prices for natural gas. Revenue arrived at $3.67 billion, down 7% year-over-year. But this was enough to beat Street estimates of $3.62 billion. Despite the beat on revenue, unlike other sectors, revenue is not what drives energy. Investors were more interested in production outputs.

In the first quarter, Apache's production of oil and natural gas averaged out to 639,804 oil-equivalent barrels per day, or BOE/d. This was down roughly 13% year-over-year. Likewise, there was an 8% decline in oil and natural gas liquids ((NGLs)) production, which arrived at 371,701 barrels per day (Bbl/d). I won't say this was Apache's best output. But the results didn't sway that drastically from what Chesapeake and Anadarko have reported.

It also seems that Apache suffered slightly from a slight decrease in crude oil prices, which registered at $101.03 per barrel, down 1.4% year-over-year. The good news is that the average realized natural gas price, which is measured in per thousand cubic feet (MCF), was up almost 20% year-over-year.

All of this led to an operating profit of $1.78 per share, which beat most estimates by more than 10%. I'm encouraged by the how well management is mitigating the rough revenue/production patch with strong expense controls. Apache's lease operating expenses totaled $597.0 million, down 17.3% from $722.0 million in the year-ago quarter. More than anything, this is what led to such a strong beat in earnings.

These numbers suggest that management's maneuvering, which included selling a third of Apache's Egypt business to China Petrochemical, or Sinopec, for $3.1 billion, was not as misguided as initially believed. Recall, Egypt was impacted at certain points last year, with unplanned downtime and outages caused by severe winter weather.

Not only did the deal inject the company with much-needed cash to pursue debt-adjusted production growth, in the process, management reduced some investor fears regarding Egypt's instability. It's hard to not credit management for its decisions.

The only question today is to what extent can these improvements continue? The results affirmed my position on Apache as a top-notch energy producer. Expectations are now going to be raised, as evident by the recent popularity in the stock. But investors shouldn't ignore that this is still a highly volatile, commodity-driven industry - albeit one that is in recovery mode.

With the shares trading at around $88, I project Apache's fair value to reach $100 on the basis of growing free cash flow and debt-adjusted production growth. Consider, even after the recent 14% run-up in the stock, shares are only trading where they were last December, and the stock is still down 7% from its 52-week high. Management has demonstrated that they have a strong pulse on this industry, and I don't believe there is another company that is better positioned to play the recovery in energy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's energy sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.

Source: Why Apache Is Heading To $100