- Portfolio successfully repositioned against geopolitical risks: baseline valuations established.
- Very attractive valuations on numerous metrics, particularly given the stock trading at near book value.
- Growth powerhouse in the US Permian/Eagle Ford Shale plays that has been under appreciated by the Street.
What a difference a couple of years make.
Apache Corp (NYSE:APA) is a midsized oil and gas driller that has gone through a very eventful decade. The company levered up significantly in an acquisition spree the past decade on the back of a booming energy market in the late '00s, then see its shares fall from grace In 2008 from a peak of almost $150 post-financial crisis. While the company was able to recover much of its value in 2011, in just two years after the financial crisis as oil price stabilized at around $100, fears on the geopolitical front in Egypt sent shares tumbling again from the $130s back down to the $80s that Apache has been hovering over for the past 2 years.
Granted in a situation as volatile as Egypt, investor caution is a prudent reaction as seen in 2012 when Apache shares plummeted amidst chaos on the streets of Cairo. Yet, shares have largely remained at the same levels for the last 2 years even as the conflagration calms back to a mild simmer. At the same time, a closer look at Apache's corporate strategy is starting to reveal a much differently focused company compared to itself just several years ago.
So one should ask: Is Apache really deserving the proper attention and valuations?
Coming Home: A Global Refocus
As the world came out of the depths of the crisis of 2008, Apache was a decentralized, international O&G play with operations stretching from the US Gulf to Egypt, Argentina, the North Sea, and Australia. The company leveraged up its balance sheet to take on megaprojects as oil prices climbed to new highs, and the story sounded good for a number of years as Apache expanded internationally. However, as the Arab Spring erupted and spread like a wildfire, investors quickly cooled to areas like Egypt and Argentina as political instability and strife jeopardize the very strategy of the company came under fire and investors punished the company.
Thankfully, their grievances did not fall on deaf ears. Management has been busy repositioning the portfolio by selling off partial or whole stakes of operations in higher risk regions to boaster the balance sheet, and also at the same time to reconfigure the geographic mix. In 2009, only 1/3 of company production came from North America onshore, with another 20% of revenues coming from the Gulf of Mexico and almost another 30% from Egypt and Argentina. As the company enters the '10s, this revenue mix was less than desirable under the almost daily bombardment and reminders of the BP Macondo spill and global political upheaval. The steps management undertaken in the past year has dramatically improved the risk picture, as now over 60% of production is generated onshore in North America, with the company completely exiting Argentina, as well as scaling down the Gulf of Mexico, and right sizing Egyptian operations by selling a third of its stake to Sinopec, to the point that only 15% of overall production is now in high risk regions. At the same time, the company has invested heavily in the Permian Basin and Eagle Ford, as well as increasing production to a more liquid mix, from 50% in 2009 to 58% in 2013, which has offered a much more stable pricing pattern than the more volatile natural gas.
Management has also taken steps to reduce overall debt load after a string of acquisitions in 2010 and 2011. With the sale of the Egypt stake, Argentina, and properties in the Gulf and Canada, Apache has announced plans to reduce overall debt levels, as well as initiating a share buyback initiative. Dividends were also increased by 25% from 80 cents to 1 dollar per year.
Going forward, management has commented that they will continue to take advantage of the US shale boom, with the region providing double digit growth in volumes (production volume of the North American onshore regions is projected to grow 15-18% in 2014). New projects are also coming online in Australia and the North Sea in the coming years, including one of Apache's large liquefied natural gas plants in Australia (Wheatstone LNG), which will start production in 2016 what will sell LNG to Asian consumers.
What is Driving Apache Forward
1) Strong Performance in the North American Region, Clarity in Valuations of Higher Risk Assets
In the Q1 2014 Earnings call, Apache was able to deliver strong production growth in the North American onshore region despite challenging weather conditions. Management is expecting production in NA to grow 15-18% in 2014, as well as rigorous cost discipline to maintain operating costs at a stable level.
The cloud over the Egyptian uncertainty is also greatly reduced with the Sinopec acquisition of 1/3 of Apache's interest in the region for slightly over $3 billion. This marks a 50% upside to Apache's investment in the region in a deal that was largely inked during the worst of the political upheaval in Egypt. As mentioned above with the company now greatly refocusing to politically stable regions of the world the uncertainty facing the company in 2012 has largely been removed, yet shares have yet to behave as if the situation has gone thru any constructive resolution which in our opinion will normalize in the next 12 months.
2) Attractive Valuations
Currently at the time of writing, APA closed at $88.89. The shares are currently trading at around 1.05 price to book. Analysts were expecting earnings for 2014 to come in at 6.83 for 2014, a forward P/E of around 13.
I believe APA has room to beat those estimates, as shown already in the most recent Q1 2014 results which beat consensus estimates by over 10%. Asset sale and repositions has largely concluded and I believe management can now focus on maximizing execution and efficiencies in the remaining areas of operations.
Looking at the forward P/E ratio compared to peers with shale exposure like Anadarko (NYSE:APC) trading at around 20x, EOG Resources (NYSE:EOG) at 20x, Pioneer Natural (NYSE:PXD) at 36.5x, Occidental (NYSE:OXY) at 13.5x, and Devon Energy (NYSE:DVN) at 12.25x, the company is trading at the lower end of the spectrum even at the current consensus estimate which I believe will be revised higher in the coming weeks.
The Price-to-Book ratio is at historical levels. Most plays with a significant exposure to Texas shales often trade at relatively high multiples (Anadarko at 2.64x, EOG at 3.47x). Apache is currently trading at just 1.05x price-to-book. Management's has also been willing buyers of their own stock and at these levels.
3) Responsive Management to Shareholders and a Gradually Improving View on Cash Flow
The sharp attentive focus of Apache's management to respond to investor caution of geopolitical risks, as well as numerous shareholder friendly initiatives such as buybacks and dividend hikes is quite positive for investors.
Apache is expected to return to organic free positive cash flow as the Wheatstone LNG and Kitimat LNG are coming to conclusion in the coming 2 years. Already management has reduced Kitimat capital plans and announced they are now actively seeking alternatives to complete the project with additional capital from outside partners or other means. Whereas in the Wheatstone LNG project, once complete it is expected to generate over $1 billion per year in free cash flow in 2016.
Our View on Apache
We believe investors will see Apache emerging as a solid, secure O&G play as the geopolitical risk clouds clear from view. The more solid and streamlined Apache the company should begin to recapture the P/B premiums lost in 2012. Shares were trading at around 2x price-to-book back in mid 2011. As the company is currently trading at only 1.05x P/B we see a great opportunity for upside in the coming 12-24 months as cashflow and earnings normalize.
I have a year end target of $115 which represents a price to book ratio of 1.3 on year end book value of around $88/share.