Is Apache Still A Worthy Investment?

Aug.22.14 | About: Apache Corporation (APA)

Summary

Apache has made the largest discovery in 20 years off the coast of Western Australia from where around 300 million barrels of oil could be extracted.

Since 2013, Apache has divested $10 billion of its properties which reduced the year-over-year production level in this quarter.

The company’s net earnings dropped around 50% in the second quarter due to negative revenue growth losses on derivative instruments and squeezing margins.

As Apache’s revenue growth is highly dependent upon oil and gas prices, it is not expected that the revenues will experience any improvements in the future.

In the last few months a constant pressure has been building on Apache Corporation (NYSE:APA) regarding the rising demands of its investors. The company's investors demanded the company sell its international holdings and concentrate more on drilling opportunities in the U.S. where oil output has reached its highest level in more than 25 years. Apache eventually gave in to the demands and made divestitures of some of its international assets.

However, now the company is a little relieved that it did not sell all of its international assets as the Phoenix South-1 off the coast of Australia has become its first discovery in the Canning Basin. The company announced that it has made the largest discovery in 20 years off the coast of Western Australia and holds a 40% stake in the area.According to six samples from a well about 110 miles north of Port Hedland, the Canning Basin may hold as many as 300 million barrels of oil.

However, according to an industry analyst the discovery would only yield about 60 million barrels of oil as the explorers usually recover only 20% of their oil in place estimates. However, the oil and reservoir are of great quality and points towards a commercial discovery. According to another analyst, the discovery would make Apache's international portfolio more attractive to the potential buyers and would boost its value by $2 per share.

The discovery would also help the company to increase its oil production which dropped more than 10% YoY in the latest reported quarter leading to negative revenue growth. Further drilling and evaluation of the area is expected to be conducted in 2015.

Divestitures

To concentrate more on the opportunities present in the North American onshore resource base and to meet the demand of its investors, Apache has divested $10 billion of its properties since 2013. In North America, it made the Gulf of Mexico deep-water divestiture for $1.4 billion and dry gas producing hydrocarbons assets in the Deep Basin area of western Alberta and British Columbia, Canada for $374 million. From its international portfolio, it sold one-third of its non-controlling interest in Egypt and all of the assets in Argentina.

Due to the demand from one of its activist investors, Jana Partners, Apache has also decided to divest the Wheatstone LNG project in Australia and Kitimat project in Canada. The reason behind the investor's pressure to divest the LNG projects is that these projects take years to develop before the ports can ship the liquid gas. Therefore, these projects slowdown the revenue growth and increase the operating costs. After the divestitures, it is anticipated that Apache's revenues will increase at a greater pace and its margins should also expand.

Operational Highlights

As a result of the divestiture of the Gulf of Mexico Shelf assets and certain Western Canadian assets in the last year, Apache's production volumes dropped in the latest reported quarter leading to negative revenue growth.Worldwide production of crude oil decreased 36 thousand barrels of oil per day to 313 thousand barrels of oil per day in the second quarter of 2013 reflecting a percentage decline of greater than 10%. Worldwide production was 452 million cubic feet per day lower or 22.62% compared to the figure reported in the second quarter of 2013 whereas the worldwide production of NGL was up 0.4% year-over-year.

Source: SEC Filing

However, the negative effect of these lower production levels was partially offset by higher price levels. Overall, the net revenues were down by 7.32% compared to the figure reported in the same quarter last year.

The company's operating margins were hurt in this quarter as Apache bore losses on its derivative instruments and the operating expenses as a percentage of revenues were higher compared to the figure reported in the 2nd quarter of the previous year. Though the year-over-year operating expenses were down this quarter, management could not cut the expenses in proportion with the negative revenues growth. Together these factors squeezed the bottom line by approximately 50%. Per share earnings fell to $1.31 per share compared to $2.54 per share in the second quarter of 2013.

Apache's net profit margin of 8.1% is considerably lower than the industry average of 13.1%. The lower net margin along with lower return on assets led to lower returns which Apache earns on its equity compared to its peers' average. Apache currently has a ROE of 3.78% compared to the 11.33%collective average of its peers.

Future Outlook

Apache's revenue growth is highly dependent upon the future oil and gas prices and the company's production levels. Currently, the oil prices have slumped to a 14-month low as a result of softening global demand, ample supplies and easing concerns about the conflicts in Ukraine and Iraq. The Brent is now trading below $103 per barrel and presently there isn't any hope that the prices will improve in 2015. Similarly, the prices for natural gas continue to fall and are expected to decline further in the next year.

Since Apache has made $10 billion divestitures since the beginning of last year, the production level has also fallen. Since the company has neither made any acquisition nor improved its production capacities in this period, the production levels will remain low in the coming period. The discovery at Phoenix South-1 will not be enough to compensate for the low production as a result of divestitures. Therefore, it will be really hard for Apache to bring positive growth to its revenues and improve its net margin in the second half of 2014.

Final Thoughts

Apache could not perform well due to lower production levels and losses on instrumental derivatives. The lower operating margin was another factor behind the poor performance. The company's management should have made an effort to cut its expenditure so that the expenses were proportionate to the revenues after the divestitures.

Since oil and gas prices are projected to decline in the second half of 2014 and in 2015 as well and since the company has reduced its production capacity, I do not expect any positive growth in future revenues. This would lead to lower net margins which would further decline the return on equity. Therefore based on these facts I would not suggest investing in the stock.

Disclosure: The author has 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 APEX Financial Consultants. This article was written by one of our research analysts. APEX Financial Consultants is not receiving compensation for this article (other than from Seeking Alpha). APEX Financial Consultants has no business relationship with any company whose stock is mentioned in this article.