Look For Apache To Benefit From Rising Domestic Oil Production

Sep.23.11 | About: Apache Corporation (APA)

One bright spot amid all the gloomy economic headlines coming out of the United States is its rising oil and natural gas liquids production in the 48 states, according to the August monthly energy review published by U.S. Energy Information Administration[1]. Domestic field production of crude oil and natural gas liquids increased 3% year-to-year in 2010, and the same thing happened in 2009 by 4%. Of the 7.7 million barrels (i.e. monthly average) produced daily, 2.6 million barrels are exported. Given the current political urgency on job creation and the financial community’s concerns about the chronic U.S. trade deficits, my view is that environmental activism has to take a backseat for the time being, and the momentum to drill has arrived for the domestic producers. Anything like last year’s Deepwater Horizon explosion will provide temporary setbacks and slow the process, but not revers the push for increasing domestic production.

Amid the recent turmoil in the stock markets mispricing in the domestic oil producers has occurred. In my view, one of the undervalued stocks is Apache Corporation (NYSE:APA). As one of the world’s biggest independent oil and gas producers, it has operations in the United States, Canada, Egypt, the United Kingdom (North Sea), Australia, and Argentina. At the end of 2010, its proved reserves totaled 2,953 million barrels of oil equivalent (i.e. 44% liquids and 56% natural gas), approximately 11% of the proved reserves of Exxon Mobil (NYSE:XOM). The high percentage of liquids in Apache’s reserves is bullish for the stock when oil prices have been rising, but North American natural gas prices have been languishing. During the second quarter of 2011, oil and liquids provided for 78% of the company’s revenue. Furthermore, when Brent is trading at a $29 premium to WTI, it helps that Apache derives nearly 60% of its oil revenues from international regions. Also, one third of Apache’s natural gas production is outside of North America, where the company can often negotiate higher prices in a more favorable supply/demand environment.

The CEO of Royal Dutch Shell (NYSE:RDS.A) said in a recent Financial Times article, “Oil output from fields in production declines by 5 per cent a year as reserves are depleted,”[2] Oil majors all over the world are struggling to stand the decline rates of their oil fields, find new productions, and build up the infrastructures that are necessary to ramp up production. Apache has increased its North American oil production by 26% from 2009 to the second quarter of 2011 (from 104,319 barrels per day to 131,665 barrels per day), and its international oil production by 19% during the same period (from 174,407 barrels per day in 2009 to 207,227 barrels per day). It recently purchased some North Sea assets from Exxon Mobil for $1.7 billion, which would boost its production in that region by 54%.

The company has a strong balance sheet, with a debt ratio of 12% as of June 30, 2011. During the forth quarter of 2008 when oil prices tanked to $36 per barrel, the company took an impairment charge of $3.6 billion (i.e. net of tax), and in 2009, it took another impairment charge of $1.98 billion (i.e. net of tax). These charges are nonreversible even after oil prices have recovered, so my view is that even if we have another economic downturn and tumbling oil prices, Apache’s balance sheet is not likely to take further major hits.

Besides, the chance for oil prices to nose dive the same way as in 2008 is small. As my previous article indicates[1], the medium outlook for global oil supply is tight despite the economic downturns in the developed countries. At the time of this writing, as DOW dropped 400 points, gold tumbled $75, Brent is still traded at $108 per barrel.

The consensus estimate on Apache’s third quarter EPS of $2.83 is, in my view, low, and the company will probably surprise on the upside in November. I predict the company will deliver an EPS of $3. APA is trading at a historically low multiple and a lower multiple than most of its peers, but its fundamentals are strong. I would value APA at a target price of $144 per share. After Thursday’s market massacre it traded at $83.69 per share while its net book value as of June 30, 2011, was $67.17 per share. Investors should take advantage of the recent “blood on the street” to pick up this bargain!

[1] Major Trends Point to Higher Crude Prices: Statoil to Benefit, July 1, 2011

[1] Monthly Energy Review August 2011, U.S. Energy Information Administration

[2] FT, September 22, 2011

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