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Apache Corporation (NYSE:APA) is one of the largest independent oil and gas companies in the U.S. Texas-based Apache has operations in Gulf of Mexico, Texas, Permian and Anadarko basins. It also has exploration and production interests in several other countries around the globe. The company reported 3rd quarter earnings above expectations. Q3 EPS of $2.95 was $0.10 higher than consensus estimate, andRevenue of $4.3 billion was also 44% higher than the last year.

As of the time of writing, Apache stock was trading at $100, with a 52-week range of $73 - $134. It has a market cap of $37 billion. Trailing twelve month [ttm] P/E ratio is 10.2, and forward P/E ratio is 7.9. P/B, P/S, and P/CF ratios stand at 1.5, 2.6, and 4.5, respectively. The 3-year annualized revenue and EPS growth stand at 6.7% and 0.3%, respectively. Operating margin is 45.3%, and net profit margin is 25.8%. The company has some minor debt issues. Debt-to-equity ratio is 0.3. Apache pays some dividends. The projected yield is 0.6%.

Apache has a 5-star rating from Morningstar. It is categorized as a large-core company. While its trailing P/E ratio is 10.2, the industry average is 25. Thus, Apache is trading well below the industry average. Out of 30 analysts covering the company, 18 have buy, 4 have outperform, and 6 have hold ratings. Wall Street has diverse opinions on Apache’s future. The bottom line is -25.9% growth, whereas the top-line growth estimate is 32.4% for the next year. Average five-year annualized growth forecast estimate is 10.6%. Related industry peers include Anadarko Petroleum (APC), CNOOC (CEO), Chesapeake Energy (CHK), Canadian Natural Resources (CNQ), Devon Energy (DVN), and Noble Energy (NBL).

What is the fair value of Apache, given the forecast estimates? We can estimate Apache’s fair value using discounted earnings plus equity model as follows.

Discounted Earnings plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate.

Since we are in the middle of the year, it will be more feasible to take the average of ttm EPS of $9.92 along with the mean estimate of $11.97 for the next year.

E0 = EPS = ($9.92 + $11.97) / 2 = $10.95

Wall Street holds diversified opinions on Apache’s future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 10.60%. Book value per share is $66.28.

The rest is as follows:

Fair Value Estimator

V0

E0

$10.95

V1

E0 (1+g)/(1+r)

$10.91

V2

E0((1+g)/(1+r))2

$10.87

V3

E0((1+g)/(1+r))3

$10.83

V4

E0((1+g)/(1+r))4

$10.79

V5

E0((1+g)/(1+r))5

$10.75

D

E0(1+g)5/[r(1+r)5]

$97.72

BV

Equals

$66.28

Fair Value Range

Lower Boundary

$162.80

Upper Boundary

$229.08

Minimum Potential

60.27%

Maximum Potential

125.52%


I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5 year discounted-earnings-plus-book-value model, the fair-value range for Apache is between $162 and $229 per share. As of November 4, Apache was trading at a price of $100. The current price indicates that the stock is deeply undervalued. Based on my FED+ fair value estimate, Apache has a minimum 60% upside potential to reach its fair-value range.

Peer Comparison

Company

Yield

O-Metrix

Fair-Value Range

YTD Return

Apache

0.59%

5.97

$162 - $229

15.51%

Anadarko Petroleum

0.44%

2.33

$47 - $90

8.66%

CNOOC

3.00%

3.42

$260 - $346

15.71%

Chesapeake

1.21%

2.87

$26 - $46

5.37%

Canadian Natural Resources

0.90%

4.88

$46 - $66

-16%

Devon Energy

1.03%

3.87

$74 - $125

-16%

Noble Energy

0.96%

3.95

$87 - $130

6.77%

Apache’s yield of 0.59% is well below that of CNOOC. Hong Kong headquartered CNOOC offers a yield of 3.00%. Chesapeake and Devon also offer yields of 1.21% and 1.03%, respectively. Apache and CNOOC have the lowest trailing and forward P/E ratios. Thus, their downside potential is limited. On the other hand, with an EPS growth estimate of 10.60%, Apache is ranked somewhere at the middle of its peers in terms of future growth estimates. Only Anadarko and Canadian Natural resources have significantly higher EPS growth estimates than Apache. Analysts estimate Anadarko to grow by 16.60% and Canadian Natural Resources to grow by 21% for the next 5 years.

Summary

Apache has been an outperformer, returning 15% since January. However, the company still has great upside potential. As of November 5, Apache was trading at $100, significantly lower than my fair-value range of $162 - $229. Its price to book ratio of 1.5 is well-below the market average of 1.9. Its O-Metrix score of 5.97 is also the highest among its peers. As companies with higher O-Metrix scores tend to outperform, I expect Apache to be an outperformer. The stock has at least 60% upside potential to be fairly-priced. Barclays has an overweight rating with a target price of $151.

I also think that the red-chip company CNOOC can also be an outperformer. Similar to Apache, CNOOC is also trading with a low P/E ratio of 8.19, and a lower forward P/E ratio of 8.5. CNOOC also has a minimum of 34% upside potential based on fair value estimate.

In terms of O-Metrix scores, Apache has the highest score of 5.97, followed by Canadian Natural Resources (4.88). Based on the fair-value analysis, Apache offers the highest value, followed by CNOOC, and Canadian Natural Resources. Devon Energy, Noble Energy, and Chesapeake Energy look fairly-valued, but Anadarko is relatively expensive.

Source: Apache Has At Least 60% Upside Potential