At the second week of January, the price of natural gas declined more than it ever has in 2.5 years with a drop of 13%. In light of this backdrop, a review on Apache (APA) and ConocoPhillips (COP) is in order. I find that both companies warrant a "hold" rating due to a pesimistic outlook on gas and macro uncertainty.
From a multiples perspective, the two are roughly in line with peers. Apache trades at a respective 9.5x and 7.9x past and forward earnings while ConocoPhillips trades at a respective 9x and 8.6x past and forward earnings. The latter has slightly less volatility and a dividend yield that is 310 bps higher at 3.7%. Moreover, ConocoPhillips also has greater scale and is still less preferred on the Street with its "hold" rating.
Both companies have recently reported solid performance. At the third-quarter earnings call, Apache's CEO, G. Steven Farris, noted:
We had a great quarter and as I mentioned in the silent part of this, it was -- we set a new record year. We had record production of 752,000 barrels of oil equivalent in a day, which is 50% was liquids. The bulk of that was oil. We had record cash flow, as Patrick pointed out, of $2.7 billion, which on an annualized basis gets us real close to $11 billion for the year. We reduced our debt by $650 million and we funded it our very ambitious investment program…
[W]e had an excellent drilling results across the wide portfolio of exploration and development plays around the world during the quarter. And on the project side, we had achievements of positive final divestment decision on our Australian Wheatstone LNG development, a major long-term project with Chevron, it was a visible value over a long period of time, 20 years, with no decline in its -- it's based on oil-linked revenue. Importantly, Wheatstone is really a growth platform, which will provide us multiple additional phases of development that we can bring additional gas in from other discoveries in the Carnarvon Basin.
With natural gas prices at a low due to warmer climate, however, Apache is in a more precarious position. Output is rising from horizontal drill and gas production is expected to average a record of 67.34 Bcf/d in 2012, up 2.2% year-over-year. Apache further agreed to buy Van Gogh FPSO, an offshore Australian asset, for $185M after two years of operational difficulties.
Consensus estimates for Apache's EPS forecast that it will grow by 33.1% to $11.87 in 2011 and then by 4.2% and 14.2% more in the following two years. Assuming a multiple of 9.5x and a conservative 2012 EPS of $12.21, the rough intrinsic value of the stock is $116, implying 18.7% upside. This does not meet the threshold that I consider merits calling the company a "value play."
Ditto for ConocoPhillips, which has also had strong performance. The top-line has grown by an average of 32.7% for the four quarters ending 3Q. During the fourth quarter, management once again crushed expectations with adjusted EPS of $2.02 versus the consensus of $1.75. Refining margins declined while taxes and commodity prices rose. ConocoPhillips had $1.5B worth of pipeline asset sales, which will help streamline the company and add efficiency. Toward this end, the company recently - and surprisingly - announced that it would be spinning off its downstream assets. I question the extent to which this will drive value creation for two reasons. First, the return-improvement plan has already been successful in closing the discount to peers. And second, a standalone E&P business would face tougher comparisons that are likely to have faster growth rates.
Consensus estimates for ConocoPhillips' EPS forecast that it will grow by 44.6% to $8.56 in 2011, decline by 2.6% in 2012, and then grow by 6.2% in 2013. Of the 15 revisions to estimates, 12 have gone down for a net change of -1.4%. Assuming a multiple of 9.5x and a conservative 2012 EPS of $8.28, the rough intrinsic value of the stock is $78.28, implying 10.9% upside. Again, the macro uncertainty warrants a "hold."