Apache (APA) is a 57-year old company headquartered in Houston, Texas, and is one of the largest independent exploration and production companies in the world. Apache utilizes both conventional and unconventional resource plays in 10 core areas in six countries. After a string of sizable acquisitions Apache's MBOE production is extremely diversified with no region accounting for greater than 20%. The company produces and explores in North America, the Gulf of Mexico, Egypt, Australia, Argentina, and the U.K. The largest area of production for Apache is Egypt, which accounts for about 20% of production. Due to the volatility created by the Arab Spring uprisings, the stock is trading at an unfair discount to its peers. Investors are underestimating Apache's strong relationships and solid production in the region, and we think that Apache is likely to be a target for an acquisition by a larger integrated company if the stock price doesn't rise to a more comparable level with its peers.
Apache didn't dive headfirst into the North American shale gas plays, which have been hurt by drastically lower natural gas prices. Because of this, and its consistent and balanced growth approach, about 50% of Apache's production are liquids, which is extremely beneficial due to the significant price disparity between liquids and dry gas. Many companies such as Chesapeake Energy (CHK) are diverting their spending to more liquid rich plays to maintain adequate profit margins, and to more closely emulate the production mix that Apache already has. Apache specializes in maximizing the exploitation of acquired assets that are often bought from one of the larger integrated companies. It also purchases property on its own and develops it internally.
At a recent price of $98.72 Apache has a market cap of $38 billion and an Enterprise Value of $48.6 billion. In the last 12 months it has generated $4.5 billion in net income or $11.47 per share. That puts the TTM P/E at 8.6. Apache has one of the best production growth profiles of any of the mid-majors, with large projects starting up in New Zealand, Kenya, Alaska, etc. The company's recent Cordillera acquisition, will basically double its position in the prolific central United States region of Oklahoma, and Texas. In 2011 Apache's production climbed 14% to 748,000 barrels of oil per day. It increased proven reserves to 3 billion boe, replacing 125 percent of production through drilling. Over the last 20 years Apache has performed exceptionally well at the drill-bit obtaining a compound annual growth rate of 13% as exhibited below:
(Click chart to enlarge)
In 2012 the company expects to grow production by 7%-13%, and with current oil prices we believe the company could earn $13 per share implying a forward P/E of 7.6, which is just too cheap for a diversified and growing energy company such as Apache. Based on TTM EBITDA Apache is selling at an EV/EBITDA ratio less than 4, which is among the cheapest of any large energy companies. It might be cheaper for an Exxon (XOM) or a Royal Dutch Shell (RDS.A) to increase production through acquiring Apache, than it would be to find and develop energy resources that are becoming more difficult to acquire, in locations where state-owned companies have so much influence.
Debt is about 20% of Apache's capitalization and is very manageable due to the nearly $10 billion of operating cash flow that the company is generating at current oil prices. The biggest risks to the company would be if the political situation in Egypt deteriorates further, or if energy prices were to decline greatly. We think that Apache has nearly 50% upside from current levels and should trade at an EV/EBITDA of about 5.5 times.
If you are wary of energy prices and want to make a more conservative investment you might sell the January 13 $100 put for $11.00 or $1,100 total. This would equate to a 12.3% return on the maximum risk in 290 days if the option expires worthless, or you'd end up owning Apache at $89.00 if the stock closes below $100 at expiration. However you decide to play it, at TTCM we believe that Apache is the best investment opportunity in the E&P sector, and is a great hedge on a future inflationary environment.
Disclosure: I am long APA.
