Seeking Alpha
Profile| Send Message| ()  

With holdings in oil and gas exploration and production, Anadarko Petroleum (APC) is diversified in natural gas, crude oil, and natural gas liquids. However, Anadarko is heavily investing in the liquid-heavy aspects of its holdings, a useful strategy for the present oil and gas price structure. Anadarko's exploration strategy has proved successful though riskier than its peers. Its recent levels of profitability and valuation have justified much of the excess debt that it has incurred in exploration and test well creation.

I recommend a 1-year and 5-year buy on Anadarko shares. The recent downward trend in share price, hovering around $70, makes it a more accessible investment and increases the overall earnings potential for positions initiated in the second quarter 2012.

Valuation

Anadarko's 52-week range spans $57 to $89, and a recent breakdown in price (around April 2012) leaves this stock undervalued. A reasonable 12-month consensus forecasts a $95 target. One of the world's largest oil and gas exploration firms, Anadarko's exploration ventures leave a substantial upside, particularly in liquid-intensive commodities. At a price of $80, I would say that the potential for significant increase in value is slim, whereas a buying price of around $70 leaves quite a bit of room for increased value.

While Anadarko might be trading at a discount, there are two quite different but perhaps more appealing options for those looking to make a significant 1-year return. Kosmos Energy (KOS) shares, for instance, have somewhere between a 60% and 100% upside, particularly as it trades around $11. Unlike Anadarko, much of Kosmos' actual value is yet to be reflected in its price-exploration territory in Africa for both natural gas and oil give Kosmos a target upwards of $22.

Growth and Commodity Prices

The current dance in oil and gas prices remains an uncertainty for oil and gas E&P companies. We could see a leveling out of natural gas prices by 2013, but in the meantime, the 2012 year average price is forecasted for $3.00/Mmbtu. This compares to a consensus forecasted $3.70/Mmbtu stabilization in 2013 and around $4.75/Mmbtu long term. Right now, Anadarko is effectively weathering natural gas price uncertainty by decreasing its overall natural gas holdings and focus. In the coming year, management expects 90% of drilling to be liquid-rich, intending to curtail dry gas production by 3 MMBOE. This might lessen potential long-term potential in gas, but oil is the star of the market, at least for now.

Anadarko has an impressive commitment to exploration. Of its drilling ventures in the coming year, 20% will be exploratory in nature. Anadarko's exploration strategy is aggressive; it does not hesitate in acquiring boom or bust land. However, this strategy has historically allowed Anadarko to acquire very productive lots inexpensively. With an expertise in deep water research in the Gulf of Mexico and emerging prospects in West Africa, it tends to clump projects together geographically, lessening associated costs. In the Gulf of Mexico, the Ceasa/Tonga site, it began production this year and is expected to reach a total output of 45 MBOE/d. Aside from this, 50% of Anadarko's 2012 capital expenditures will be dedicated to development of the U.S. onshore niche. This solid production base will aid Anadarko as it looks to produce 256-260 MMBOE this year.

Oil prices, even in bearish estimates, will average $118/bbl for 2012, and the bulls place it around $130/bbl. Prices are forecasted to remain unnaturally high through 2015, with a mid-range estimate around $130/bbl. With bullish estimates of $150/bbl in 2014 and 2015, it is less difficult to see why most of Anadarko's new projects are liquid-heavy. The retreat from these high prices is something of an inevitability, but just when this will occur seems both uncertain and well in the future-the long term (real) price of Brent crude registers around $90/bbl. Thus, over a 5-year investment time arch, Anadarko's increased emphasis on its already strong oil holdings and its decreased emphasis on natural gas exploration and holdings make it a competitive E&P company, despite fluctuating or volatile commodity prices.

One check to the optimism here is Anadarko's relatively high cost structure; there's no free lunch in oil exploration. In the fourth quarter 2011, operating expenses were $8.30 per boe, a 3% increase year-over-year. It is encouraging to see the management actively taking steps to counteract this: The recently tapped fourth well at Utica Shale, a 390,000 acre plot in Ohio, is already beginning to provide crude (9500 barrels of light crude in the first 20 days). This site, like many others, is easier to explore and is not subject to the rising production costs that offshore drilling is. On the other hand, Anadarko maintains these Utica Shale positions while diversifying elsewhere, unlike Range Resources (RRC), which has focused on the Marcellus Shale-atop the Utica Shale-leading to its narrow output spectrum of 78% natural gas and an overall uncertain outlook.

Finances and Management

Another consistent misgiving against a robust optimism, perhaps, has been Anadarko's debt-heavy finances. Its debt/capital ratio lies at around 45%, one of the highest in the sector. With a slight management shake-up and new CEO, the company intends to reduce this number to a target between 25% and 35% within the year. Furthermore, much of the debt incurred in the last year was a result of settling the Macondo litigation with BP (BP). BP, with whom Anadarko had a 25% share in the Macondo drilling project, has been making a more sluggish recovery, though it too (like most of the oil sector) is at least slightly undervalued. Nevertheless, this settlement was a wise despite its overall increase in Anadarko's debt/capital ratio.

Overall, the financial strength of Anadarko is average. The debt issues at Anadarko pale in comparison to Chesapeake's (CHK) finance and management woes, though Anadarko's finances are not quite as solid as Apache's (APA). Apache maintains an A+ debt rating from Morningstar, while Anadarko maintains a BB+ rating.

Conclusion

Despite its cost-intensive exploration approach and high debt/capital ratio, Anadarko remains an attractive and overweight option for a 1-year and 5-year investment strategy. Anadarko is heavily exposed to the deep see drilling market, and the cost of drilling in these areas is likely to rise due to increased government oversight--an outcome that would be in tension with Anadarko's already high cost structure. Nevertheless, Anadarko's diversified set of holdings makes it an attractive choice among other E&P companies.

Source: 3 Hot Oil And Gas Stocks To Consider Along With Anadarko