Buy Anadarko Now, Sell Range Resources

Includes: APC, BP, LINEQ, RRC
by: Investment Underground

By Robert Gordon

Anadarko Petroleum (NYSE:APC) is among my favorite energy companies to check up upon, as it is often in the news, and once again it is. It reported its first quarter earnings, that pattern persists in a big way. Anadarko is one of the largest exploration and producing oil and natural gas companies in this country.

In 2011, Anadarko's big news was putting the 2010 Gulf Coast oil spill disaster behind it, by making a $4 billion dollar settlement payment to BP, PLC (NYSE:BP). Anadarko had no role in the operation of the stricken well, but did own a 25% stake in the well. Therefore, its liability for part of the damages was certain, only the amount was left to determine. $4 billion was a fair and reasonable settlement, but more important, it has allowed management to get back to running the business.

In the first quarter of 2012, Anadarko reported revenues of $3.45 billion, up about 7% from the first quarter of 2011. GAP earnings came to $2.16 billion, or $4.28 per share. However, one-time net benefits, largely due to a settlement in the company's favor of an Algerian tax dispute, accounted for all but $0.92 per share. This still represented more than double the $0.43 of a year ago.

Anadarko has struggled, as have its peers, with the collapse of natural gas prices, and has focused on growing its liquid portfolio at the cost of dry gas production increases. While still far below its historical level due to oversupply, natural gas futures prices have risen the past few weeks, from below $2.00 per MMBTU, to up to over $2.70. I believe over the long run, the future of natural gas, due to its domestic availability and environmental footprint, will compete with coal as this country's dominant fossil fuel source. But that day is a long ways away.

Anadarko still has one major litigation piece ahead of it. That is, its exposure to as much as $25.5 billion stemming from its spinoff of properties in 2006. The at issue property was originally contaminated by Kerr McGee, which Anadarko acquired the bulk of in 2005. The suit, which is taking place this month, uses some novel but persuasive issues in an attempt to pin Anadarko with $15.5 of residual environmental damage, plus $10 billion in interest, from over 70 years of Kerr McGee's existence. Anadarko has reserved about $525 million for this, so the stakes are high.

If we take the Kerr McGee litigation out of the equation, Anadarko's future is as secure as any other big oil companies. Its five year PEG is under 1.0, its balance sheet is in decent enough shape with debt at 43% of capital, and both earnings and cash flow will advance by percentages in the low to middle teens if fossil fuel prices remain stable; more growth is likely if prices increase. The company's aggressive capital budget has done an admirable of increasing reserves.

While this Kerr McGee mess is still unsettled, I cannot endorse an investment in Anadarko. However, if it gets though the current trial relatively unscathed, Anadarko can be fine, long term holding to many investors.

A smaller exploration and production company I urge you to look at is Berry Petroleum (BRY). Berry is strictly a domestic driller which focuses on the western parts of the United States. Much of its oil and liquid natural gas is in its home state of California. Berry did not have a terrific first quarter of the year from either a production or an earnings perspective. Revenues of $241 million were up about 22% from the $197 million in the first quarter last year. Adjusted net earnings came to $50.3 million, or $0.91 per share, which more than doubled the year ago's $0.41 per share, but missed by 12% analysts' expectation of $1.03 per share.

Production in the first quarter, on an oil barrel equivalent basis, was down 4% from the year earlier to an average of 34,447 barrels per day. Dry gas production fell by 6%, and liquids fell by 2%. The company, despite this first quarter bump in the road, still sees production, mostly liquids, increasing 8% to 10% this year over last. Time will tell. Management has noted, among other factors, that California's regulatory climate has of late become more hospitable.

Expected earnings for this year of $4.30 per share would represent a 60% increase over 2011's adjusted earnings. Those 2011 earnings of $2.69 per share represented a 76% advance from 2010. Analysts see 5 year earnings growth continuing to average 59%, driving Berry's 5 year PEG to an extraordinary 0.14. Now, Berry has its downsides. Its debt is 62% of capital, and the dividend yield of 0.90% won't excite anybody. But to those with a speculative bent, Berry has a winning formula.

Most exploration and production companies I see as attractive at current prices. One I do not see that same way is Range Resources (NYSE:RRC), which while still involved in both liquids and dry gas, is heavily exposed to hydraulic fracturing in the Marcellus Shale Formation, and Range has "doubled down" by increasing its investment in natural gas rich regions in Pennsylvania. 78% of Range's first quarter revenue game from natural gas. Earnings for all of 2011 came to $1.11 per share, and likely will not reach $1.00 this year. The great caveat for that is a surge in natural gas prices. Signs of recovery are underway, but domestic inventory stockpiles are still more than desirable, and I really doubt natural gas will breach the $3.00 per MMBTU during 2012.

Another troubling issue for Range is that its capital budget for 2012 of $1.6 billion will not be covered by its free cash flow. The company's balance sheet shows at year end 2011, debt was 45% of capital, and I do not want to see additional debt taken on to fund discretionary spending. Yet, that appears to be the direction Range is headed toward. Given the many choices within the P/E sector of the energy industry, I would avoid investing in Range.

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