Apache Corporation (APA) is being cautious amid the ongoing weakness and volatility in oil prices. The company has significantly reduced this year’s capital budget as compared to its previous forecast which, I believe, is a step in the right direction. Apache Corp., however, will deliver more bang for the buck since it continues to target production growth and expects to generate ample levels of cash flows even in a weak oil price environment of just $53 a barrel. At higher prices, Apache can generate strong levels of free cash flows.
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Oil prices have tumbled substantially from more than $75 a barrel (NYSE:WTI) in October to $53 currently, thanks in part to growing supplies from the US which has now become the world’s top oil producer, high levels of OECD crude oil stockpiles, the US sanction waivers on Iran, and weakness in the global economic activity which may have a negative impact on oil demand. A number of analysts and industry experts now believe that oil will end up averaging lower in 2019 as compared to 2018. Analysts from HSBC, Citigroup, and the US Energy Information Administration, expect WTI to average less than $60 a barrel in 2019, down from $65.06 in 2018.
Apache burned cash flows when oil prices were weak in 2017 and early-2018 but turned around quickly once WTI climbed to ~$70 a barrel in 2018. With oil prices dropping back to under $60 a barrel, Apache should try to preserve its financial health by reigning in its spending levels and aligning them with the operating cash flows - and that’s exactly what the company is doing. Apache has recently revealed it has slashed next year’s upstream capital budget to $2.4 billion, down from its original 2019 plan of $3 billion and 23% lower than last year’s expenses of $3.1 billion.
But what I like about Apache is that even though it will now spend meaningfully lower levels of capital expenditure than its original estimate, it hasn’t significantly reduced its production growth plans. The company expects to report 2018 adjusted production of 395,000 boe per day when it releases its annual results later this month and has been targeting 2019 production of 410,000 to 440,000 boe per day. The company has kept the guidance unchanged except now, the production will come closer to the mid-point of the guidance while in the original plan, it would have come near the top end. The company has further said that adjusted production between Q4-2018 and Q4-2019 will increase by 6% to 10% on the back of 12% to 16% growth from the US including 5% increase in Permian Basin oil volumes. As a result, although Apache’s operating cash flows will come under pressure due to low oil prices, the impact will be partly offset by growing levels of production.
So essentially, Apache has considerably reduced its spending outlook but hasn’t meaningfully changed its production growth plans. As a result, its cash outflows as CapEx will decline while cash inflows will receive support from growing levels of production. This will help the company in achieving cash flow neutrality – or matching operating cash flows with upstream CapEx and dividend payments – in a weak oil price environment. Apache believes that it can hit cash flow neutrality at just $53 WTI. This means that if oil price ends up averaging just $53 a barrel in 2019, the company will generate enough cash flows to fully fund its upstream investments as well as dividend payments.
This will be a turnaround for Apache which has so far been unable to consistently generate strong levels of cash flows in a weak oil price environment. In the third quarter of 2018, Apache delivered $162 million of free cash flows (or operating cash flows in excess of upstream capital expenditure) as operating cash flows of a little more than $1 billion exceeded spending of $844 million. Its free cash flows were $396 million in the second quarter. But these strong levels of cash flows came at a time when WTI was around $69 a barrel. In the preceding quarters, when WTI largely remained below $63 a barrel, the company faced cash flow deficits of $127 million in 1Q18, $51 million in 4Q17, and $170 million in 3Q17.
Additional deficits could have hurt Apache’s financial health if the company were to fund the cash flow deficit with borrowings. Remember, Apache doesn’t have a strong balance sheet. The company had a debt to equity ratio of 108% at the end of Q3-2018 which was higher than the large-cap peer average of 64%, as per my calculations. But now, Apache will be able to preserve its financial health if oil prices end up averaging $53 a barrel in 2019.
The company has also done a commendable job of spinning off the Alpine High midstream program and listing it as Altus Midstream (OTC:ALTM). In the short term, the benefit for Apache will be that it no longer has to fund the development of midstream infrastructure at Alpine High. This frees up capital which can now be diverted to the upstream business, making it easier for the company to achieve cash flow neutrality.
Oil prices, however, may move well past $53 in the future if the Iran sanction waivers end, production growth from the US moderates as oil producers exercise caution by reducing capital plans and cutting drilling activity, oil supplies from Venezuela continue to head lower, or OPEC members and the cartel’s partners scale back production.
The improvement in oil prices will push Apache to free cash flows. The company may return the excess cash to shareholders as dividends and buybacks. Note that Apache’s board approved a 40 million share repurchase program in October – that’s equivalent to little over 10% of the company’s shares. It has so far repurchased 7.8 million shares under this plan and will buy back an additional 32.2 million shares in the future. That should have a positive impact on its stock performance.
Apache stock has tumbled by 3.2% in the last month to $29.87, near 52-week lows of $24.58. The company’s cash flow outlook is looking better now as it heads into 2019 which could be a challenging year for oil prices. I believe Apache’s shares will recover in the near term if oil prices improve, the company delivers on its free cash flow promise, and it continues to buy back shares.
This may be a good time to consider buying Apache stock. But remember, this is a high-beta play with a weak balance sheet and those investors who are building a defensive portfolio for a weak and uncertain oil price environment should avoid this stock. Apache carries a debt-to-equity ratio of 108% (end of 3Q18), which is substantially higher than the large-cap peer average of around 64%.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.