Apache Corporation: Significant Exploration Potential
Summary
- Apache Corporation has significant exploration potential. A significant part of its value includes the company's Suriname Basin exploration, a project which has 50+ prospects.
- Additionally, Apache Corporation is continuing to produce respectable oil. The company anticipates 2020 production at ~410 thousand barrels/day, with a ~$50/barrel WTI and FCF.
- Current prices are much lower. I recommend investors wait until the end of March to invest allowing some volatility to settle. Alternatively, investors can invest now and use options.
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Apache Corporation (NASDAQ:APA) started the year looking like it was going to buck the trend in oil and gas companies on the back of major discoveries. However, the company ended up being dragged into the COVID-19 crisis among the rest of the oil majors. This is despite the company's history of "company creating" discoveries like Alpine High and its recent Suriname discovery.
Apache Corporation - Apache Corporation
Apache Corporation is a unique company because it's an interesting balance between companies that'd been discussed for subscribers before. Oftentimes, these companies are either small-cap high-risk, high potential reward exploration companies that are ignored by the market. Other times, these companies are majors, with significant cash flow potential in all environments.
Apache Corporation is an interesting and opportunistic mix of the two, with significant growth potential and also existing sources of production and FCF.
Apache Corporation 2019 Results
Apache Corporation had an impressive 2019. Despite what's suggested by the financial results, the result of massive capital spending, the company progressed well towards its goals.
Apache Oil Corporation 2019 Production - Apache Oil Corporation Investor Presentation
The company reported adjusted production of ~413 thousand barrels/day with costs and investments at $4.9 billion. That means the company's net expenses were $32.48/barrel. The company's net cash was respectable; however, the company's massive investment spending and difficult write downs resulted in strong negative earnings per share.
Apache Oil Corporation 2019 Spending - Apache Oil Corporation Investor Presentation
Apache Corporation, in a difficult oil environment, delivered a massive reduction in its capital budget to manage costs. The company is aiming for a 2020 upstream capital budget of $1.6-1.9 billion. With a market capitalization of less than $8 billion, that means the company is spending more than 20% of its market capitalization on growth.
In a difficult oil environment, the company would need to cut capital spending even further.
The company did maintain strong production, ahead of its guidance, with production in the Permian Basin the highest in the company's history. That's exciting to see because the Permian Basin has one of the lowest breakeven rates across the major U.S. oil fields. More production here can help support the company's earnings.
At the same time, the company agreed to a 50/50 JV agreement with Total S.A (TOT). The company recently announced a significant discovery here, indicating that it's on the path to a potential Guyana-sized discovery. With Liza Phase 2 having estimated break evens at $25/barrel Brent, this discovery is a company maker for the $8 billion company.
This highlights the company's 2019 success.
Apache Corporation 2020 Goals
On top of its 2019 success, Apache Corporation has set up its 2020 goals.
Apache Corporation 2020 Plan - Apache Corporation Investor Presentation
Apache Corporation is, as we already discussed, planning to reduce its upstream capital budget focusing on a $50 WTI price. With WTI prices at just over $41/barrel, with significant additional potential to drop this coming week, obviously, the company won't be meeting its budget plans. That could result in production dropping.
It's worth noting that the company is slowing down production at its massive Alpine High discovery, with no activity.
The company is, at the end of the day, focused on achieving a $150 million run rate on savings and generate positive FCF after an almost 5% dividend. Achieving positive FCF, with the goal of starting debt reduction, is incredibly impressive. However, with oil price drops since the start of the year (the company's been planning for $55/barrel Brent), it's worth it.
Apache Corporation Suriname Discovery
One aspect of the company I want to focus on is its Suriname discovery, something that is effectively baked into ~25-40% of the company's current share price.
Apache Corporation's Block 58 is composed of 1.4 million acres with 50+ prospects mapped. For reference, that's about as many un-drilled prospects as Exxon Mobil (XOM) has in Guyana. The company has drilled one of these prospects (Maka Central-1) which had impressive results. The company hasn't quantified the reserves, but the initial guidance (404 ft. of oil/gas condensate) is incredibly impressive.
However, it's not surprising given the extension of the region from Exxon Mobil's Stabroek block, as visible above. The company is, currently, drilling another Sapakara West-1 spud, which is currently drilling multiple additional prospects. Exxon Mobil's average Stabroek discovery has been 500 million barrels/well. Assuming that continues, that means 1+ billion barrels in potential reserves from these two wells.
We need to estimate the potential production here. Exxon Mobil has turned 8 billion in current resources (from 18 drilled prospects and 50+ potential ones) to 1 million barrels/day in production. Apache Corporation is roughly 2-3 prospects away from a single FPSO (~250 thousand barrels/day). Potentially, the company can set up synergies with Exxon Mobil in Guyana.
Either way, I expect that, by 2025, assuming oil prices average ~$55/barrel Brent, Suriname will see a 25-50% production increase attributable to the company from Suriname.
Apache Corporation 2020 Cash Outlook
Apache Corporation, from the combination of these things, has announced its 2020 cash outlook.
Apache Corporation 2020 Guidance - Apache Corporation Investor Presentation
As we can see, the company is guiding for production ~410 thousand barrels/day. That's in line with the company's FY 2019 adjusted production. The company expects ~100 thousand barrels/day of this production to be from the Permian Basin, so ~25% of its cash flow will have low breakeven. As we discussed above, the company expects FCF at $50/barrel WTI.
That means, assuming the company would be FCF breakeven at $50/barrel WTI, at current WTI prices, it'll be -$1.28 billion at FCF. Assuming another 10% drop in WTI prices, this will decrease to ~negative $1.7 billion. Accounting for capital downside potential, we'll assume that for the year, the company will have FCF at -$1 billion.
That's significant for an $8 billion company, and a dividend cut might make up half of that. I don't know if the company will make that decision; however, it does need to cut capital spending rather quickly at the current pricing environment. Or it needs to find a better way to hold out for a rise in prices.
Apache Corporation Investment Recommendation
Apache Corporation is a fairly high-risk high-reward play at a difficult time in the oil markets. However, with significant potential upside, from its Suriname assets, there is an exciting risk-reward play here.
My first recommendation is to not invest in Apache Corporation for the remainder of March.
This is a high-risk but exciting oil production company, and oil markets are incredibly volatile. I recommend, for such a volatile company, waiting ~3 weeks for the markets to calm down before investing. At that point, I recommend investing in the company with a relatively small % of your portfolio (~5%).
Alternatively, investors can take advantage of the implied volatility in current options to make a yield play investment. For example, if you invest in 100 share batches right now, you can sell Jan. 2021 covered CALLs with a strike price at $20 costing ~$5.33/share. Given the 10-month time period and the current $20.7 strike price, that's a 26.8% annualized yield from options.
More importantly, that doesn't count the company's dividends of almost 5%, meaning an annualized overall yield for shareholders of more than 30%. Assuming you think the company is worth at least 70% of its current price, which I think so, it's a solid investment.
Apache Corporation Risks
Apache Corporation, with its potential and growth opportunity, has significant potential, but there are some risks worth paying attention to.
The single largest risk, as we've alluded to several times in this article, are oil prices. The company needs WTI prices at ~$50/barrel long term to succeed. Current prices are under $42/barrel. This coming week, as Saudi Arabia turns on the spigots, prices could drop down towards $30/barrel WTI. Just a few weeks ago, they were at more than $50/barrel, before COVID-19 picked up.
The question when investing in the company is based on whether share prices will recover. By using options to get a >30% yield, you can avoid a significant part of the risk from the drop in oil prices. However, there is still the risk that oil prices will not recover, a risk that investors should pay close attention to. That's why I recommend waiting until the end of March.
At more than $50/barrel WTI, the company has significant potential. Exxon Mobil's Liza Phase 2 project has breakeven at $25/barrel Brent. A single FPSO from Apache Corporation, with its 50% stake, at that breakeven at $35 Brent price (Liza gets a several $ premium over Brent) would give Apache Corporation more than $500 million in annual cash profit.
That alone is significant for an $8 billion company, especially with our pessimistic assumptions.
Conclusion
Apache Corporation is planning with FCF and $1.6-1.9 billion in capital spending, a significant decline over the past year. That's good, the company is continuing growth, especially with its impressive Suriname assets, while managing its capital spending. At the same time, share price declines have pushed its dividend towards 5%.
As investors watch for the biggest catalysts of 2020 though, updates on the Suriname well, there remains a significant risk from COVID-19 and the OPEC+ argument in terms of oil prices. I recommend investors attempt to avoid this by either capturing the implied volatility with options or waiting until the end of March to invest.
Let me know what you think in the comments below.
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This article was written by
The Value Portfolio specializes in building retirement portfolios and utilizes a fact-based research strategy to identify investments. This includes extensive readings of 10Ks, analyst commentary, market reports, and investor presentations. He invests real money in the stocks he recommends.
He is the leader of the investing group The Retirement Forum with features including: model portfolios, macro overviews, in-depth company analysis and retirement planning information. Learn more.Analyst’s Disclosure: I am/we are long APA. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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