Update - Apache's Growth Makes Earnings Miss A Good Buying Opportunity

Aug. 03, 2012 8:56 AM ETAPA Corporation (APA)5 Comments
Tim Travis profile picture
Tim Travis

On August 2nd Apache Corp. (NASDAQ:APA) reported earnings of $337MM on $3.956 billion of revenue, or 86 cents per diluted share for the second quarter. These earnings were distorted by a $480MM non-cash after-tax reduction in the carrying value of its oil and gas properties in Canada, stemming from lower North American natural gas prices. These Canadian properties are the most gas levered in the portfolio; therefore I don't believe this write down is indicative of future trends for Apache in the company's other plays.

Oil and gas price realizations were down 12% and 8% respectively from the 1st quarter. Apache's adjusted earnings for the quarter, which exclude some of the extraneous items, were $821MM or $2.07 per diluted common share. This was down from $1.26 billion or $3.22 per share in the second quarter of 2011. Cash flow from operations for the quarter was $2.4 billion, down 10% sequentially. Excluding the write-down, cash margins in the 2nd quarter were $39.72 per BOE despite the 12% decline in average price realizations.

Apache's expansive geographic diversity and liquids rich composition makes it unique amongst the large E&P companies. Nearly all of Apache's CAPEX is being dedicated to oil rich plays, which makes tremendous economic sense with oil trading at 30 times the price of North American natural gas. Over 40% of Apache's North American oil production comes from the Gulf Coast regions where average crude price realizations currently reflect over a 20% premium to WTI pricing. Over 50% of Apache's production is liquids, enabling the company to generate solid profits, despite the depression-like conditions in the natural gas market.

Although production of 774,000 barrels of oil equivalent (BOE) per day was actually up from 748,519 YoY, lower realized prices in both oil and natural gas has been causing most E&P firms to post declines in earnings from the prior year's period. On a global basis Apache received an average of $97.66 per barrel of oil, down from $106.31 year over year. Fortunately for the company 73% of crude oil production was Brent Crude allowing the company to realize better prices than in North America. North American natural gas price realizations fell 35% YoY to $3.17 per thousand cubic feet (MCF), and the company's international regions saw prices rise 8% to $4.08 per MCF. International gas production rose 100 million cubic feet per day from the prior-year period and represented 37% of Apache's total gas volumes.

In the Permian Basin the company is now operating 36 rigs up from 26 at the end of 2011, and in the Andarko Basin Apache has 24 rigs up from 7 at year end. Production in the Permian Basin was up 5% sequentially or 23% on an annualized basis, and the company believes that it remains on target to grow production on this play by 13% per year. Production in the Permian Basin is about 72% liquids with about three quarters of that being crude oil. Growth was even faster in the Andarko Basin, where production increased 47% sequentially, including volumes from the Cordillera Energy Partners III acquisition that closed April 30. Apache believes that the company remains on target to grow production by 24% per year through 2016.

In Apache's Wolfcamp Shale play four horizontal wells have produced more than 190,000 barrels of oil equivalent since March 19th. Currently the company is operating three rigs on this play, and the company has drilled five additional wells which are completed, or are expected to be completed very soon.

North Sea production was flat sequentially but was up 36% YoY. Apache believes that growth should come in the second half of 2012 after strong drilling results in the Bacchus and Beryl Fields. Apache announced that a new development well drilled in the Pyrenees Field offshore Western Australia commenced production on July 14th, and the well is currently producing 11,000 barrels of oil per day, 3,135 of which go to Apache. The company is looking to expand operations in the high-margin Gulf of Mexico (GOM) from its current base of 6 rigs, after being the high bidder on 90 blocks in the Bureau of Ocean Energy and Management's recent lease sale. This represents a massive 40% increase in the exploration portfolio in the GOM, and the strategy is consistent with what has made Apache successful in the past by picking up attractive assets when they are out of favor for various reasons.

Egypt has been a lightning rod for Apache since the Arab Spring, but in the 2nd quarter Apache was operating a record 28 rigs in the Western Desert. The company drilled 68 wells, including 16 exploratory wells with 13 successes. Production declined slightly largely due to some maintenance on one of the plants and several of the trains. Egypt should continue to be a solid producer of profits and cash flows moving forward.

In total Apache anticipates 6-9% production growth in 2012 from 2011, net of 11,000 BOE per day from assets in Canada and East Texas sold in the second half of 2011. 2nd quarter production would have even been stronger if it weren't for unanticipated downtime totaling approximately 16,000 BOE per day. Most of the 16,000 barrels a day is already back on-stream or is expected to be back before the year end. Management of Apache continues to emphasize that the company has over 67,000 future drilling locations that have been technically assessed, and 9 billion barrels of oil equivalent net un-booked inventory that will likely be responsible for years of future growth.

Apache's debt-to-capitalization ratio increased to 25% from 21% in the 1st quarter, as the company took advantage of the attractive available rates to fund the Codillera acquisition. Common shares outstanding increased by 7 million in the quarter to 391MM. The company isn't likely to hit our original earnings estimates https://seekingalpha.com/article/476861-apache-possible-takeover-opportunity-due-to-very-low-valuation-and-strong-production-growth, but that is much more a function of commodity prices, as opposed to production. At TTCM we've been advocating selling puts on Apache to get in at cheaper prices than just buying the stock outright. This allows the investor some protection from the wild commodity price swings which tend to increase volatility on the stock.

One might consider selling the January 13 $82.50 put for $6.80. Assuming this option expires worthless the return would be about 9% in 169 days, or around 20% on an annualized basis. If the stock closes below $82.50 the investor will own the stock at $75.70, which represents about 5-7 times forward earnings assuming $100 crude oil. One might also buy the stock in addition to selling the puts as Apache's extensive growth portfolio, and cheap valuation make it one of the finest hedges for long term inflation that we have been able to identify.

Disclosure: I am long APA.

This article was written by

Tim Travis profile picture
Tim Travis is a veteran deep value investor and money manager. Travis has extensive experience in traditional investments such as stocks and bonds, in addition to having a unique methodology of combining options and distressed investing with value investing to generate income, reduce risk, and to add an element of timing. Currently Tim Travis is the founder, Chief Executive Officer, and Chief Investment Officer of T&T Capital Management. T&T Capital Management is a Coto de Caza, California based Registered Investment Advisor that manages accounts for both individual and institutional investors. Travis was born in Laguna Beach, California and became captivated with the value investment philosophy in his early teens through reading books written by Benjamin Graham, and the shareholder letters from Berkshire Hathaway, and the Buffett Partnership L.P. Tim Travis became intrigued by the notion that stocks aren’t just pieces of paper but instead are fractional shares of a business that can be analyzed by comprehensive analysis of the balance sheet, income statement, and statement of cash flows. He majored in Business and Economics at the University of California Santa Barbara, graduating in 2004, and he also had the privilege of studying international economics at the University of Richmond in Florence, Italy. Tim Travis got his feet wet in finance working for both Scottrade and AG Edwards & Sons during his college career. Upon graduation Travis worked at the Vanguard Group in Scottsdale, Arizona. It was there that he learned that most mutual funds underperform their respective indexes, and he became disappointed at the overwhelming diversification in most mutual funds, that really makes most of them function as “closet” index funds. After leaving the Vanguard Group, Travis worked for a small futures and commodities firm in Mission Viejo, California. It was there that Tim developed an adept knowledge of options, particularly the selling of options to take advantage of the higher probabilities involved. It was also during this time in his life that Travis began reading everything he could possibly find on value investing. Some of his role models in the field are Warren Buffett, Martin Whitman, Bruce Berkowitz, Seth Klarman, Peter Lynch, Glenn Greenberg, etc. After working with clients from around the world Travis broke away and started T&T Investment Management L.L.C. At T&T, Travis refined his unique methodology combining value investing, with the selling of options to generate income and reduce risk. T&T experienced explosive growth by partnering with a local commodities firm. After several years Tim Travis realized that without controlling the majority of the company any longer, he didn’t have full control over the company’s strategic direction. Divergent business principles caused Tim Travis to break away and form T&T Capital Management. At TTCM which Tim Travis is the sole owner, he is allowed to offer only the best products and services, at a reasonable price, without conflicts of interest. T&T Capital Management’s goal is build wealth for both individual and institutional investors, and to accomplish these goals Travis as Chief Investment Officer employs his deep value investing techniques. Each account is managed on a day to day, personal basis, and there are no cookie cutter portfolios defined only by one’s age and risk tolerance. Every security is researched and hand selected by Travis and his research team. T&T Capital Management takes pride in first class customer service and research which is regularly communicated to clients for education purposes.

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