Trade: Long Apache (
), Short Brent crude
Current price: $87
Expected price: $122
Time: 1-2 years
recent strategic acquisitions which have huge potential still to be
capitalized, room to improve margins, significantly undervalued to
peers, trading below 2008 levels on valuation basis, diversified
asset base, enormous option on natural gas upside, capex peaking
out in 1-2 years, divestitures to reduce debt, recently initiated
buy-back program, possible shareholder activism.
While many oil names just touched their 52-week high, Apache
recently touched its 52-week low. The stock reached a peak of 130
in mid 2011 and is currently trading in 80s. The fall has been due
to significant acquisitions financed via debt and excessive capital
spending (capex) on the newly acquired assets, resulting in
significantly lower profits, low dividend payments and slower than
expected growth. Significant capex outpaced operating cash flow in
FY12 resulting in negative free cash flow ((
)). FY12 EPS declined by 56% and recent 1Q13 quarterly EPS declined
by 12%. Revenue for the recent quarter (1Q13) declined 10%, on a
Additionally, political turmoil in Egypt, where the company
generates 20% of its current production, 30% of its current
operating cash flow and has 10% of its reserves, is also one of the
main reasons for the stock to remain undervalued.
Situation in Egypt:
In February 2011, the former Egyptian president Hosni Mubarak
stepped down, and the Egyptian Supreme Council of the Armed Forces
took power, announcing that it would remain in power until the
presidential and parliamentary elections could be held. In June
2012, Mohamed Morsi of the Muslim Brotherhood's Freedom and Justice
Party was elected as Egypt's new president. This new political
regime comes with potential threats such as deterioration in the
political, economic, and social conditions or changes in laws or
regulations in the region, export restrictions, nationalization of
APA assets and/or forced renegotiation or modification of existing
contracts with the government of Egypt. Losing Egyptian assets
would mean a direct 30% hit to APA's operating cash flow. Apache
does mention that as a risk in its recent filing. However, in
recent month tens of thousands of locals protested demanding Mr.
Morsi's removal. Under the Morsi's government the Egyptian economy
has been crumbling. Shortages of electricity and fuel have further
created anger against the government. On 3rd July 2013, Egyptian
military ousted the country's first democratically elected
president, Mohamed Morsi of the Muslim Brotherhood, for inviting
violence and killing of protesters. The Constitution was suspended
and the chief justice of the Supreme Constitutional Court is now
the acting president with plans for new parliamentary and
presidential elections under an interim government. This has helped
bring political and situational stability in the region. This is
evident by the fact that the Egypt's stock market surged 7% on 4th
July 2013, after Mr Morsi's removal, to a month high. It had fallen
notably due to protests and weakening Egyptian economy. The US and
Egyptian military are allies with American military providing USD
1.3bn annual aid to Egypt.
The company continues to receive development lease approvals for
drilling in Egypt and plans to invest USD 1.1bn in the region in
FY13, highlighting that the situation is not as bad as it seems.
Management has met with Egyptian officials, kept production steady,
and is actively monitoring the situation. As per management, assets
are in very remote areas, and hence the drilling isn't affected
even while protests engulfed the major cities.
Grown on acquisitions
The company has grown through acquisitions financing it via
debt. The strategy has been to acquire strategic and rich assets at
a decent price and then focus on getting value out of them. From
1999 to 2003 APA went on an international acquisition spree to
acquire oil rich international assets. From 2009 until present it
did the same in the US, focusing on shale plays in the mid-con.
During FY10-FY12, APA completed USD 17bn in acquisitions (compared
to current book value of USD 30bn), leaving a lot of room for
growth in the future. The timing of these acquisitions has been
right due to low cost of financing. By acquisitions, the company
has grown its tangible book value by 11% CAGR in the last 5 years
and 17% CAGR in the last 10 years. Below is the list of
2012 (Canada): Kitimat, BC, partnership with Chevron:
In December 2012, entered an agreement with Chevron (
) to build and operate the Kitimat LNG project. Each will become
50% owner of the proposed Kitimat LNG plant, the Pacific Trail
Pipeline, and 644,000 gross undeveloped acres in the Horn River and
2012 (US): Central Anadarko basin acquisition:
In April 2012 acquired Cordillera Energy Partners III, LLC
, for USD 2.7bn in cash and approximately 6.3 million of APA common
stock, increasing the diluted outstanding shares by 4%, from FY12.
Cordillera's properties include approximately 312,000 net acres
basically doubling APA's position in liquids-rich Anadarko Basin.
APA issued USD 5bn fixed-rate long-dated notes in 2012 at an
average rate of 3.5% for the acquisition and to pay down maturing
debt and commercial paper balances.
Yara Pilbara Holdings Pty Limited acquisition:
In January 2012, acquired a 49% interest in Yara Pilbara Holdings
(YPHPL, formerly Burrup Holdings Limited)
for USD 439m. YPHPL is the owner of an ammonia fertilizer plant on
the Burrup Peninsula of Western Australia.
North Sea acquisition:
In December 2011, acquired Mobil North Sea Limited from Exxon Mobil
) for USD 1.25bn, adding to other North Sea assets it acquired from
) a decade ago.
2010: Gulf of Mexico Shelf acquisition
In June 2010, acquired oil and gas assets in the Gulf of Mexico
shelf from Devon Energy Corporation (DVN) for USD 1.05bn.
In August 2010, acquired acreage and infrastructure in the Permian
Basin for USD 2.5bn, net of preferential rights, from BP's oil and
2010 (Canada): Canadian acquisition
: In October 2010, acquired BP's upstream natural gas business in
western Alberta and British Columbia for USD 3.25bn.
2010 (Egypt): Egyptian acquisition
In November 2010, acquired BP's assets in Egypt's western desert
for USD 650m.
2010: Mariner merger:
In November 2010, acquired Mariner Energy, Inc. for stock and cash
consideration totaling USD 2.7bn. APA also assumed approximately
USD 1.7bn of Mariner's debt with the merger.
Focusing on extracting value from assets acquired:
CEO, Steve Farris, mentioned in the 1Q13 earnings call that the
company has done enough acquisitions and will now focus on
extracting value from them. This would mean high initial capital
expenditures on these projects to get them started. APA has an
expected capex of USD 10.5bn for FY13. Capex
has increased significantly by 36% in FY10, 44% in FY11, 35% in
FY12 and an expected 10% in FY13. Of the USD 10.5bn in FY13, main
focus will be onshore North America shale play regions with a
dedicated USD 4.6bn capex. USD 2.2bn will be on other projects such
as Australian oil developments, Gulf of Mexico deepwater,
Wheatstone project, and Kitimat, BC. These significant capex
spending would have noteworthy increases in production in the
future. Also, with capex peaking in 1-2 years, it would decline in
the future boosting free cash flow considerably in years to come.
Below are details of the future projects:
US shale play:
The US contributes 40% of the total production
(17% oil, 4% NGL, 18% gas)
. The Permian, Anadarko and Central Region assets
(on-shore U.S. assets related to shale)
have huge potential in horizontal drilling with over 88% of the
company's resource potential going forward. That's where APA has
seen the most growth in recent years with liquid production
(oil and natural gas liquids ((NGLS)))
in the US growing by 16%, 28% and 19% in FY10, FY11 and FY12,
respectively. In 1Q13, oil production from the US was up 19% and
NGLs' production 121%, on a y-o-y basis. Natural gas production was
only up by 4% as the company is keeping gas production flat due to
depressed prices. The US is the strong growth region for the
company with its huge recently acquired shale plays. As of 1Q13,
about 44% of the current production and 50% of the estimated proved
reserves are in the US, a very safe region. In FY13, Apache plans
to direct USD 4.6bn of total capex (40%) toward North American
(mostly in the Central and Permian regions)
. This focused drilling program should help Apache deliver 25%
y-o-y growth in North America onshore liquids
(oil and NGL)
Canada contributes 16% of the total production (2% oil, 1% NGL, 13%
gas) and has 19% of the estimated proved reserves. In Western
Canada Apache is working with Chevron on developing the Kitimat LNG
project to provide an export route for 50 billion cubic feet of gas
reserves in that region. This will increase the total production by
3%. In FY12, Chevron paid Apache USD 400m to buy a 50% stake in
Kitimat. The Kitimat plant has received all significant
environmental approvals and a 20-year export license from the
Canadian federal government. Kitimat is one of the closest ports to
the Asian markets, especially Japan, where LNG prices are currently
at USD 16 per Mcf, 3x as compared to that in Canada.
Australian oil developments
: The company has interests in 30 exploration permits, 17
production licenses, and 13 retention leases that cover a total
area of 7.9 million gross acres located in offshore Western
. Approximately 90% of this acreage is undeveloped contributing
12% of FY12 estimated proved reserves.
Australia contributes 9% of total production
(4% oil and 5% natural gas)
. The production in the region will more than double, increasing by
110% over the next 4 years and contributing an additional 10% to
the total production, with major projects including Macedon (2013),
Balnaves (2014), Coniston (2014) and Julimar/Wheatstone (2016)
: In Australia APA has a 13% piece of Chevron's giant Wheatstone
LNG project, which will come online in 2016. After coming online,
the production is expected to be 11 million barrels of oil
(4% of current total production)
annually for 20 years. LNG rates in Australia are at USD 8/MCF,
more than double that in the US. APA will be the biggest domestic
gas supplier in Western Australia by FY13. APA's Australian
subsidiaries have been already signing long-term sales and purchase
agreements for supplying LNG to Asian companies.
The start of the Forties Alpha satellite platform should add to
Apache's production growth in 2013
and more than offset the natural field declines continuing in
Australia, Canada and Argentina.
Egypt is a cash cow for the company as it generates USD 2.7bn
operating cash flow of which USD 1.1bn is spent on capex, with
remaining USD 1.6bn in free cash flow that is used for other parts
of the business. The region provides 20% of total production
(13% oil and 8% gas)
. Average sale
in the region is one of the highest at USD 111 per bbl. APA
announced three new discoveries in the Western Desert of Egypt
during 1Q13, extending the company's production.
The region has 10% of FY12 estimated proved reserves. Even with
all the turmoil,
the company has continued to receive development lease approvals
for drilling in Egypt and plans to invest USD 1.1bn in the region
: North Sea provides 9% of total production
(8% oil, 1% gas)
. The region has one of the highest average sale price for oil (108
per bbl) and natural gas (8.95 per Mcf). APA increased its
portfolio in the region by acquiring Mobil North Sea Limited in
FY11, which provided the region with additional exploration and
development opportunities across numerous fields. This resulted in
a y-o-y production increase of 37% in FY12 in the region. The
region has 6% of total estimated proved reserves.
Reduction in executive pays due to
: Due to significant underperformance of the stock among its peer
group, the board has reduced the compensation of CEO, Steve Farris,
who is also the chairman, by 18% as compared to previous year and
bonus to 150% of the base salary from 200%, as per SEC filings. The
shareholders did not pass an advisory vote on compensation of
executive officers during the annual meeting on 16 May 2013. Also,
the total director compensation was being reduced to USD 300k from
USD 350k, with a cut in the equity component of the pay package.
Overall, this puts pressure on the management for better
performance. I think the board and the CEO are fully aware that
activist shareholders can take greater positions anytime and shake
things up if the management does a sloppy job with good assets and
doesn't create value. We have recently seen a lot of shareholder
activism in oil and gas sector such as Hess (HES), Transocean (RIG)
and Chesapeake (CHK).
3) Divestitures, reduction of debt and share
On 9 May 2013, APA reported 1Q13 earnings and announced a plan to
divest USD 4bn in assets by year-end 2013. The company recently
hired Goldman Sachs to unload shallow water Gulf of Mexico assets.
Another likely divestiture could be Argentinean assets. Fortunately
oil prices have remained high, so the company should get good
value. APA intends to use USD 2bn to reduce debt and another USD
2bn to repurchase stock under a 30 million share repurchase
program. With a current market cap of USD 30bn, this is
approximately a 7% share buy-back program and puts some floor on
the stock price, in case of a fall. Divesting potentially heavy
future investment non-core assets, reducing debt and buying back
stock would create more value.
Recent hedge fund and Insider buying:
In 1Q13, quite a few hedge funds were buyers of the stock including
T Boone Pickens, Wallace Weitz, Brian Rogers, Third Avenue
Management, NWQ Managers, Manning and Napier Advisors, Inc.,
Diamond Hill Capital, Richard Pzena, George Soros, Louis Bacon,
Charles Brandes, Jeff Auxier, Paul Tudor Jones, Jeremy Granthan and
Ray Dalio. In Feb, March and April 2013, we saw some insider buying
Margins and cost efficiency
: APA has lower margins than its peers but that's where it has the
opportunity to improve. OCF margin has declined from an average of
55% in the last 6 years to 50% in FY12, due to significant declines
in natural gas prices. Also, acquisitions had deviated management
focus. However, the acquisition spree has ended and APA is now
focusing on costs by reducing drilling days and frac cost by self
sourcing and optimizing frac design. With shareholders ousting
executives and revamping boards because of poor performance, the
pressure to improve margins and be cost efficient is real.
Natural gas play with diversified asset base:
The company is a less-levered play for the potential upside in the
natural gas, due to its diversified asset base both within the U.S.
and internationally. If gas prices soar, Apache's top quality
on-shore assets could significantly increase profitability. As of
FY12, 45% of APA's production was oil and 49% natural gas. That
said, 78% of revenues come from oil and only 19% from natural gas.
This is due to drastic declines in natural gas prices, which has
forced APA to focus on liquids where margins are higher and keep
natural gas production flat. APA can boost its production with an
increase in natural gas prices, which could have a significant
upside on its revenues and bottom line. Also, APA took heavy
write-offs on its various natural gas assets last year due to lower
prices. Increase in natural gas prices would also increase the
value of those assets on balance sheet, growing the book-value.
Below points highlight the potential increase in natural gas
i) Natural gas prices have declined by 70% in the last 5 years,
to USD 3.9 mmbtu in June 2013 from USD 13.2 mmbtu in June 2008.
This has created a huge divergence between price of oil and natural
gas. The chart below shows price of natural gas
(per barrel of oil equivalent)
as a percentage of oil price. On average in FY12, natural gas was
24% of oil price in the US for one barrel of oil equivalent. This
means it could be bought at a 76% discount to oil. This energy
source will be exploited in the future and price differential will
not remain at these levels.
(click to enlarge)
ii) Many power plants are opting for the cleaner burning natural
gas to replace coal and some of that transition is permanent.
iii) Major manufacturers of chemicals, steel, etc., are
increasing their utilization of, or shifting to, cheap natural gas
to lower their overall cost structures. In this case as well, some
of the transition is permanent.
iv) At present, global natural-gas markets are not integrated.
Prices are USD 0.75 Mcf in Saudi Arabia (subsidized by government),
USD 3.9 Mcf in the US, around USD 12 Mcf in Europe and as high as
USD 16 Mcf in Japan. Over time market forces will narrow this gap.
One such way of exploiting this arbitrage is exporting it to Asia.
Export will eventually open up reducing the arbitrage and
increasing natural gas prices.
v) Compressed natural gas (CNG) vehicles are very common in
Asia. As of 2011, worldwide, there were 14.8 million vehicles that
run on compressed natural gas (CNG), with approximately 5.7 million
in the Asia-Pacific region followed by 4 million vehicles in Latin
America. This number has been growing rapidly as CNG is a much
cleaner fuel and produces much less pollution, is significantly
cheaper than oil
(Asian consumers are very sensitive to oil price)
and has a lower maintenance cost than hydrocarbon-fuel-powered
vehicles. CNG vehicles are encouraged by governments in Asia due to
high pollution in these countries.
vi) Export of LNG is already on its way with the US sanctioning
two LNG export terminals and another 12 waiting for approval. On 17
May 2013, the US Energy Department
it has conditionally authorized Freeport LNG Expansion, L.P. and
FLNG Liquefaction, LLC (Freeport) to export domestically produced
liquefied natural gas((LNG)) to countries that do not have a Free
Trade Agreement ((FTA)) with the United States from the Freeport
LNG Terminal on Quintana Island, Texas. Freeport previously
received approval to export LNG from its facility to FTA countries
in February 2011. In May 2011, Cheniere Energy's Sabine Pass, in
Louisiana, was the first LNG terminal to get authorization to
export LNG to non-FTA countries. Freeport's and Cheniere's combined
capacity would amount to 5.2% of US production.
As of 17 April 2013
, 12 new LNG export terminals have been proposed in the US to
Federal Energy Regulatory Commission (FERC) and there are currently
63 LNG export terminals planned or under construction
Discount to peers:
Apache has proved reserves of 2.9 billion barrels of oil equivalent
((BOE)) and is currently producing 779,000 BOE per day. This is in
line with Anadarko (APC), its closest competitor. APC trades at an
EV/EBITDA of 7.1x, price to tangible book of 2.1x and a forward P/E
of 16.1x as compared to APA's multiples of 3.8x, 1.1x and 9.1x,
(see table below)
. APA's stock price would have to increase approximately by 80% to
trade at APC's multiple.
Anadarko Petroleum Corp.
: Despite taking heavy write-offs on various natural gas assets
last year due to lower natural gas prices and increasing its debt
to finance acquisitions, Apache's trades at price to tangible book
of just 1.1x
(tangible book value per share of USD 77)
. This is historically low, even lower than 2008 levels. Also, on a
price to EBITDA (P/EBITDA: 2.64x) and price to OCF (P/OCF: 3.8x)
basis it's trading close to or below 2008 levels.
Peak in capex
has doubled from its 5-year average. It has risen from a 5-year
average of USD 4.7bn to USD 9.5bn in FY12 and is still growing. As
the company is investing significantly in capex to extract value
from the recently acquired assets, capital expenditure will peak
out in 1-2 years resulting in significant increases in production.
Also, reduction in capex in the future will significantly increase
free cash flow.
: As per International Energy Agency (IEA) report, for the period
2012-2018, world liquid capacity would grow by 8.4 million barrels
per day, significantly faster than demand, which is projected to
grow by 6.9 million barrels per day. This could depress liquid
prices on the downside.
Revenues heavily dependent on oil:
Approximately 78% of APA's total revenues come from oil.
Selling oil at Brent price
: Approximately 72% of APA's crude oil production is priced
relative to Brent crude and sweet crude from the Gulf Coast, which
continue to be priced at a significant premium to West Texas
Intermediate ((WTI))-based prices.
: 71% of the oil consumption in the US is from transportation. In
the next 3-10 years fuel efficient hybrids, LNG, CNG and electric
cars might be more common than we expect and the dynamics of oil
industry could change significantly.
Fracking is relatively young, and probably not all of the
environmental and geological consequences are fully understood. As
time goes by, it is reasonable to expect more government
regulations, which inevitably increases costs and could even put
smaller producers out of business.
Threats in Egypt include deterioration in the political, economic,
and social conditions or changes in laws or regulations in the
region, export restrictions, nationalization of APA assets and/or
forced renegotiation or modification of existing contracts.
: For the above first four reasons, it is better to buy the stock
with a hedge, downside protection to Brent oil. This makes sense
especially now, as Brent is trading at 105, due to risks in Syria
: Market is neglecting APA's diversified asset base and attractive
long-term production growth in its asset rich shale plays and
paying too much attention on Egypt, short-term results and
increased capex spending. Recent strategic acquisitions have huge
potential still to be capitalized with room to improve margins and
an enormous optionality on natural gas upside. The stock is
significantly undervalued as compared to its peers and is trading
below 2008 levels on valuation basis. Decline in oil price is a
concern; by hedging the same one can bet on relative-value and a
natural gas upside.
: Apache Corporation, an independent energy company, explores for,
develops, and produces natural gas, crude oil, and natural gas
liquids. It holds interests in asset bases of 12.3 million gross
acres located in the United States; 7 million gross acres in
Canada; 9.7 million gross acres in Western Desert, Egypt; 30
exploration permits, 17 production licenses, and 13 retention
leases that cover a total area of 7.9 million gross acres in
offshore Western Australia; 32 concessions, exploration permits,
and other interests covering an area of 4.4 million gross acres
located in 4 hydrocarbon basins in Argentina; and various
properties located in the United Kingdom, North Sea.
As of 31 December 2012, it had total estimated proved reserves
of 1,441 million barrels of crude oil, condensate, and natural gas
liquids; and 8.5 trillion cubic feet of natural gas. Combining
both, Apache has proved reserves of 2.9 billion barrels of oil
equivalent , and the company is currently producing about 779,000
BOE per day. However, including its Permian/Central resources that
number goes up to 11.7 billion barrels of oil, four times higher
than the current proved reserves. The company was founded in 1954
and is based in Houston, Texas.
Long APA, short Brent oil (via DTO)
It is very important to read the disclaimer before making
any investments based on the above article.
I am long [[APA]]. I wrote this article myself, and it expresses my
own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
Ameriprise Financial, Inc. (AMP) Management
Discusses Q2 2013 Results (Webcast)