|Shares Out. (in M):||379||P/E||0||0|
|Market Cap (in $M):||19,708||P/FCF||0||0|
|Net Debt (in $M):||8,972||EBIT||0||0|
Apache Corporation (NYSE: APA)
This write-up will not mention anything about EUR’s, type curves, IPs, or individual well economics, because those things don’t really matter to me. I look for companies with good management teams and solid balance sheets that are misunderstood by investors and where fear or uncertainty has created a buying opportunity. I believe that Apache checks all of these boxes.
Simplify, simplify. – Henry David Thoreau
Recommendation: Buy APA
Apache is a high-quality E&P focused on North American onshore drilling with core assets in the Permian Basin. In addition, ~40% of production comes from slower-declining, high-FCF assets in the North Sea and Egypt. Apache is highly levered to an increase in the price of oil and as oil continues to recover to the marginal cost of production (at least $75), APA should outperform.
As of December 31, 2015, APA had ~1.6 billion BOE of proved reserves. Apache produced 204 mmboe in 2015, of which 52% was oil, 37% was natural gas, and 11% was NGLs.
New management has implemented a new capital allocation strategy that increases the focus on portfolio-wide returns on capital. In the past, capital was allocated on a regional basis, which resulted in projects with inferior returns being allocated over those with superior returns. The market does not appreciate this new pivot in strategy and misunderstands the company’s future growth profile.
The company has stated that they could have held 2016 production flat with a $2.5 billion capex budget (2016 production will instead be down ~9% with a $1.6 billion capex budget). The 2016 capex budget was done using $35 oil, and they have stated that every $5 increase in the price of oil generates ~$500 million of additional cash flow. Therefore, if oil averages $50 in 2016, I estimate that the 2017 capex budget could be ~3.1 billion, which would generate 2017 production growth of ~13%. The market currently expects APA’s production to decline 1-2% in 2017.
Apache has a clean balance sheet that is underlevered relative to several large cap E&P peers, with a history of producing free cash flow and solid returns on capital (shocking for an E&P, I know). The company has been free cash flow positive in 8 of the last 12 years, with cumulative free cash flow over that period of ~$9.5 billion and through-the-cycle ROIC of ~10%. APA currently has net debt/2015 EBITDA of ~2.5x. This number decreases to 1.5x under my 2017 base case. The peer group currently average net debt of ~2.5x 2017E EBITDA.
We are clearly seeing a much faster drop-off in oil production and a much stronger demand environment than most market participants expected. Just as the market oversold many of these stocks many of these stocks as oil prices were declining, it is likely to do the opposite as oil prices recover. As long as the price of oil remains below what I believe to be fair value (at least $75), I would continue to hold this stock regardless of my estimate of its fair value.
Perhaps most importantly, good things tend to happen to cheap stocks. In the past 9 months, APA has been the target of take-out rumors by both APC and OXY. In the first instance, APA rejected a low-ball bid, while in the second instance the rumor turned out to be false. Even so, I believe that Apache’s superb acreage and clean balance sheet combined with its cheap valuation and ability to generate free cash flow will continue to make it an attractive target for larger E&Ps.
As an added bonus, it appears that Apache has a very intriguing asset offshore Suriname that is directly across the Suriname-Guyana border from Exxon’s significant Liza-1 discovery offshore Guyana. Apache has a 45% working interest in Block 53 and a 100% WI in Block 58. Both of these blocks were obtained prior to the Liza well being drilled.
APA currently trades at a discount to the peer group on an EV/EBITDA basis. The group currently trades at an average EV/2017 EBITDA of 10.3 versus APA at 8.3 (using consensus 2017E EBITDA). However, I believe the Street significantly underestimates APA’s 2017 EBITDA and under my base case, APA currently trades at just 5.8x 2017E EBITDA.
Based on a scenario using $65 oil in 2017, I estimate that APA can generate ~$5.3 billion of EBITDA (versus consensus $3.7 billion). Using APA’s current valuation of 8x 2017E EBITDA, I value APA shares at $91.
Oil prices reverse their recent gains and remain in a “lower for longer” scenario.
The company’s Egypt operations are affected by terrorism or political turmoil.
Production continues to decline.
|Subject||Re: Re: Analysis|
|Entry||06/29/2016 11:39 AM|
I think a discussion of relative acreage quality could be beneficial for those that follow Permian results. Sancho, do you / any other VIC member have data that support your claim that “APA's reinvestment opportunities in the Permian don't hold a candle to core Permian players like PXD, FANG, etc”? My view is somewhat consistent with Werd’s – Apache has had a management problem, not necessarily an asset quality problem in the past. Apache’s Permian assets are actually among its lowest decline assets – see p. 9 of its most recent presentation. I would imagine that Apache’s Permian base decline rate compares favorably to the other Permian players.
Some questions that are important to address in this exercise:
How much of Apache’s 3.3mm gross acre Permian position is goat pasture?
If APA’s average Permian acre is inferior to other Permian players, does APA have any acres that are comparable? If so, how many years of drilling inventory is this?
How inferior is the acreage? If Werd is correct and Apache can grow production 13% at current oil prices within cash flow, I would argue that Apache has prospects that are worth drilling and the company can recycle capital at attractive returns.
What is the appropriate valuation premium for premium acreage? Just looking at 2017 EV/EBITDA multiples, PXD and FANG trade at 13x and 14x, respectively, vs. 8.3x for APA.
Are other Permian player just better operators than Apache and can generate better returns on the same acreage?
How should we think about half cycle vs. full cycle economics here? If one needs to issue a bunch of shares to buy the best acreage at high prices to continue its growth profile, is that really a fair comparison? What happens if that company loses its low cost of capital and can’t buy growth with paper? The recent historic decline in oil prices did not knock any of the Permian pure plays off of the proverbial treadmill, so maybe that will never happen.
|Subject||Re: Re: estimates|
|Entry||07/15/2016 03:23 PM|
thanks for the analysis... you mention the various rumors (and actual unsolicitied bid)... do you think APA management would consider selling?
looks like apc moved on and oxy denied it pretty strongly. but oxy seems like it could be an interesting fit. not sure what they could pay of course.
|Subject||Re: Re: Re: Re: estimates|
|Entry||07/18/2016 12:14 PM|
thanks for the observation. agree re empire.
what's a "fair offer" in your mind? APC tried to do a low premium deal. doubt that works.
|Subject||Re: Re: Re: Re: Re: Re: estimates|
|Entry||07/19/2016 10:08 AM|
the APC "offer" was pretty silly unless their definition of Low Premium is different than mine.
|Entry||07/19/2016 10:24 AM|
You value APA at $91 but a "fair offer" is $70 or higher evenm though we are very depressed cyclically? How is that fair value? Why wouldnt it be a 40-50% premium or higher?
|Subject||Re: Re: Question|
|Entry||08/02/2016 01:34 PM|
in your mind who would be a natural buyer for these assets?
personally i think OXY should use their strong currency but it might be too big of a bite for them. that doesn't leave too many players.
|Subject||Re: Re: estimates|
|Entry||08/12/2016 10:46 AM|
Thanks, Werd. So for Apache to have a $65 oil realization, you probably need front-month Brent to be >$70, and Brent-WTI spreads narrow, given basis differentials. Whether oil is likely to be $70 is probably beyond the scope of this thread, so I won't address that here, even though I can't see the argument, particularly before 2019. With that being said, at $70 oil (Apache realization: $65), i can get to your $5.3 billion of Adjusted EBITDA (adding back ARO, impairments, transaction, separation, and reorganization costs, but not exploration).
What i don't understand is your valuation approach. At stabilized oil prices of 2013/14, Apache used to trade at 4x EBITDA. It seems to me you are double counting. If oil prices go back to $70, you are arguing that today's valuation on "depressed" realizations will persist even as realizations "normalize." For what its worth, the $5.3 billion in Adjusted EBITDA would be ~$3.85 in EPS, again adding back transaction and separation costs. Your $90 target would imply a mid 20s multiple of EPS for a company that never traded above 15x from 2006-2014...
|Subject||Re: Re: Re: High Alpine|
|Entry||09/08/2016 05:05 PM|
@coldcall "but also result in the opportunity cost of foregoing activity in existing assets?"
i think the oppo cost is negligible if this field is as good as it seems. if/once proven out, there will be plenty of industry money coming in on reasonable terms.