It feels like it wasn't all that long ago when Apache (NYSE:APA) was one of the most well-regarded energy companies in the game. Management had a knack for acquiring assets from larger companies at attractive prices and driving a surprising amount of productivity out of them. Along the way, the company developed a very broad portfolio that was well-balanced between oil/gas, individual basins, and near-term/long-term productivity.
SEE: Oil And Gas Industry Primer
Unfortunately, there's a blurry line “diversified” and “unfocused”, and Wall Street has come to the conclusion that Apache is too much of the latter these days. What's more, there are now substantial questions about the company's asset mix and its ability to generate good returns from those assets. Management is responding to these concerns with an asset sale program, and while Egypt is going to loom large in investors' minds for a while yet, I believe these shares are meaningfully undervalued today.
Where Has The Production Gone?
While Apache had once been prized in part for its strong production growth profile, these days the company looks a lot more like majors like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) with recent production growth of just 2% (and down 2% sequentially in the first quarter). While production in the Permian and Anadarko basins has grown to more than a quarter of the company's total, Egypt is still a major contributor as well.
I don't believe the company's portfolio has transitioned permanently to a lower-growth collection of assets. Rather, I think management may have made the mistake of investing too much in the development of long-term assets (particularly those acquired from 2010-2012) and losing sight of the company's (or rather, the stock's) near-term growth needs.
The company certainly has been spending to develop its reserves. Although Apache's balance between oil and gas is okay (45% of the former), the company's finding and development (F&D) costs have been trending considerably higher, and now sit well above the average of its peer group. With Wall Street's newfound obsessions regarding capital efficiency at energy companies, that's a problem today. Likewise, the company's cash flow per barrel has dropped to just “average” and below the level of companies like Occidental (NYSE:OXY) and EOG (NYSE:EOG).
The Egypt Issue
Apache generates more than 30% of its cash flow from its substantial asset base in Egypt, not to mention around 20% of its total production. With Egypt spasming with political unrest, what was once seen as an invaluable asset for the company is now seen as an albatross that many analysts wish the company would sell.
SEE: 3 Economic Reasons Behind The Protests In Egypt
I think that's much too hasty. First, Egypt generates very attractive returns for the company, as the level of ongoing investment is pretty modest relative to the production. Second, I think it's too soon to assume that the turmoil in Egypt is going to result in confiscation or interference with operations – of course it's a risk, but I think the odds of Apache getting fair value in a sale today would be near zero anyway.
Asset Sales Should Generate Cash And Upgrade The Asset Base
Apache management does appear to be bowing to pressure to expand its asset sale program. Management has upped the 2013 target to $4 billion from $2 billion, with the cash generated going towards debt repayment and a share buyback.
This is a solid opportunity for Apache to upgrade its portfolio of assets, and that may well include selling the seemingly always-hated Gulf of Mexico deepwater assets. Companies like Exxon and Anadarko (NYSE:APC) are “in the neighborhood” so to speak, but I could also see Apache doing partial sales through JVs and partnerships and bringing in financial investors (private equity groups) as part of this process.
The Bottom Line
I think I've made it pretty plain that I'm still a fan of Apache and believe these shares have been punished too much. It would seem that at least some sell-side analysts agree with me, as most of the highest-ranked analysts in the Institutional Investor poll have targets above the average. In any case, if you use the historical average EBITDA multiple for Apache, the shares should trade near $114 today. Using the bottom of the historical range (sub-4x) still points to a target of $90, or roughly 10% higher than today's price.
Clearly Apache has work to do to get back in the good graces of the Street, and using this asset sale program to improve the quality (returns and growth potential) of the portfolio would be a great start. While I don't think sentiment will turn quickly on this stock, this could be a good name for more patient value investors to consider.