So far, 2012 has looked like a year of risk aversion in the energy space. By and large, the bigger you look, the better your returns have been - the stocks of companies like Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) have done pretty well, while companies like Anadarko (NYSE:APC) and Apache (NYSE:APA) have languished by comparison. Although I see that Apache's recent production growth guidance cuts aren't going to make it the hottest property in the space, I still believe that investors ought to consider owning this name for its combination of long-term potential and near-term value.
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Familiar Challenges in the Second Quarter
Apache really didn't thrill anybody back when it reported second quarter earnings. Revenue fell 8% from last year (and 12% from the first quarter), missing estimates on a combination of disappointing production and lower pricing.
Although the company does not generally offer quarterly guidance, the Street nevertheless expected more than 3% annual production growth. Volume was hurt by unplanned downtime in the Gulf of Mexico, North Sea and Canada, but frankly investors don't much care about the "why" as opposed to the "how much." Pricing, not surprisingly, was weak - particularly natural gas, where realizations fell almost 23%, despite the company's leverage to higher international gas prices.
While pricing and production are wobbly, expenses continue to increase. While lease operating expense inflation was modest on a per-barrel basis (about 3%), G&A and DD&A costs grew much more significantly and pre-tax income dropped 62% from the year-ago period.
SEE: Oil And Gas Industry Primer
Giving the Audience What It Wants
Apache has been criticized and discounted in the past for a portfolio that was oriented towards short-life/high-intensity assets and more challenging operating environments like the Gulf of Mexico, North Sea and Egypt (though the challenges in Egypt aren't exactly operating issues per se). That looks to be changing, though you wouldn't know it from looking at the stock's multiples.
Apache is significantly ramping up its activity in the Central and Permian regions - it's actually the second-largest player in the Permian alongside other well-known names like Occidental (NYSE:OXY), Chesapeake (NYSE:CHK) and Exxon. Overall, the company is going to be focusing more on its organic growth potential in the U.S., where the company has not only substantial acreage but also a promising return on investment potential.
Reaping Vs. Planting for the Future
Of course, Apache is still Apache and this is a company with a long history of following its own map. So while it sounds like many on the Street would prefer to see Apache focus on cash flow generation and simply drilling what it already owns, management is still thinking about the future. More to the point, the company continues to explore unconventional energy prospects in far-flung areas like New Zealand, Kenya, South America and so on.
Frankly, I think this is a good idea. Investors have seen repeatedly what happens when energy companies under-invest in future production sources.
SEE: A Guide To Investing In Oil Markets
The Bottom Line
If the bottom falls out of energy prices due to further erosion in the global economy, there won't be many places to hide, so that's a risk that potential Apache shareholders just have to accept. That said, I think Apache is undervalued on its long-term prospects. I don't see why the company should share basically the same forward multiples with much larger energy giants that frankly don't have the same growth prospects.
Assigning a 4.5 times multiple to Apache's 2013 EBITDA, I believe fair value falls between $110 and $130 for these shares. That doesn't make Apache the cheapest name in energy, but the combination of valuation and quality certainly make this a name worth considering.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.