If it were only a question of the quality of its oil and gas operations, Anadarko Petroleum (NYSE:APC) would be an easy stock to like at today's price. In the case of this company, that's a whopper of an "if," as litigation over Tronox (NYSE:TROX) nears its end and brings a large range of potential outcomes. Although Anadarko looks too cheap based on its energy operations, any investors looking to exploit that discount must be prepared for the potential that an adverse ruling could seriously dent the stock.
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Another Quarter of Strong Performance
Anadarko came through with another good quarter to end 2012. While revenue declined 11% on a reported basis and about 12% on an operating basis, the Street rarely pays much attention to revenue figures. More important was that production increased more than 8% from last year, beating the midpoint of its own guidance and most Street estimates. The makeup of that beat was a bit less than ideal, however, as NGL was a little weak and gas was strong.
Anadarko also did well on its operating expenses. While DD&A expenses increased 2% per BOE, operating expenses were down more than 13%, helped in part by lower workover expenses. The latter is not a tremendous surprise given what we've heard from the likes of Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL) recently, but it's positive news all the same and helped Anadarko post a meaningful operating beat for the quarter.
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An Increasingly Interesting Portfolio of Global Assets
Investors seem to go back and forth on whether they want to see E&P companies diversify their resource base outside the U.S. In Anadarko's case, it has been a pretty successful move thus far. The company's Jubilee field in Ghana should see production improve 50% in 2013. The company made a huge gas discovery in Mozambique earlier in 2012 (which could be worth more than $10 per share). Plus, there has been steady progress in Algeria and Ivory Coast. What's more, the interest of Apache (NYSE:APA) and Total (NYSE:TOT) in offshore Kenya lends credence to the idea that Anadarko's acreage there has potential as well.
I would expect 2013 to be another busy year for the company. While management won't be discussing its capital budget plans for 2013 for a couple of weeks (until its February Analyst Day), multiple wells will be drilled offshore in Africa and in the Gulf of Mexico. Although companies like Seadrill (NYSE:SDRL) and Transocean (NYSE:RIG) have been seeing higher day rates, Anadarko has a strong "on time, on budget" culture, and the company's historical finding, along with development and production costs, compare well to E&P peers - particularly in light of the production growth.
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Tronox Still the Biggest Risk Factor
The nature of Anadarko's operations guarantee a higher level of ambient risks than a company like Chesapeake Energy (NYSE:CHK) or Whiting (NYSE:WLL), as the recent attacks on an Algerian energy facility served to highlight. However, it's not operating risk that's the biggest threat to Anadarko shareholders. Rather, it is the outcome of litigation tied to Tronox.
Kerr McGee spun off Tronox prior to Anadarko's acquisition, in part to make it an easier, more palatable deal for Anadarko. Tronox was spun off with significant environmental liabilities, and Anadarko is being sued for what amounts to fraudulent conveyance. While Anadarko has fought these charges, it seems to be generally accepted on the Street that the company will be held liable. The question is for how much. Nobody seems to think that the maximum amount (which is north of $20 billion) is in play, but there are definitely risks that it could exceed the $4 billion or so that seems to be the average Street expectation. With about half a billion shares outstanding, it's not too hard to see how the shares could be impacted by a substantially higher-than-expected award in the case.
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The Bottom Line
Absent the Tronox matter, it wouldn't be too hard to argue that Anadarko is worth close to $110 a share. Given the low interest rates at present and the company's considerable asset base, raising the capital to pay even a larger-than-expected award would be crippling to the company. Consequently, these shares look undervalued on a long-term fundamental basis, but investors should not approach without understanding the risk that a bad ruling on Tronox is a definite near-term risk for the share price.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.