Apache (IL/A): Shares look inexpensive versus peers, but lack company-specific catalyst - Goldman Sachs - October 27, 2005
We continue to view Apache shares as inexpensive and believe it can rise on an absolute basis in the context of our Attractive coverage view. Relative to its peers, though, we rate Apache In-Line, as we believe our top large- /mid-cap E&P picks--XTO Energy, Newfield Exploration, Southwestern Energy, and EnCana (all OP/A)--offer a better combination of visible growth/returns, near-term catalysts, and risk/reward. We believe Apache's balance sheet is on-track to reach net debt free status some time in 2006. With management historically not of the mindset to repurchase large quantities of stock, we see Apache's next acquisition as the possible catalyst for investors to take a fresh look at its inexpensive share price. However, patience may be required, as management prudently searches for a deal that can generate both growth and attractive returns.
KEY COMPANY-SPECIFIC CATALYSTS
(1) Use of free cash flow. We estimate that Apache's balance will have as much as cash on hand as debt outstanding at some point in 2006 in the absence of a large acquisition or share repurchase program. Management has indicated that it prefers to retain its balance sheet capacity rather than repurchase shares. Given the company's strong track record of performance, we do not find its opposition to share repurchase unreasonable, though our own preference is that some amount of stock buyback can make sense, especially given how inexpensive the shares currently appear to be. We believe Apache is patiently waiting to make its next major acquisition, the timing of which is of course uncertain.
(2) Timing of return of shut-in Gulf of Mexico production. Apache expects the majority of its impacted Gulf of Mexico production to return over the next two quarters, with most of the remainder to return later in 2006. Similar to other Gulf producers, the issue appears to be with problems at third party pipeline and processing infrastructure, rather than at its own platforms or fields.
(3) International production increases in Canada, Egypt, Australia, and the North Sea. We continue to view positively Apache's international E&P operations, with drilling/new field start-ups anticipated to increase production in 2006 in each of its key areas: Canada, Egypt, Australia, and the North Sea. The combination of recovering Gulf of Mexico production and rising international output could lead to more robust production performance in 2006 than 2005, though Gulf hurricane season will return in 2006.
3Q 2005 EPS BELOW EXPECTATIONS DUE TO HURRICANE IMPACTS
Apache reported 3Q 2005 EPS of $2.05, which was below the $2.31 First Call consensus expectation as well as our $2.35 forecast. We attribute the majority of the miss to the impact of Hurricanes Katrina and Rita, though Canadian gas volumes did not ramp quite as fast as we had expected due to weather and infrastructure delays.
UPDATED ESTIMATES
We have lowered our 2005 EPS estimate to reflect the 3Q 2005 shortfall as well as a slightly lower expectation for 4Q 2005. We now project 4Q 2005 EPS of $2.65 ($2.77 before) and full-year 2005 EPS of $8.13 ($8.56 before). The lower 4Q projection is primarily a function of additional downtime in the Gulf of Mexico, partially offset by expected insurance recoveries.
For 2006-2010, we have changed the way we are treating the excess cash we forecast Apache will generate. Previously we had for modeling purposes assumed Apache would buyback shares, even though our view was that the company would be more likely to make an acquisition. We have changed our modeling approach to now reflect a cash build on its balance sheet and corresponding interest income on the income statement, rather than a share repurchase. For 2006 and 2007, we assume a 5% pre-tax return on cash. For 2008-2010 normalized, we assume a 12% pre-tax return on cash, which is consistent with our view of Apache's normalized profitability levels, as by then we think the cash will have been redeployed into an acquisition. The impact of this modeling change has lowered our EPS forecasts for 2006-2010. Our updated EPS estimates are as follows: $10.65 ($11.40 before) for 2006E; $11.00 ($12.75 before) for 2007E; $4.90 ($5.00 before) for 2008 normalized; $5.15 ($5.26 before) for 2009N; and $5.37 ($5.48 before) for 2010N.
I, Arjun Murti, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. |
