Apache (IL/A): Inexpensive relative valuation; 2H 2006 volume acceleration could improve sentiment - Goldman Sachs - February 02, 2006
Apache has traded up meaningfully on an absolute basis in concert with the broader sector, but did meaningfully lag its large-cap E&P peer group in 2005, as its pursuit of a diversified growth strategy did not fit with the Street's current preference for unconventional, onshore North America gas pure-plays. In our view, Apache is unlikely to permanently remain at such a valuation discount vis-a-vis the unconventional gas E&Ps. The catalyst to narrowing the gap could be an acceleration in E&P volume growth to low double digit rates y-o-y in 2H 2006. Apache is not the only large-cap diversified E&P that looks inexpensive, with Anadarko Petroleum and Devon Energy at similar levels (all IL/A rated). Of the three, we prefer Anadarko at this time owing to our view that it has more visible growth and exploration catalysts, but we think it is a very close call.
FAVORABLE RISK/REWARD AND INEXPENSIVE VALUATION, TIMING THE ONLY QUESTION
We see 27% upside for Apache's shares to a $94 "traditional" peak and 83% upside to a $135 "super-spike"-adjusted peak value, which is similar in magnitude to the upside we see for Apache's fellow "value" large-cap E&Ps Anadarko and Devon. Given that we see a better combination of visible near- and long-term production growth as well as catalysts, we currently prefer Anadarko as our favorite large-cap value E&P of the three companies. With that said, it is a very close call. All three companies trade between 4.5X-4.7X 2006E EV/DACF, over 15% below the 5.6X large-cap E&P average (excluding oil sands-leveraged companies) and over 25% below the 6.1X average for unconventional growth E&Ps like EOG Resources (EOG; IL/A), EnCana (ECA; OP/A), and XTO Energy (OP/A). While we continue to retain a favorable fundamental view of the unconventional gas growth E&Ps, and believe the risk/reward for XTO in particular remains compelling, we believe the valuation gap is becoming sufficiently wide that investors should seriously consider increasing exposure to the more value-oriented E&Ps.
KEY COMPANY-SPECIFIC CATALYSTS
(1) E&P volume acceleration in 2H 2006. Following a promising start to 2005 with circa 6% year-over-year (y-o-y) volume growth posted in 1Q and 2Q 2005, Apache's Gulf of Mexico production was negatively impacted by the catastrophic hurricanes Katrina and Rita, resulting in 3Q and 4Q y-o-y volume declines of -1% and -6%, respectively. However, with volumes steadily recovering and new international projects ramping-up, we see Apache's y-o-y volume growth showing a modest uptick in the 1H 2006 followed by 10%-15% growth in 2H 2006. The fact that investors will likely worry about the risk of further hurricane damage in 2006 suggests Apache may not receive advance credit for expected 2H growth.
(2) Can Apache improve confidence in the sustainability of US volume growth long-term? Overall, we are expecting 8.5% E&P volume growth in 2006 and a similar jump in 2007. With decent visibility in its international program, we believe the US outlook is the key uncertainty in terms of whether Apache can gain the type of longer-term production growth visibility that can argue for a more meaningful re-rating up for its shares. Although its Gulf of Mexico operations garner an excessive amount of the Street's attention, Apache has long had a large exposure to onshore properties. To the extent the company can gain access to a large resource opportunity, like it has with the Exxon Mobil acreage in Canada, we think the Street's perceptions of its US business could improve.
(3) FURTHER USE OF SIGNIFICANT BALANCE SHEET CAPACITY.
Apache's balance sheet, like much of the sector, appears very healthy with its net debt-to-tangible capital ratio now in the teens. Management historically has not been proponents of share buybacks, a view we think could soften as cash eventually builds meaningfully on its balance sheet should commodity prices stay strong as we expect. Apache of course will continue to pursue acquisitions, which historically have been key catalysts for its shares.
4Q 2005 RESULTS WERE BELOW EXPECTATIONS
Apache reported 4Q 2005 EPS of $2.35, below the $2.42 First Call consensus forecast and our $2.48 projection. E&P production of 433 MBOE/d (thousands of barrels of oil equivalent per day) in 4Q was above our 427 MBOE/d expectation. The realized oil price of $53.63/bbl was below our $55.59/bbl forecast and the realized natural gas price of $7.86/Mcf was also under our $8.35/Mcf expectation. "All-in" unit costs were $21.65/BOE, higher than our $20.17/BOE forecast.
UPDATING ESTIMATES AND INTRODUCING 2006 QUARTERLY EPS FORECASTS
We are introducing 2006 quarterly EPS estimate for Apache as follows: $2.70 (1Q), $2.64 (2Q), $2.65 (3Q), and $2.95 (4Q). Our full-year forecasts are now $10.95 ($10.00 before) for 2006E, $10.80 ($10.43 before) for 2007E, $5.15 ($5.00 before) for 2008 normalized, $5.47 ($5.24 before) for 2009N, and $5.74 ($5.52 before) for 2010N. The higher estimates are a function of slightly higher E&P volume assumptions, a slightly lower expectations for costs, and minor other adjustments. See Exhibit 1 for our summary financial model for Apache.
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. |
