Big Upside Potential for this Undervalued Energy Play
Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Energy prices have been on retreat over the last several months -- economic concerns, climatic factors and high inventory levels are some of the reasons behind that fall. But leaving short-term volatility aside, fundamentals remain strong from a long-term point of view.
China, India and other emerging markets are demanding increasingly higher amounts of energy, and their industrialization process is a secular trend that may find some bumps in the road, but will not be derailed due to the economic cycle. According to a report from ExxonMobil, energy demand is expected to be 30% higher in 2040 in comparison to 2010 due to factors like population growth and economic development in emerging markets.
One of the most exciting ways to bet on higher energy prices is buying shares of independent energy explorers and producers. These kind of companies usually deploy big amounts of capital on exploration and production projects that sometimes take many years, so their earnings trend to fluctuate widely with the evolution of energy prices.
Businesses in this sector have relatively high fixed costs, which means that rising energy prices generate big increases in profitability due to the effect of higher sales on a relatively fixed cost structure. This can be a double edged sword, of course, and shares of oil and gas explorers can be very volatile in reaction to fluctuating energy prices. This sector is not for the faint of heart, or those who have a bearish long term outlook for energy prices.
It’s not only a matter of sector analysis and energy prices of course. Just like in every sector, some companies are better than others, and certain stocks provide cheaper valuations. Investing in the most attractive energy producers and explorers provides investors with two ways to profit in the long term as the fundamental qualities of individual stocks can be an extra return driver in addition to rising energy prices.
One of the largest independent exploration and production companies in the United States, Apache (NYSE: APA) is in the business of exploration, development and production of natural gas and crude oil. The company has operations in seven countries: U.S., Canada, Egypt, the United Kingdom, Australia, Argentina and Chile.
Apache has a diversified asset base from different perspectives. The company combines conventional and unconventional projects with different maturity dates, and natural gas is nearly 50% of production and 54% of proved reserves, 43% of which are in in the U.S. This diversification provides a more controlled exposure to different kinds of price fluctuations and potential events that could affect production levels in different projects.
The company has done several acquisitions over the last quarters, spending more than $11 billion in projects from BP, Devon and Exxon, as well as a $4 billion merger with Mariner Energy and a $3 billion acquisition from a private equity firm. Apache has a strong portfolio of projects with a considerable potential for growth over the following years.
Apache has delivered healthy growth rates over the last years: cash flows per share have expanded at 20% annually and earnings per share at an even higher 23% annually during the 2002-2011 period. Considering the recently acquired projects and the fact that Apache has been able to increase both production and reserves through different economic scenarios, there is no reason to doubt the company's ability to keep delivering solid results in the foreseeable future.
When comparing valuation ratios and profitability margins for Apache versus competitors like Anadarko Petroleum (NYSE: APC), Devon Energy (NYSE: DVN), EOG Resources (NYSE: EOG) and Occidental Petroleum (NYSE: OXY), Apache comes ahead of its peers since it has both the lowest P/E ratio and the highest operating margin of the companies in the group.
While Occidental Petroleum has similar operating margins to those of Apache, its shares are more expensive at a P/E ratio of 10.27 versus 8.25 for Apache. Devon and EOG have lower profitability and higher valuation ratios, while Anadarko has negative results and hence is a much more uncertain investment.
Shares of Apache Corporation provide a convenient way to get exposure to higher energy prices via a strong company with a proven track record of success and many growth opportunities due to its recently acquired projects. Besides, the company’s superior profitability and low valuation make it an attractive bet in comparison to its peer group.
acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of Devon Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.