Are Hedge Funds Right on Anadarko?

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Anadarko Petroleum (NYSE: APC) was one of the most popular energy stocks among hedge funds during the third quarter of 2012 (see the full rankings). 58 files in our database of funds and other notable investors reported a position in the independent oil and gas company, up from 55 at the end of June. Anadarko Petroleum Corporation produces oil, natural gas, and natural gas liquids and also has midstream and marketing operations. The company’s revenue was up 4% in the third quarter compared to the same period a year ago, led by higher oil volumes. Natural gas and natural gas liquids volumes also increased, but because of lower prices for these commodities sales in these two businesses were down. Ignoring Deepwater Horizon costs and an impairment from the third quarter of 2011, operating income was up about 30%.

The stock trades at 18 times forward earnings estimates as earnings per share are expected to be higher in 2013. Considering that Anadarko Petroleum Corporation recorded 24 cents in EPS in the third quarter and the current stock price is above $73, the market and analysts alike seem to be expecting higher natural gas and NGL prices; combined with continued increases production, this could drive earnings up enough to justify the stock price. However, it’s possible that producers who are focused on natural gas, such as Chesapeake Energy (NYSE: CHK) would have a similar upside at a cheaper valuation. We’d also note that the stock has a beta of 2.2, likely because much of its valuation depends on energy prices which in turn are driven by demand. Billionaire Steve Cohen’s SAC Capital Advisors increased its stake by 27% during the quarter and closed September with a position of 3 million shares (find more of Cohen's stock picks) while billionaire and former oilman T. Boone Pickens also added shares during the quarter (check out more energy stocks Pickens is buying).

The closest peers for Anadarko as a company are energy producers which are diversified among oil and gas, and so we’d compare it to ExxonMobil (NYSE: XOM), BP plc (NYSE: BP), and ConocoPhillips (NYSE: COP). BP carries a forward P/E of 8, with ExxonMobil and ConocoPhillips trading at 11 and 10 times consensus earnings for 2013 respectively. In fact, each of these oil majors has a trailing P/E multiple less than 10. Because these larger companies haven’t been increasing their production as much as Anadarko, their revenues have been down. ConocoPhillips actually reported a 31% decline in earnings in its most recent quarter compared to the same period in the previous year, while the other two majors had their income change by less than 10%. We’d pass on ConocoPhillips, but BP and ExxonMobil seem cheaper enough than Anadarko that we’d call them better buys even with lower growth rates.

We’d also look at Chesapeake, which we mentioned earlier as being comparable in the sense of being tied to natural gas prices. Chesapeake is down 32% in the last year as the company has suffered from governance issues and from concerns that it will have difficulty raising cash from asset sales. Of course, natural gas prices have also negatively impacted the company. This has left the stock trading at 13 times forward earnings estimates. It might be a better way to invest in higher natural gas prices.  

It’s not clear to us that Anadarko is such a good investment. Some major oil producers are considerably cheaper in terms of their forward earnings (and projections for Anadarko may be a little generous), and even natural gas focused Chesapeake seems to have a lower valuation. For now we would prefer a mix of stocks from these two industries until it becomes more clear that Anadarko is going to deliver earnings in line with the current stock price.

This article is written by Matt Doiron and edited by Meena Krishnamsetty. Meena has a long position in COP. The Motley Fool owns shares of ExxonMobil. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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