Diversified Assets and an Impressive Track Record - What's Not to Like?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Approximately 68% of Apache’s (NYSE: APA) proved reserves and 55% of its production are located in North America. Internationally, the company has core operations in onshore Egypt, offshore U.K. North Sea, onshore Argentina and offshore Western Australia.  In addition, it holds exploration interests on the Chilean side of the island of Tierra del Fuego. Apache has a diversified geographical base, good balance between natural gas and crude oil assets, and an impressive track record. But is this enough to drive production growth and strong investment results in 2013?

Outlook

JPMorgan has reiterated its "Overweight" rating on Apache, but lowered its target price from $103.00 to $90.50. Apache was downgraded by Deutsche Bank from buy to hold with a price target of $80, citing that operating trends have not been good in recent months.

Apache has used its resources to take advantage of recently acquired oil-rich properties in the Permian and Anadarko basins of the U.S. As a result, revenues are expected to increase by 8% in 2013, after being flat in 2012. The shift toward oil production has increased Apache's total North American production to 55%, compared to 46% in 2010. Apache is continuing to add drilling rigs and accelerate activity in the Permian and Anadarko basins. Production in these two regions increased 30% year-on-year, now accounting for nearly 25% of Apache's overall production.

With the shift to increase oil production, the price of oil is critical to Apache's future success. Credit Suisse is expecting the price of West Texas Intermediate (WTI) crude oil to dip by over 5% to $102.75 per barrel from $106.00. Its forecast for Brent crude remains unchanged at $115. The pessimistic expectation of low end prices is around $65 per barrel, but I think this level is unlikely. I expect 2013 demand to be moderate in the context of a continuing weak global economy. I predict prices will hover around $110 per barrel.

Risks

Apache is sensitive to the volatility of oil and gas prices, drilling costs, geo-political risks and delays in executing projects. Apahce sells natural gas in Western Australia under long-term, fixed-price contracts, many of which incorporate clauses about price escalation on the basis of the Australian consumer price index. This exposes Apache to greater-than-average margin pressure.

Kitimat Liquefied Natural Gas Terminal

Chevron (NYSE: CVX), the second-largest U.S. oil company, agreed to buy a 50% stake in the proposed Kitimat liquefied natural gas terminal from Encana (NYSE: ECA) and EOG (NYSE: EOG) to join competition in shipping the fuel from North America to Asian markets. Chevron will also acquire 50% of a pipeline serving the Canadian project along with drilling rights for 644,000 acres in British Columbia’s Horn River and Liard basins.  

Chevron will operate the LNG terminal and pipeline while Apache will manage the acreage. The project has a license from Canadian regulators to export 10 million metric tons a year of the liquefied fuel. Chevron's involvement in the project increases the chances of this early stage project moving forward. Chevron and Apache are already partners in the Wheatstone LNG export project in Australia. The Horn River and Liard shale basins hold an estimated 50 trillion cubic feet of potential gas. Apache expects to net approximately $400 million from the transaction. The project is well situated to meet the growing demand for reliable cleaner-burning fuels in Asia, which is expected to double from current levels by 2025.

The Competition

Royal Dutch Shell and Malaysia’s Petroliam Nasional Bhd are also pursuing gas exports from western Canada to Asian markets, where heating and power plant fuel sells at a premium to currently depressed North American prices. Both EOG and Encana held 30% stakes in the Kitimat project. EOG is selling its stake to focus on onshore crude oil production, which it believes is a more attractive investment opportunity. Encana, Canada’s largest gas producer, has said that it does not have experience in LNG projects.

Apache's strong balance sheet, strong margins, and diversified asset portfolio mean that the company generally has a lower risk profile compared to its peers. The company also has comparatively limited exposure to the problems with U.S. natural gas. However, it does face political risks in Egypt, Argentina, the U.K., and Australia.

Conclusion

Apache does not appear to be a compelling investment at this time. Its ROI stands at around 8.71, compared to an industry average of 13.5. Apache's PEG ratio is on the high side at 1.36. Only strong earnings growth will create upside potential. But the predicted continuing weakness in oil prices for 2013 makes this unlikely. Investors with a position in Apache should hold onto the stock, but new investors should avoid buying the stock for now.


jordobivona has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of Apache. 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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