An Oil & Gas Company To Avoid

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

With the rising public unrest and military support, the elected Egyptian government has been shaken off in just a year’s time. To stabilize the country, an interim government will be formed and an temporary Prime Minister will be appointed. After everything is settled, an election schedule will be announced so that a new government can be elected and take control of things. This sounds like a long and painful process, and companies like Apache Corporation (NYSE: APA) could witness shrinking earnings amidst this political mess.

Why Strained Earnings?

Apache has been operating in Egypt since 1994, and is counted amongst the largest active oil and gas companies in the region. The company generates 27% of its overall revenues from the country, which also accounts for 20% of Apache’s overall oil production. Furthermore, its long term strategy includes expanding in the country, to ramp up its production over the next decade. Hence, it's evident that Apache is relying on Egypt for its long term growth.

But over the last 5 years, the Egyptian Pound has depreciated by nearly 35% against the US Dollar due to the prolonged political mess in Egypt. Currency depreciation not only induces domestic inflationary pressures, but also strains the cash flows of foreign companies. Since Egypt is currently functioning without a government, it's obvious that Egyptian Pound will continue to depreciate further, resulting in higher forex losses for Apache Corporation.

Debt Position

If Apache has a long term view on Egypt, it can pump-up capital in the country and take advantage of its weak currency. Then it can expand its Egyptian assets over the next couple of years and start reaping the rewards. But unfortunately, Apache isn’t counted amongst the cash rich companies.

The company carries a huge long term debt burden of $12.48 billion, which results in a debt/equity ratio of 41%. Meanwhile, the debt/equity ratio for Chevron (NYSE: CVX) and Royal Dutch Shell (NYSE: RDS-B) are much lower at 10% and 19%, respectively. Besides that, Apache has just $248 million in cash and cash equivalents.

To ease the cash crunch, Apache will be selling its non-core assets this year, with an aim of raising around $4 billion. Management stated that around $2 billion will be used to reduce its debt burden, while the remaining $2 billion will be used to repurchase around 6.25% of its outstanding shares. But even after repaying its debt, Apache doesn’t have enough cash reserves to finance such aggressive expansion plans.

So the best option available is to reduce its exposure to Egypt.

Reducing Exposure

Both Chevron and Shell are active oil and gas companies in Egypt. Needless to say that they are much bigger than Apache Corporation, and are often referred to as cash cows. But even these mighty companies are shedding their Egyptian assets.

According to a recent press release, Shell has agreed to sell its downstream assets in Egypt to Total S.A. The company operates 85 fuel stations in Egypt, which altogether rakes in a domestic market share of 5%-7%. It was a cash-based transaction, but the exact terms of the deal were not disclosed. However, Shell’s asset divestiture is being cheered by the Street due to its reduced exposure to the country. Since Shell has been eying a stake in the Mozambique LNG plant, I believe that the cash generated from the deal will most likely be used to fund that purchase.

Similarly, Chevron is looking to offload $300 million worth of downstream assets in Egypt and Pakistan. These numbers aren’t huge because only its downstream assets were considered for the sale. Its spokesperson recently stated that Chevron is currently reviewing its fuel operations in Egypt and Pakistan, following which the company will decide whether to keep or divest its assets in the countries. But since most rating agencies are advising the sale of Egyptian assets, I'm inclined to say that Chevron will follow suit

But since Apache Corporation hasn’t announced the divestitures of its Egyptian assets, Oppenheimer has downgraded its shares to market perform. Its analysts stated that Apache’s earnings have been dampened by 20%-30% due to its significant exposure to Egypt. So, to unlock shareholder value, Oppenheimer suggests that Apache divests some of its Egyptian assets and use the cash generated to repurchase around 15% of its outstanding shares.

Conclusion

In my opinion, Apache is a great company and its recent spurt of expansions will be its key growth drivers. But its huge exposure to Egypt has nullified its positive catalysts, and offers little potential for growth. I firmly believe that Apache should offload some of its assets in the country this year, as the Egyptian Pound will most likely continue to weaken. But until that happens, I wouldn’t recommend Apache Corporation to conservative investors.

 

If you're on the lookout for some currently intriguing energy plays, check out The Motley Fool's "3 Stocks for $100 Oil." For FREE access to this special report, simply click here now.


Piyush Arora 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!

blog comments powered by Disqus