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Three Reasons to Own Anadarko Petroleum

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

Shares of Anadarko Petroleum Corporation (NYSE: APC) are poised to continue to hit new highs as the company benefits from a much more healthy environment for natural gas producers.
 
While the majority of Anadarko Petroleum's production is comprised of liquid energy products (primarily oil), the company is also the third largest US natural gas producer as measured by the Natural Gas Supply Association. 
 
This puts Anadarko Petroleum in a strong position for future growth, as the natural gas market is set to undergo some significant changes over the next few years.
 
Below are three reasons you should consider adding Anadarko Petroleum to your portfolio today. 
 
Favorable natural gas price expectations 
 
Over the last several years, natural gas prices in the US have plummeted due to a massive supply glut. New technology allowing producers to extract natural gas from shale rock formations has boosted production across the country. Of course, the laws of supply and demand cause prices to drop whenever there is an oversupply of a commodity.
 
One of the biggest issues holding local natural gas prices down is the problem with transportation. In North America, the majority of natural gas transportation takes place via a growing network of pipelines that move product from wells to end users.
 
While US prices for natural gas have remained very low due to the supply glut, international prices have been much higher in areas where there is less supply. The key issue is the difficulty of overseas transportation.
 
However, last month the Department of Energy approved a large liquid natural gas (LNG) export facility in Texas which will allow tankers to transport US-produced natural gas to overseas destinations.
 
This approval is seen as a landmark decision because it paves the way for other export terminals like this to be built. The Department of Energy appears to believe that the economic benefits of transporting the natural gas outweighs the potential economic detriments of selling our natural gas to other countries.
 
The transition will take several years before natural gas will be exported in bulk, but the decision opens the gates for higher natural gas prices in the US simply because the supply glut can be eased by selling to other markets.
 
Over time, the higher domestic natural gas prices will clearly benefit companies like Anadarko Petroleum that are major producers of natural gas.
 
Increasing production as prices stabilize 
 
Anadarko Petroleum is poised to increase its energy production by a factor of five to seven percent each year over at least the next seven years.
 
This production is anchored by the company's high-margin portfolio of liquids (again, mostly oil), which provide Anadarko Petroleum with a solid base of increasing revenue. But the real growth opportunity comes from the potential for increased natural gas production.
 
Management has indicated that as prices for natural gas rise above $4.50 (and remain stable above that level), the company will increase its natural gas production. This makes sense because at higher prices, the company can afford to spend more in exploration and production costs to pull more natural gas out of the ground.
 
As you can see in the chart below (taken from a recent company presentation), a higher natural gas price would allow the company to increase their production to a range of seven to nine percent annualized, which is very strong for a company of Anadarko Petroleum's size.
 
 
 
Higher levels of production, coupled with higher selling prices for the natural gas produced will directly affect the company's net income over the next seven years and beyond.
 
Rising analyst estimates and higher investor sentiment 
 
The third reason you should consider Anadarko Petroleum for your portfolio is the recent improvement in Wall Street sentiment.
 
Of course our approach is to analyze investments for long-term growth opportunities (and Anadarko Petroleum fits that profile perfectly). But it certainly doesn't hurt to own a stock that Wall Street is keen on - and recommending to institutional and individual investors.
 
Over the past two months, Wall Street analysts have been increasing their estimates for Anadarko Petroleum, based on the company's strong performance and the strong guidance from management.
 
 
The increase in analyst estimates can be a catalyst to send Anadarko Petroleum shares higher as investors begin to realize its strong earnings power.
 
If US natural gas prices continue their broad advance, these expectations will continue to increase as Anadarko Petroleum captures wider margins and boosts current and future earnings per share. 
 
A year from now, analysts may very well be projecting earnings of $7.00 per share for 2015. This represents a slightly accelerated earnings growth rate as I expect Anadarko Petroleum to increase production due to sustained US natural gas prices above $4.50/Mcf
 
If investors are willing to pay a growth multiple of 20 times forward earnings, which is reasonable given stronger natural gas pricing and increased production, the stock would rise to roughly $140 in price. This represents more than  a 55% increase from Anadarko Petroleum's current price and may very well wind up being a conservative scenario.
 
Comparing Anadarko Petroleum to key natural gas rivals 
As mentioned, Anadarko Petroleum is the third largest US natural gas producer. So why choose this company over the other two top producers?  Let's take a look at each so see why Anadarko Petroleum is the best choice.
 
In first place is ExxonMobil (NYSE: XOM). In 2012, the company produced 3,822 MMcf per day, more than 20% above its closest competitor. 
 
But ExxonMobil is much less appealing when you consider the fact that the company is actually decreasing its production levels. In the fourth quarter of 2012, ExxonMobil saw a 6.4% decline in production, while Anadarko Petroleum actually increased production by 8.3% year-over-year.
 
ExxonMobil is a stable "cash cow" business with reliable profits and a 2.8% dividend yield. But analysts are only expecting earnings to grow by 2.6% over the next year.
 
With a mature business like ExxonMobil, the best investors can hope for is a steady, reliable dividend and a meager rate of return. Considering the strong growth opportunities in the natural gas market, I would much rather own a company that has a high growth profile.
 
The second largest US natural gas producer is Chesapeake Energy (NYSE: CHK). To be sure, Chesapeake Energy is a strong competitor with some very high-quality properties. But it is not a company I would want to own.
 
Chesapeake Energy is mired in controversy after the company granted then-CEO Aubrey McClendon personal stakes in company wells. Both the SEC and the US Department of Justice are investigating the company on separate matters.
 
Fundamentally, the company looks fairly attractive, with earnings expected to grow nearly 40% between 2013 and 2014. Chesapeake also offers a 1.6% dividend yield.
 
But ethical issues can have a way of resurfacing and diluting shareholder value. So given the choice between two strong natural gas producers, I prefer the one with solid growth and a less tarnished reputation.
 
The time to act is now 
Anadarko Petroleum has a tremendous opportunity to grow profits over the next several years as the natural gas market stabilizes.
 
The company has a strong base of producing assets with the capacity to increase production under the right circumstances. Management has shown the discipline to keep from producing peak natural gas with prices much lower, while still maintaining the ability to ramp production when prices increase.
 
I'm impressed with the overall growth opportunity here and believe that investors would be well served to steadily accumulate shares of Anadarko Petroleum over the next year.
 

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Zachary Scheidt has no position in any stocks mentioned. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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