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S&P Capital IQ


08/22/16 10:00:10 AM



This week's Focus Stock of the Week is Anadarko Petroleum (APC: $54.83) which carries S&P Global Market Intelligence's highest investment recommendation of 5-STARS, or Strong Buy. We view APC as one of the leading oil and gas upstream companies in our coverage universe, with a solid track record of turning oil and gas development today into cash flow tomorrow.

Crude oil prices have now entered the 3rd year of a cyclical downturn, after peaking in June 2014 at $108 per barrel. About 26 months later, in August 2016, WTI crude oil prices were in the $46 per barrel range, but have not shown the ability to break through the $60 per barrel barrier. Interestingly though, the S&P 1500 Oil & Gas Exploration & Production (E&P) sub-industry is up 19% year to date through August 12, outpacing the 7.3% gain for the S&P 1500 overall. We suspect that the market is anticipating a recovery in crude oil prices to loftier levels. Not all E&P names have performed quite this well though. APC, for example, perhaps by virtue of having more debt on its balance sheet than peers, has only risen 11% year to date, trailing its peer index by about 800 basis points. We think some pending catalysts can help it close the gap against peers.

At year-end 2015, APC had proved reserves estimated at 2.1 billion barrels of oil equivalent (boe), which ranks it as 6th largest among our coverage universe of U.S. independent E&P companies. During 2015, APC produced an average of more than 838,000 boe/d, which ranks it 2nd highest in this peer group. APC holds sizable acreage positions in the U.S. Rocky Mountains, including Land Grant rights. The latter enables APC to receive a royalty fee from rival E&Ps for drilling in about eight million acres of portions of Colorado, Wyoming and Utah, due to its April 2000 acquisition of Union Pacific Resources. In addition to its Rockies acreage, APC also has large positions in the Permian Delaware Basin (which, according to Bentek Energy, a unit of S&P Global Platts, has the best economics of any unconventional crude oil play in the onshore U.S.), offshore Gulf of Mexico, and Mozambique. We think its Gulf of Mexico assets could be a near-term catalyst, given APC's ability to add relatively low-cost wells that tie into existing offshore infrastructure.

APC's capital spending plan for 2016, as guided in July, is a range of $2.6 billion - $2.8 billion. The midpoint of this range, $2.7 billion, is down 54% from $5.9 billion in 2016, and down 71% from spending levels in 2014 - the year when the crude oil collapse began. We think APC is being conservative relative to peers, likely in part from elevated debt levels, but possibly also because it has lower estimated exposure to proved undeveloped (PUD) reserves. We estimate that as of year-end 2015, APC's PUD reserves, as a fraction of total proved reserves, stood at just 21%, well below the peer average of 34%. We view a low PUD exposure as a positive, given that undeveloped reserves typically require higher capital spending to transform those reserves into production. APC's track record of turning production into cash flow is also fairly good in our view: we estimate an average 'cash recycle ratio' of 111% in the three years ending 2015. Any such ratio above 100% is desirable, in our view.

For 2016, we see an operating loss of $2.74 per share, narrowing to a loss per share of $0.98 in 2017. However, despite these projected operating losses, APC looks to remain free cash flow positive. Capital IQ consensus estimates suggest that 2017 operating cash flow will amount to 106% of projected capital spending, above the peer average. On valuation, we apply an 8.3X multiple of price to projected 2017 operating cash flow, to arrive at our 12-month target price of $65 per share. The selected multiple is a premium to peers, merited by APC's above-average free cash flow profile, in our view.

Investing in the E&P space brings risks, which can be substantial. E&Ps are in the business of extracting crude oil and natural gas and selling them to the market, but prices for these commodities are notoriously volatile. In addition, APC carries a higher debt burden than peers, with a net debt to capital ratio of 56% at June 30, above peers at 36%. We expect APC to use proceeds from asset sales on debt reduction. In addition, E&Ps are exposed to potential regulatory or environmental restrictions, and run the risk of unexpected accidents or damage from natural or man-made disasters (e.g., hurricanes in the Gulf of Mexico).

S&P Global Market Intelligence's views on stocks are constantly re-evaluated. Please refer to our most recent publication on this stock to see our current view.


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