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Stalking Apache

By Robert Rapier on May 24, 2016

Last week shares of Apache (NYSE: APA) briefly spiked on a rumor that the company would be acquired by Occidental Petroleum (NYSE: OXY). The report was swiftly denied by Occidental, and the publisher was forced to retract it.

It turns out that the initial source of the rumor was an article in Geopolitical Monitor titled The Case for Occidental Petroleum Buying Apache. The author argues that Apache would be an attractive acquisition for Occidental, which later got misconstrued into a story about the acquisition actually taking place.

As oil prices continue to firm up, it’s becoming more likely that some of the larger exploration and production (E&P) companies and integrated oil majors that have survived the bear market in decent financial shape will swallow up smaller companies with attractive features. Today I want to briefly review what makes Apache attractive, and to highlight a few companies that share those characteristics.

Apache has an enterprise value (EV) — essentially market capitalization plus net debt — of $30.9 billion. Among the pure E&P companies in my database, it ranks as the 6th largest. Occidental is categorized as an integrated company with an EV of $62.4 billion.

In Apache’s favor is its positive free cash flow (FCF) over the past 12 months, something fewer than 40% of all E&Ps managed to achieve. Further, Apache’s FCF was 3rd highest among E&Ps, and higher than that of its five peers with larger enterprise value.

But FCF isn’t the whole story. The company that led all E&Ps in FCF was Linn Energy (NYSE: LINE), which recently declared bankruptcy. Why? High debt levels. Linn has a Debt/EBITDA ratio of 9.4. Apache’s is a respectable 2.7, once more ranking it among the best in the E&P category.

Apache’s EV/EBITDA ratio is 9.7, which is also better than the five producers with a larger EV.

At the end of 2015, Apache had 1.6 billion barrels of oil equivalent (BOE) of oil reserves. Only 37% of those reserves were in the form of natural gas, making Apache predominantly an oil producer.

Those are some of Apache’s most attractive attributes. With them in mind, I set up a screen to identify other companies that share some these positives. I screened for those with an EV of at least $1 billion, positive FCF for the past year, Debt/EBITDA less than 3.5, EV/EBITDA less than 12, at least 100 million BOE of oil reserves at year-end 2015, and with natural gas reserves making up less than 50% of total reserves.

The first thing I noticed on this screen is that as I applied those parameters, nearly all of the companies that survived each stage of the screen were Canadian. In that case, it is possible that this isn’t truly an apples-to-apples comparison because of potential differences in tax rates between the two countries.

In fact, Apache was the only U.S. company to meet all of those criteria. EOG Resources (NYSE: EOG), the second largest E&P company, met all but the EV/EBITDA metric (it has an EV/EBITDA of 18.2). Energen (NYSE: EGN) was the only other U.S. company to meet every criteria but EV/EBITDA, and it got closer than EOG at 12.9.

Most of the five largest E&P companies failed both the FCF test and the Debt/EBITDA test. I think what this suggests is that among the largest E&P companies, Apache does indeed stand out. EOG looks good across most metrics, but its large size means it would probably have to be swallowed by a large, integrated company. (EOG is nearly as large as Occidental). Energen also looks potentially attractive, and has shown up on previous screens.  

Of course I need to apply the standard caveat that the purpose of these screens is primarily to identify companies for additional due diligence. We survey financial filings and industry trends as well as company-specific risks before adding a stock with attractive stats to one of the three portfolios in The Energy Strategist.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)


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