US energy major’s profits will rise as crude soars

published 31 August 2012

Brent crude has soared 25% since late June due to escalating tensions in the Middle East, lower US inventories and some comforting rhetoric from the European Central Bank that has temporarily eased debt worries across Europe. Add in the possibility of an Israeli air strike on Iran's nuclear facilities and oil prices are unlikely to drop near term. That's good news for Apache, America's fourth biggest oil and gas producer.

So why have the shares fallen 20% since March? Investors are nervous about the firm's exposure to Egypt, which accounts for a fifth of production. However, any such fears should be mitigated by Egypt's new government, which is welcoming foreign investment with open arms.

What's more, 18 months into the Arab Spring and Apache hasn't yet suffered any significant disruption. Indeed, during the last quarter it drilled 68 potential well sites in Egypt and enjoyed 13 successes. Apache also owns coveted assets in the Gulf of Mexico, North Sea, Kenya, Australia and Argentina. The jewel in its crown is its onshore reserves in America output in the Permian Basin rose 5% in the second quarter.

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The board has been criticised in the past for buying short-life, high-intensity assets. But this strategy is changing. New fields are being brought on stream with the aim of ramping output 6%-9% per year to one million barrels of oil equivalent per day by 2016. This would be industry leading and is a target underpinned by a large oil reserve base.

Apache Corp (NYSE: APA), rated a BUY by Buckingham Research

Wall Street is forecasting 2012 revenues and underlying earnings per share (EPS) of $16.9bn and $10.16 respectively, rising to $18.5bn and $11.04 in 2013. That puts the stock on a price-to-earnings (p/e) ratio of below nine. The balance sheet is in good shape, with a debt-to-equity ratio of 25%. That leaves enough firepower to snap up complementary assets as and when bargains arise.

I'd value the group on a 5.5 times earnings before interest, tax, depreciation and amortisation (EBITDA) multiple. Adjusting for net debt of $9.8bn and $4.2bn in legacy liabilities generates an intrinsic worth of more than $130 per share. There are a few risks not least volatile commodity and foreign currency prices, along with economic uncertainty, geopolitical instability and possible future write-downs on its North American gas interests.

All the same, Apache's well-balanced portfolio of liquid and gas assets, onshore and offshore interests, plus its North America and international presence, offers patient investors 40% upside. Buckingham has a price target of $129.

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI, or phone 020-7633 3634 for more.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.