APACHE CORPORATION Investment Analysis

By Jordan Hart

Spring 2012

ANALYSIS OVERVIEW This report provides analysis of the Apache Corporation, a leading independent oil and gas exploration company based in Houston, Texas. A brief look at the company and its respective industry will be followed by fundamental and technical analysis of the companys stock. Apache Corp is listed on the New York Stock Exchange (NYSE) under the ticker symbol APA. It is also a component of the Standard & Poors 500 index.

COMPANY PROFILE The Apache Corporation was founded on December 6, 1954 in Minneapolis, Minnesota, with an initial investment of $250,000. The three founding partners Truman Anderson, Raymond Plank, and Charles Arnao looked to early employees for help naming the company. One employee had the idea to add che to the APA (the founders initials), and the name Apache Corporation was born. After flipping a coin, the partners decided Raymond Plank would be the first president a position he held until his retirement in 2002. Apache Corp drilled its first oil field in Cushing, Oklahoma in 1955. Initially, it yielded seven barrels of oil per day.1

Today, Apache Corp is a multi-billion dollar energy company, with oil and natural gas operations in the U.S., Canada, Egypt, Australia, the United Kingdom, and Argentina.2 According to their website, the companys mission is to grow a profitable global exploration and production company in a safe and environmentally responsible manner for the long-term
1

http://www.apachecorp.com/About_Apache/History/the_early_years.aspx http://www.apachecorp.com/Operations/index.aspx

benefit of our shareholders.3 According to Standard & Poors, $10K invested five years ago is now worth $14, 677, or a 46.77 percent return.4

Apache Corp has proved reserves of 2.9 billion barrels of oil equivalent, mostly from its North American operations.5 According to its most recent (February 29, 2012) 10-K filing with the Securities and Exchange Commission (SEC), the company strives to maintain a balanced portfolio of assets. In 2011, no single geographic region contributed more than 22 percent of production or 29 percent of revenue.6

INDUSTRY PROFILE The oil and gas industry has played an important role in global affairs since the late 1800s. Modern transportation methods are almost solely reliant upon petroleum products. The first major oil company was the Standard Oil Company, founded by John D. Rockefeller in 1870. Initially, the United States dominated the global oil industry, controlling nearly half of the worlds production. After 1950, the industry spread throughout the world, with the Middle East, Europe, Asia, and Russia emerging as key players.7

http://www.apachecorp.com/About_Apache/Mission.aspx https://research.scottrade.com/qnr/Stocks/GetPDF?docKey=72-03741110-1GGC1GCNU5T79I7NKMB9PJ2UAO http://www.lexisnexis.com.ezproxy.lib.usf.edu/hottopics/lnacademic/ http://investor.apachecorp.com/secfiling.cfm?filingID=1193125-12-86217&CIK=6769 http://www.loc.gov/rr/business/BERA/issue5/history.html

Oil and gas exploration can be very capital-intensive, with development costs of up to several billion dollars. Projects also take years to fully develop, with exploratory wells taking anywhere between 2 to 6 months on average.8

Oil and gas prices tend to be very volatile, and are primarily driven by supply and demand, but other factors play a key role, including geo-political risks, natural disasters, and a lack of viable energy alternatives.

As prices for crude oil have steadily risen since the Great Recession of 2008, industry experts are expecting natural gas to offer a cheaper alternative in the years to come. Experts expect consumption of natural gas to rise by 70 percent by 2025. If developed economies like the U.S. and Europe can find ways to utilize natural gas for transportation purposes, that number could be even higher.9

Major oil companies like Chevron and Exxon Mobil have ramped up their efforts to find natural gas, pushing domestic supplies to record levels. Professor Mark Perry from the University of Michigan recently charted Figure 1 (next page), visualizing the price difference between natural gas and oil on an energy-equivalent basis from January 1994 to March 2012.

http://www.loc.gov/rr/business/BERA/issue5/production.html http://www.loc.gov/rr/business/BERA/issue5/trends.html

Figure 1: Prices of natural gas vs. Oil

Dr. Perrys analysis is based on the following assumptions: To compare oil and natural gas on an energy equivalent basis, natural gas prices have to be increased by a factor of 5.8, because one barrel of oil produces 5.8 million BTUs of energy.10 According to his analysis, natural gas has never been this cheap compared to oil on an energy equivalent basis. As of March 30, 2012,

10

http://mjperry.blogspot.com/2012/03/chart-of-day-natural-gas-vs-oil.html

West Texas Intermediate (WTI) crude oil (Cushing spot) price is $103.02/bbl, while Brent crude spot costs $123.31/bbl. Natural gas spot price is $2.14 per million BTUs.11

SECURITY ANALYSIS Overview Apache Corps stock price, like any oil and gas company, is certainly subject to the price of the underlying commodities it produces specifically WTI and Brent Crude, and also natural gas. This analysis will focus on Apaches underlying fundamentals, including (but not limited to) cash flows, price-to-earnings ratio (P/E), stock beta, debt levels, return on equity (ROE), and return on assets (ROA). A brief technical analysis will also be included, primarily based on stock price relative to its moving averages, volume, and Relative Strength Index (RSI). A recommendation based on the analysis is also given.

Industry Fundamentals Crude oil prices have been rising in recent years, lifting the stock prices of oil and gas companies. Apache is no exception. Figure 2 (next page) is a 3-year chart for the companys stock.12 While crude oil prices have remained high due to tensions growing in the Middle East, specifically between Israel and Iran, experts dont expect a dramatic drop in prices anytime soon. Demand from emerging economies continues to grow, offsetting a domestic supply glut, partially due to weak economic fundamentals (specifically labor markets) in the United States.
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http://www.bloomberg.com/energy/ http://stockcharts.com/h-sc/ui

12

Figure 2: Apache Corp 3-year stock chart

In the last several months, Brent and sweet crude (from the gulf coast) have traded at a significant premium to West Texas Intermediate (WTI). This trend is likely to continue, which will help boost profits for Apache Corp. According to the latest 10-K, Brent and sweet crude represents 76 percent of the companys oil production. Figure 3 (next page) illustrates the BrentWTI crude oil spread (Brent price minus WTI price) as of March 28, 2012.13

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http://ycharts.com/analysis/story/so_much_for_efficient_global_markets_american_and_foreign_crude_oil_19_apar t

Figure 3: Brent-WTI Spread ($)

Stock Fundamentals As mentioned in the company profile, Apache Corps long-term strategy relies on maintaining a balanced portfolio of assets. The company has successfully diversified its portfolio by spreading operations across the globe, and not relying heavily on one region for revenue. Company earnings continue to grow through strategic acquisitions and oil price gains. According to Standard & Poors, earnings per share (EPS) have grown from $7.64 in 2006, to $11.47 in 2011, or by 50.13 percent. S&P expects EPS of $12.75 in 2012, and $15.45 in 2013, primarily based on production growth and oil price appreciation.14

14

https://research.scottrade.com/qnr/Stocks/GetPDF?docKey=72-03741110-1GGC1GCNU5T79I7NKMB9PJ2UAO

Revenues have steadily grown since 2006 as well (see Figure 4 below). In 2006, the company reported $8.29 billion in revenue. That number grew to $16.89 billion in 2011 (data gathered from Standard & Poors). Figure 4: Apache Corp Revenue Data (2006 2011)

Revenue (Millions $)
18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Revenue (Millions $)

The company is well positioned fundamentally with respect to its competitors. For this analysis, well look at Apache compared to four major oil and gas companies Anadarko Petroleum, Devon Energy, BP, and Exxon Mobil. Apaches forward price to earnings ratio of 7.22 is lower than all but one company from the group, but is lower than the basket average (calculated using simple arithmetic average). Apaches stock beta is 1.69, which is a bit higher than the competitor basket average of 1.47. At 1.69, their beta implies a 69 percent greater volatility than the market. This is likely based on the volatility in oil prices. However, the stock compared

favorably with respect to the competitor basket, based upon debt/equity levels, return on equity, and return on assets. See Figure 6 below for a spreadsheet comparison (all data taken from finance.yahoo.com). Figure 6: Apache Corp vs. Competitors
Company Apache Corp Anadarko Petroleum Devon Energy BP Exxon Mobil Competitor's Avg Operating Cash Flow ($) Price/Earnings (P/E) 9.95B 2.5B 6.22B 22.15B 55.34B n/a 7.22 15.72 9.82 6.52 9.81 10.47 Beta 1.69 2 1.4 1.86 0.61 1.47 Debt/Equity 24.89 86.55 45.64 39.31 10.6 45.53 ROE (%) 17.18 -12.71 10.49 25.05 26.93 12.44 ROA (%) 10.97 3.01 7.82 6.93 10.68 7.11

According to the Standard & Poors stock report (previously mentioned), Apaches stock price reflects a discount to peer valuations, based on their calculated net asset value (NAV) of $151/share, and the companys weighted average cost of capital (WACC) of 11 percent. With future growth prospects for Apache, as well as expected appreciation in oil prices, the companys shares appear cheap on a relative basis. Of course, if economic conditions (domestically and globally) deteriorate, the shares may suffer as a result. However, central bank policy will likely remain accomodative through 2014, keeping a floor under oil prices, and commodities in general. Due to their subdued outlook for inflation, the Federal Reserve will likely keep interest rates at exceptionally low levelsthrough 2014, according to their latest release.15

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http://federalreserve.gov/newsevents/press/monetary/20120313a.htm

Technical Analysis Referring back to Figure 2 (page 6), Apaches stock price broke its long-term uptrend back in August of 2011. Shares have since rebounded, and look to be forming a new intermediate-term uptrend. In March, 2012, the 50-day moving average broke above the 200-day moving average, a phenomena that analysts sometimes refer to as the golden cross.16 This is typically a bullish indicator, but in order to confirm this, analysts would like to see heavy volumes, which have been absent from the market in general recently.

The Relative Strength Index (RSI) measures a stocks momentum based on price movements. RSI is considered overbought above 70, and oversold below 30.17 Apaches RSI is currently around 43, meaning the stock is neither overbought, nor oversold. Apaches shares must continue to move higher, with an uptick in volume, before the technicals signal a new bullish trend. The technical indicators for Apache Corp are neutral at this time.

Recommendation Based on fundamental analysis, Apache Corps shares appear undervalued. Investors with a long-term focus should buy the stock on pullbacks. However, technical analysis hasnt confirmed a bullish uptrend in the short-term. If volume rises significantly along with the 50-day moving average, investors/traders should look to accumulate shares.

16

http://www.investopedia.com/terms/g/goldencross.asp#axzz1qqW3fgpg http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:relative_strength_in

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Sources
http://www.apachecorp.com/About_Apache/History/the_early_years.aspx http://www.apachecorp.com/Operations/index.aspx http://www.apachecorp.com/About_Apache/Mission.aspx https://research.scottrade.com/qnr/Stocks/GetPDF?docKey=72-037411101GGC1GCNU5T79I7NKMB9PJ2UAO http://www.lexisnexis.com.ezproxy.lib.usf.edu/hottopics/lnacademic/ http://investor.apachecorp.com/secfiling.cfm?filingID=1193125-12-86217&CIK=6769 http://www.loc.gov/rr/business/BERA/issue5/history.html http://www.loc.gov/rr/business/BERA/issue5/production.html http://www.loc.gov/rr/business/BERA/issue5/trends.html http://mjperry.blogspot.com/2012/03/chart-of-day-natural-gas-vs-oil.html http://www.bloomberg.com/energy/ http://stockcharts.com/h-sc/ui http://ycharts.com/analysis/story/so_much_for_efficient_global_markets_american_and_foreign_crude_o il_19_apart http://federalreserve.gov/newsevents/press/monetary/20120313a.htm http://www.investopedia.com/terms/g/goldencross.asp#axzz1qqW3fgpg http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:relative_strength_in http://finance.yahoo.com/