Description

Anadarko Petroleum (APC)

APC is an independent oil and gas exploration company that has significant operations onshore in virtually every major resource basin in the US and is the industry leader in offshore deep-water and sub-salt exploration & development. APC’s offshore discoveries in the Gulf of Mexico, Mozambique and West Africa will be a major source of growth as the new fields enter production over the next few years.

The company’s EBITDAX, now about $10 billion, will increase 20% to more than $12 billion by 2016, from existing discoveries only – not including the upside from any deep-water prospects currently drilling or planned.   The stock is current trading at $111 and with a NAV of $140. 

There are significant corporate capital structure opportunities/drivers to monetize assets.  There is also a very good possibility that APC is acquired by a Major, it has the size and asset base to make it a perfect acquisition target for a Major.

The stock should trade closer to its $140 NAV with the management focused on optimizing its asset portfolio.  There is a takeout premium on top of the $140 NAV if a Major decides to acquire APC.    

APC Business Model & Corporate Strategy

APC has established a “best in class” record of developing large-scale projects and of subsequent portfolio management – monetizing offshore projects to accelerate cash flow, and high-grading onshore reserves to focus on the most competitive and profitable basins. The company is widely recognized as having one of the best exploration staffs and unconventional resource capabilities in the E&P industry.

 APC was the prime mover in the GOM Lower Tertiary play and was an early entrant into similar deep-water prospects offshore Ghana, Liberia, Mozambique and Brazil.

In US onshore, APC was a leader in the Rockies unconventional plays, notably the Wattenberg-Niobrara, Pinedale and Greater Natural Buttes fields of Colorado, Utah and Wyoming. These Rockies fields, most of which were acquired with KMG and Western Gas Resources (WGR), are APC’s single most valuable asset.

Newer shale plays include the Eagle Ford, Permian, Haynesville, Utica and Marcellus, in which APC has assembled a position in aggregate of more than two million net acres.

The growth for these exploration and resource plays has required APC to reinvest virtually all of its cash flow for the last three years. But that is changing: the transition from exploration of major offshore prospects to development and production will occur between now and 2016.

APC will generate more than $4 billion in Free Cash Flow over the next three years. Management’s strategy is to evolve from a growth E&P company (difficult to sustain long-term for a company with a $60 billion market value) to a balanced growth-and-cash-return company.

Monetization of its low-cash-flow assets, including offshore projects not yet producing and such things as its 91% ownership of the midstream MLP WGP (general partner of WES) – alone worth $8 billion.  APC management is firmly committed to this cash monetization and corporate transformation.

APC Asset Base

http://media.corporate-ir.net/media_files/IROL/80/80451/2014IRConference_ALL_FINAL.pdf

APC corporate presentation for Match 2014 does a very good job of laying out its asset base and how APC managements get a $140 NAV for the stock.

I get $150 NAV with a very low assumption for mineral rights.      

I have attached an overview of APC asset base as an appendix. 

My price target is 90%-95% of the NAV - $140-$145.

Valuation

APC is trading at 5.7X EV/EBITDA multiple for 2014 and 2015.  It’s trading at 80% of NAV while other E&P are trading at close to NAV using NYMEX pricing.   It is cheaper than its comps while having a much better and more diversified asset base and far better exploration and development organization expertize. 

Catalysts

Valuation discount

The Tronox litigation was a valuation overhang on APC.  Its settlement was a big positive for stock and the price action of the stock reflected that.  Given where APC is trading relative to its comps the discount is not justified.  Given APC track record in adding value thru the drill bit and it’s much more conservative and prudent capital management, APC should trade at a premium to its other independent oil and gas competitors. 

Transformation from growth to development

The biggest negative for APC is it is a $60 bil. company with a high quality diversified asset base in an industry sector in which the markets mainly looks for production growth.  The independent oil and gas sector is as much a growth sector as technology.  The short term (quarterly)market focus is always been on production growth and not on other more valuation driven metrics like cash flow, return on capital ect.  At $60 bil. market cap, a new shale play or discovery does not transform the APC. 

APC management realizes that the company is transitioning from growth/exploration to production.  Its cash flow metrics should improve and free cash generation should increase as its existing portfolio of assets is developed.       

Asset Divestiture

APC has lower (more stable) cash flow generating MLP assets that it can dispose.  APC continues to own 88% of WGP, with a market value of $11 billion (WGP owns 42% of WES’s LP units and holds IDR’s). The current yield of WGP, reflecting the strong contracted nature of its cash flows, is a low 2.6%.  APC plans to gradually sell down its WGP stake, while continuing to control the entity. I have WGP units valued at current market, $11 billion. In theory, if unlikely in practice, APC could transfer control of WGP to a third party at a premium to current market value (as DVN did with XTEX for its midstream assets).

APC mineral Rights

APC owns the mineral rights to 7.5 million acres of land in the western US, on which it receives royalties from third party production of soda ash and coal, among other minerals (the rights also increase the value of some of APC’s Niobrara and other Rockies properties, as the company does not pay royalties to land owners, as most E&P companies do).

The mineral rights trace back to the Land Grants made to the Union Pacific Railroad in the administration of Abraham Lincoln: a checkerboard pattern of alternating blocks, each ten miles by one-tenth mile, on each side of the UNP right-of-way. In 2000, APC acquired Union Pacific Resources Corporation, which had been spun-out of UNP in 1996 with the Land Grant rights.

I don’t give as high a value as some street analysts to the mineral rights.  I have them at $1 bil. as I expect APC to continue to hold them.   I don’t see APC spinning the assets of into a MLP structure. 

Corporate Sale

I am more bullish than street analysts on a sale of APC to a major.  Goldman in its model has a 15% change of sale.  I think it is much higher around 30%-40%.  My timing would be in next 18-36 months. 

Why would a Major buy APC?

APC has the right size and asset base.  Its $70 bil. company (debt and equity).  It has large quality assets around the world.  Its US asset base is top quality both onshore and offshore.  APC exploration and development personal and organization structure are first class. 

Where else are Majors going to invest to offset their declining asset base?  Russia, Iraq, Libya, or Brazil?  The best place for Majors to invest is in the US and Canada.  Known property rights system, great infrastructure and deep domestic markets.    

The Majors are not going to roll up fifteen $2 bil. market cap companies to create an expanded asset footprint.  APC (APA/DVN) give the Majors that footprint in one acquisition.   

Risks

Commodity Risk – APC is too big to hedge its commodity exposure.  Going long APC assumes that investor expects oil and gas to trade around forward NYMEX prices.

Conclusion

APC is not the typical beaten down value investment.  It’s no longer an orphaned or tainted equity after the Tronox settlement.  APC is a transition play as it now focused on developing its asset base.  APC is transitioning to a cash flow generation story.  It is trading at close to all time highs.  However, it is cheap relative to its competitors, is cheap on a NAV basis, it’s a competent management and organizational structure and has a blue chip asset base.  I see a 25% upside in a year and greater upside on a takeout by a Major.  

Catalyst