- The company has $1.5 billion in cash and a $3.5 billion credit line that does not mature until 2020. Even then it can be extended.
- The current ratio is nearly two-to-one.
- Egyptian wells are low cost and provide the means to profitably increase production. North Sea wells are more expensive but also highly profitable.
- The company needs to work at making its unconventional plays profitable at current pricing. It may exit some of those plays if they cannot make a sufficient profit.
- The company sold $6 billion in assets last year and will sell more this year to amplify cash flow if needed before cost cutting efforts succeed.
A while back, I wrote an article on Transglobe Energy doing business in Egypt. The main weakness of investing in that company was that it was totally dependent on Egypt for its business. The company was not at all diversified, and even though stability appears to be returning to the country, that is far from assured.
Apache Corporation, even though it is a much larger company, has the ability to offer investors a very large return from the current price. The company has considerable exposure in Egypt along with a twenty-year relationship. Plus it has the advantage of being far more diversified and financially very strong. Its costs of operations are among the lowest in the industry, and there is a very good chance that the leases it holds in Egypt will perform better than the leases that Transglobe is drilling on.
Apache has indicated in the current year that it will continue to drill in Egypt, as this is one of the areas from which the company obtains its best return. Transglobe, on the other hand was near break-even on cash flow except for the fact that Egypt was catching up on its past due bills. This is another sign that Apache may be a better bet for investors in the long run unless investors are forecasting some very significant oil price increases.
The company has made some remarkable progress to decrease the costs of these wells. With the gross production listed above, the company now produces gross proceeds monthly that are higher than the cost to drill 13 new wells. Even with the hefty production sharing agreement with Egypt, it should be intuitively easy to see that these wells are profitable at current pricing. They should pay back easily in less than a year under most of the probable commodity pricing scenarios.
The production agreement with Egypt varies with the price of oil. Therefore, the cash flow is more steady. However, the downside of this is that the cash flow is also more steady when oil and gas prices rally. Hence, the diversification to other areas to give the company a little more exposure to the upside potential for earnings should oil and gas prices rally significantly.
Similarly, the North Sea is considered one of the company’s more profitable areas in the current operating environment.
Part of the profitability picture is the difference in realized pricing in the different geographic areas. While Egypt is the second highest cash margin, the cheap wells, which mean low capital investment are what makes the leases the most profitable. The North Sea, is low cost but higher capital per well costs, not to mention platform and other considerations. Plus the North Sea has far greater political stability than Egypt does. Since commodity prices dropped in the first quarter of 2016, those margins will decrease, but there is clearly room in both the North Sea cash margin and the Egyptian cash margin for lower commodity pricing. Those same price decreases clearly wiped out the profits of some of the North America plays.
Right now, Egypt needs more money, and will therefore use favorable production agreements to help expand its oil production for exporting purposes. Should prices remain depressed, the Egyptian government can be expected to do what it can to keep encouraging production growth. Value Digger did a great article on Egypt if readers need more information. Readers need to be aware that the region is inherently unstable, so despite the history in Egypt, politically things can change quickly.
Apache actually has a fairly strong balance sheet. The company has an unused bank line of $3.5 billion and cash at the end of the fourth quarter of $1.5 billion. Lenders have placed very few constraints on the company’s credit line so that line is readily available. Plus the bank line does not mature until 2020, and the company has options to extend the maturity further. Last year, the cash flow from continuing operations was $2.8 billion. The company sold more than $6 billion in assets and paid off a significant amount of debt. As a result, long-term debt totals of $8.8 billion, which was a significant reduction from the previous year.
While cash flow took a large drop in the fourth quarter to about $262 million or so, the company has sold assets to increase cash flow in the past successfully (during some of the worst industry times), it has the credit line to drill to increase its cash flow and the bankers have given the company a large vote of confidence with the lack of covenants in that credit line.
The company has one of the lower cost positions in the North Sea to back up its claim that it will make money from North Sea production at current pricing. This company has clearly focused on conventional projects because it is one of the lower cost players in several major conventional plays. In the future, the company will need all of its projects profitable, or it will need to sell them and concentrate on what is left. Clearly, the company has several valuable lease positions that would be readily marketable if needed.
But the company does not appear to do very well with its unconventional plays. The North America plays in particular do not appear very profitable for the company despite having leases in some of the lower cost plays on the continent. Therefore, the company will be devoting more than half of its budget to Egypt and the North Sea, where management believes it will achieve the greatest return. It is quite possible that the company has some catching up to do with its unconventional plays, and clearly from the above slides, the company intends to do just that.
Competitors in the unconventional plays such as Murphy Oil and Marathon Oil Corporation claim to be making decent returns from the unconventional plays, so Apache needs to figure out why it is not making a good return and fix the problem. Hopefully, these plays can be profitable even in the current low cost environment for the company during the year. If the leases are not profitable in the current operating environment, then the company needs to decide whether to hold the leases or sell them to the highest bidder. Many companies are consolidating into less plays and Apache could put the money to good use elsewhere.
Clearly, good progress has been made on the cost front with the unconventional plays, and the company is focusing on making more satisfactory progress. Management did not discuss well design or improved production, though there is a chart showing the latest well results. Quite possibly management needs to put more emphasis on well design, flow rates, and lowering decline rates. Profitability should be restored to these plays promptly. Like any other management, the concentration has been on the low cost plays, which in this case are largely conventional wells. Those wells are cheaper to drill and complete and easier in many ways. But commodity pricing is now so low that all the projects need to be profitable.
Apache had a sizable drop in the fourth quarter in its cash flow, which would normally be a cause for concern. However, mitigating that concern is the ability of the company to generate profitable asset sales to reduce debt as needed and the confidence that the banks have shown by giving the company a significant credit line with very few covenants, as well as a long maturity date.
The company has $1.5 billion in cash to aid in the transition to a lower cost structure, plus another $3.5 billion in accessible credit, and the current ratio is approximately two-to-one. The banks have already reduced the credit line, but the company’s ability in the past to live within its means and reduce its long-term debt meaningfully have probably given the lenders reasons to do business with this company.
Plus the company does have cash flow profitable opportunities in Egypt and the North Sea that should immediately add to cash flow as capital is spent on the leases. Egypt in particular should be a source of increasing cash flow as the year progresses. The wells are relatively cheap to drill, and the government is encouraging more production as a source of revenue for the government.
In North America, the company has some leases in some very low cost unconventional plays. Operations in those plays will either improve or the company will sell those leases and exit the play. Last year, during some of the worst industry conditions, the company sold more than $6 billion in assets, so selling more assets this year as needed should not be a problem. In fact, such a strategy could be a way for the company to shift its resources to the more profitable projects.
Management has indicated that profitability will increase this year and that balance sheet strength will be maintained. The cost ceiling write-offs nearly wiped out shareholders’ equity and added more leverage to the balance sheet. But many of the company projects are worth a good deal more than the balance sheet amount, which adds to the financial strength of the company. Plus the company has more than adequate access to the debt markets. There do not appear to be huge major projects that need to be funded, so the company is free to set its investment priorities and adjust its spending as needed.
Given the company’s success in the past of maintaining its balance sheet (except for the cost ceiling write-offs), there is no reason to not believe that the company will continue to be successful in this regard. The conventional fields are very low cost and provide a means to meaningfully expand cash flow quickly. There is only about $700 million in debt due over the next few years, and the banks have given the company the ability to extend its credit line in the future if that is advantageous to the company. While commodity prices did decrease more in the first quarter, management has admitted that it needs to line up its costs to survive the lower cost environment, and as demonstrated above, is clearly lowering the operating and administrative costs to survive the environment.
While it is hard to place a value on a company without much current cash flow, and the threat of even less cash flow in the first quarter, the company has a strong enough balance sheet, and the backing of its lenders to effect a turnaround. Previous asset sales have given this company an extra route (and more time) to increase the profitability of operations. Therefore, this stock is a play on the success of the company lowering its cost structure as well as the recovery of oil and gas prices.
Should it get its cost in a competitive position with the unconventional plays, the company should be able to thrive even if oil and gas prices do not rally as it has some very low-cost conventional projects. Should management be successful in its efforts, the stock of this company could easily double under many likely five-year scenarios. Only a further sustained drop in oil and gas prices would cause the investor to lose money in a company such as this. There is already a fair amount of pessimism priced into the stock.
While the most profitable leases are in Egypt, this country has a long history of stability and a business friendly environment. Apache itself is regionally diversified, so while the loss of a region would hurt, the company has other areas to take up the slack. The political events of the last few years were atypical, and the stability that is now appearing is far more typical. Nonetheless, readers are encouraged to read extensively about Egypt and its neighbors before making an investment decision.
(Source: Seeking Alpha)