Anadarko Revised To $77 Per Share On Lower Oil Prices, Slower Production Growth

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APC: Anadarko Petroleum logo
APC
Anadarko Petroleum

We recently revised our price estimate for Anadarko Petroleum (NYSE:APC) to $77 per share, which is more than 10% below the current market price. The key factors driving our price estimate for the company are lower oil prices and slower projected volumes growth due to reduced capital spending. Anadarko primarily operates in three segments: oil & gas exploration and production, midstream, and marketing. Its asset portfolio includes positions in onshore resource plays in the Rocky Mountains region, the southern United States, and the Appalachian basin. The company is also an independent producer in the Deepwater Gulf of Mexico, and has production and exploration activities globally, including positions in high potential basins located in East and West Africa, Algeria, Alaska, and New Zealand. At the end of 2014, Anadarko’s proved hydrocarbon reserves stood at almost 2.86 billion barrels of oil equivalent, with 69% of these reserves categorized as proved developed. [1]

See Our Complete Analysis For Anadarko Petroleum

Lower Oil Prices

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Global benchmark crude oil prices have fallen sharply over the past few months on slower demand growth and surging tight oil supplies from the U.S. The front-month Brent crude oil futures contract on the ICE has declined by more than 46% since hitting a short-term peak of $115 per barrel in June last year.  Going forward, we expect oil prices to remain suppressed in the short to medium term on global oversupply, as we do not expect the decline in production growth, relative to the demand growth to fully offset the oversupply situation anytime soon. Our current 2015 full-year average Brent crude oil price estimate stands at $70 per barrel, which is based on the global demand-supply scenario and the marginal cost of production.

This would imply lower price realizations for Anadarko on the sale of crude oil, weighing on its exploration and production (E&P) margins and revenue growth significantly. We expect the company’s E&P margin, which stood at around 56.8% last year, by our estimates, to decline to just around 51% this year. The company witnessed a similar decline in E&P margins when natural gas prices in the U.S. fell sharply in 2012. Since then, it has focused more on growing its crude oil and natural gas liquids (NGL) production, compromising on natural gas production growth for better returns. As a result, the proportion of liquids in Anadarko’s total sales volume has increased from 43.2% in 2012 to 48.75% in 2014. This has increased the sensitivity of the company’s valuation to global crude oil prices. [2]

Reduced Capital Spending

Since the independent oil and gas companies do not have downstream operations, they are relatively more exposed to the volatility in global crude oil prices, compared to the integrated players like Exxon Mobil (NYSE:XOM). This is also reflected in the fact that the S&P Oil and Gas Exploration and Production Select Industry Index (SPSIOP) has declined by almost 36% since the WTI crude oil prices peaked at around $100 per barrel in June, while the NYSE Arca Oil & Gas Index (XOI), which includes both integrated and independent players, has declined by just 18% over the same period. This is because, unlike the integrated players, these companies do not have a relatively stable stream of cash flows from refining and chemical production operations. This means that in a commodity down cycle, such as this one, these companies see a sharp decline in their operating cash flows, which lowers their capacity to invest in future production growth. Therefore, capital expenditure (which is the biggest single cash expense item in this business and the primary driver for future production and earnings growth) plans of independent exploration and production companies are far more dependent on the short to medium term outlook for global crude oil prices.

While Anadarko has not explicitly defined its capital spending plan for this year so far, it did announce during the fourth quarter earnings call that, like its peers, it would significantly reduce capital spending this year to maximize long-term returns at the expense of immediate volumes growth. Many of the company’s key competitors have announced a 20-50% cut in capital spending budgets for this year. We therefore currently expect its gross capital spending to be around 33% below last year’s level. Lower capital expenditures mean lower investment in future production growth. Therefore, while lower capital spending will improve its free cash flows to the firm,  we believe it will also slow down the company’s short to medium-term production growth. For example, last year, Anadarko’s crude oil sales volume grew by almost 17% y-o-y, but we expect the increase to be just around 5% this year. [1]

Overall, our current price estimate for Anadarko reflects the combined effect of all these factors and our 2015 full-year GAAP earnings per share (EPS) estimate for the company stands at -$0.64, compared with the consensus estimate of -$0.54 per share reported by Reuters.

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Notes:
  1. Anadarko Announces 2014 Fourth-Quarter And Full-Year Results, anadarko.com [] []
  2. Anadarko Annual SEC Filings, sec.gov []