Description

Long APC

Thesis: APC offers deep value relative to large cap oil peers and possesses several near-term catalysts to reverse the stock’s underperformance. Over the past year, APC has consistently underperformed peers due to a combination of leverage concerns and a failed APA bid which raised strategic questions. More recently, APC has lagged in the beta driven rally, and Heidelberg performance questions clouded an otherwise strong 1Q report. In the near-term, APC is likely to announce additional monetizations which will further de-lever the balance sheet and also crystalize value. Further, APC will likely continue to deliver capital efficiency gains and cost reductions. And finally, APC has the opportunity to deliver improved Heidelberg performance and additional success at Shenandoah by year-end. Longer term, APC is likely to stand out relative to peers throughout the next cycle. Unlike many peers, APC retained its deep portfolio of large-scale offshore prospects which will enable the company to more efficiently deploy capital throughout the next cycle.

FUNDAMENTAL DISCUSSION:

Assets: APC has a mix of short-cycle shale assets and a mix of longer-cycle offshore assets. The company’s strategy provides less capital flexibility than shale-only peers, however it has been proven durable over several cycles. Further, the company’s offshore portfolio provides the company with large-scale investment opportunities and greater resource depth that many peers lack.

1)      Wattenberg: APC owns 350k net acres in the Wattenberg (the majority of which are core). APC estimates ~4,000 future drilling locations which likely increases over time given additional downspacing potential. APC’s Wattenberg acreage arguably generates the highest returns in the onshore US given the company also owns the royalty interests associated with these acres.

2)      Land Grant Royalty: Through the merger with Union Pacific Resources, APC acquired royalty rights covering over 8mm acres throughout Colorado, Wyoming, and Utah. This land grant generated $460mm in revenues in 2015. This revenue stream will continue to grow over time as APC and peers develop the Wattenberg and Niobrara.

3)      Delaware Basin: APC owns 255k net acres concentrated in the core of the Delaware Basin. The company is in the early stages of its development program in the basin and has significant efficiency and productivity gains to make over the coming years. The company has focused primarily on the Wolfcamp section to date, however additional upside is likely to be realized from the Bone Springs, Avalon, and potentially other zones. While not as high return as APC’s Wattenberg or the core of the Midland Basin, the Delaware Basin offers some of the best economics in onshore US oil. And returns are likely to improve as efficiency and productivity gains are realized.  

4)      Eagle Ford: APC owns 185k net acres primarily in the volatile oil window of the Eagle Ford. The majority of this acreage is non-core Eagle Ford and is characterized by a lower oil percentage and lower productivity than core Eagle Ford. Given its non-core nature, APC’s Eagle Ford acreage receives less capital than the Wattenberg and Delaware Basin.

5)      Marcellus: APC owns 260k net acres in the Northeast Marcellus shale. Less than half of the acreage sits within the core of the Northeast Marcellus and is operated by CHK.

6)      Gulf of Mexico: APC generates 10% of total production (18% oil production) from its 4 major Gulf of Mexico developments. The company has a significant inventory (15-30) of tie-back opportunities from these existing developments to sustain and/or grow production. The company’ three major prospects for future development in the Gulf include Shenandoah, Phobos, and Warrior.

7)      International: APC generates 12% of total production (30% oil production) from Ghana, Algeria, and Alaska. Ghana production will grow over the next several years once the TEN development starts up in 3Q16. And Algeria production has been steady for some time. APC’s major prospects for future development include Mozambique (LNG), Colombia, and Cote D’Ivoire.

8)      Western Gas: APC owns 186mm shares of WGP (the general partner of Western Gas Partners) which equates to a market value of ~$8.0b (~$4.2b post-tax and liquidity discounts). The company created Western Gas in 2008 as a way to provide efficient, low-cost financing for its midstream needs. APC still retains several significant midstream assets which can be sold to WES to raise additional proceeds for APC.

Valuation:

APC trades at a 3.3x multiple discount to oil peers on my 2018 estimates for the group despite growing at a similar rate and having an average leverage profile. Amongst oil peers, only PDCE trades at a lower 2018 multiple.

Based on my model, I expect APC to be able to meet consensus production estimates through 2017 before delivering much higher production than the street models in 2018. Also, I expect APC to deliver this above consensus production growth on essentially the same capex as the street models over the next 3 years.

From a NAV perspective, APC offers one of the best risk/rewards amongst oil peers. APC has similar downside to peers at the strip. And in a normalized commodity price scenario ($65 WTI & $3.50 HH) APC offers significant upside (especially relative to large cap peers) given its deep inventory of high return opportunities including the Wattenberg, Delaware Basin, and offshore prospects.

Potential (Positive) Catalysts:

1)      Asset Sales: APC is likely to monetize additional non-core onshore US assets. APC could also sell-down working interests in offshore prospects.

2)      Capital Efficiency Gains and Cost Reductions: APC continues to drive down well costs in the Wattenberg and Delaware Basin which is reducing break-even economics. APC still has significant improvements to achieve in the Delaware which could be realized in the near-term. Further, APC continues to surprise with LOE and midstream expense reductions.

3)      Shenandoah Success: APC is drilling its 5^th appraisal well. The previous appraisal wells have encountered significant pay which suggest the prospect could be significantly larger than its other Gulf of Mexico developments. The 5^th well could go a long way to moving this prospect towards sanctioning.

4)      Heidelberg Improvement: APC’s Heidelberg project in the Gulf started-up in 1Q16 and delivered lower rates than pre-drill expectations. This could be the result of timing or other issues that APC can address to improve performance before year-end.

5)      Exploration Success: While less impactful in this environment, APC is drilling exploration wells in Colombia and Cote D’Ivoire.

6)      APC is Acquired: Given its discounted multiple and its resource depth, APC could be a target for one of the majors looking to add resource at reasonable cost.

Risks (to the Downside):

1)      M&A: Given its bid for APA in 2015, APC may still have an interest adding assets to its portfolio. However, public M&A seems less likely today given the significant increase in valuations.

2)      Additional Heidelberg Underperformance: If Heidelberg continues to underperform expectations, APC’s production outlook may need to be reduced. That said, Heidelberg is a relatively small asset (<3% total production) in the context of APC’s portfolio.

3)      TEN Start-Up Issues: APC’s TEN project in Africa is expected to reach first oil in 3Q16. Any delay or underperformance could impact APC’s 2016 outlook.

4)      Expanded Colorado Setback Rules: Residents of Colorado continue to attempt to increase the distance between new well drilling and nearby structures. The result of increased setbacks could be a reduction in future drilling locations for APC which would reduce its NAV.

Catalyst

1)      Asset Sales: APC is likely to monetize additional non-core onshore US assets. APC could also sell-down working interests in offshore prospects.

2)      Capital Efficiency Gains and Cost Reductions: APC continues to drive down well costs in the Wattenberg and Delaware Basin which is reducing break-even economics. APC still has significant improvements to achieve in the Delaware which could be realized in the near-term. Further, APC continues to surprise with LOE and midstream expense reductions.

3)      Shenandoah Success: APC is drilling its 5^th appraisal well. The previous appraisal wells have encountered significant pay which suggest the prospect could be significantly larger than its other Gulf of Mexico developments. The 5^th well could go a long way to moving this prospect towards sanctioning.

4)      Heidelberg Improvement: APC’s Heidelberg project in the Gulf started-up in 1Q16 and delivered lower rates than pre-drill expectations. This could be the result of timing or other issues that APC can address to improve performance before year-end.

5)      Exploration Success: While less impactful in this environment, APC is drilling exploration wells in Colombia and Cote D’Ivoire.

6)      APC is Acquired: Given its discounted multiple and its resource depth, APC could be a target for one of the majors looking to add resource at reasonable cost.