Description

Anadarko is trading at a discount to its $91 NAV. This is a result of the disconnect between the oil and natural gas futures markets and the public E & P equities. The sell side and equity valuations for the industry seem to be pricing in oil at $28 and gas of $4.50, the price considered “mid-cycle” based on past experience.

Anadarko Petroleum is one of North America’s largest independent oil and gas exploration and production companies. Its activities are confined to “upstream” activities and they sell their output at prevailing commodity prices.

Futures Curve:

Crude Oil (WTI) Natural Gas (Henry Hub)
Q4 '04 $55.23 $7.37
2005 $49.74 $7.21
2006 $44.21 $6.49
2007 $41.89 $5.95
2008 $40.15 $5.52
2009 $39.00 $5.17

A lot of other large E & P companies also currently trade at discounts to their net asset value based on futures pricing. This discount can persist. However, to the extent that a company either: hedges production to lock in prevailing prices, or sells assets at current valuations, and buys back stock, they will assist in the narrowing of the prevailing discount.

Anadarko is the company exploiting this arbitrage to the greatest degree. They are selling roughly 25% of the company (at prices in the m&a market that better reflect futures pricing) for $3+ billion after tax and buying back at least $2 billion of stock and paying down $1.4 billion of debt. They will also generate excess cash from operations, which will be used to buyback additional stock and pay down additional debt commensurately.

On top of this exciting financial arbitrage, APC’s operations are hitting a sweat spot, and they are likely to post nice production growth and reserve replacement numbers. This means that the company’s NAV is likely to grow assuming constant commodities prices.

The CEO and senior management are excellent.



DCF Analysis:

2H2004 2005 2006 2007 2008 2009
CFFO 2173.8 4397.0 4050.6 3860.4 3745.6 3700.9
CapEx (1780.1) (2500.0) (2420.7) (2551.5) (2689.5) (2835.1)
FCF 393.7 1897.0 1629.9 1308.9 1056.1 865.8

Terminal Value Assumptions:

Terminal Value per MBOE – $8.50
Reserve Growth – 4.5%
2009YE Reserves – 2831.0 million

Discount Rate – 7.5%

PV of CF (present – 2009) – 6016.4
PV of Terminal Value – 16,762.1
Asset Sales – 3,000.0
Land – 2,000.0*
Net Debt – (4,900.0)

Total Equity Value – 22,878.5


*In addition to their fee acres, Anadarko has a land grant for 8 million acres spread across Utah, Colorado, and Wyoming. Management estimates the value of the land to be $2.7 billion.

Catalyst

Sale of Canadian assets. Bids are in, announcement within a couple of weeks. Proceeds from these sales will be greater than current sell-side estimates.

Amount of stock repurchased in the past three months (announced with earnings on 10/29) will be significant and greater than expectations. Company is in market buying 25% of volume every day.

Announcement of blow out earnings. Analyst EPS consensus: 2H04: $3.25, 2005: $6.55. My estimates based on the futures curve: 2H04: $4.09, 2005: $10.53.