Investors could have picked just about any oil and gas stock in the past two years and made money, given the surge in commodity prices. To profit over the next year, they’ll have to look for distinctive companies.
One of the industry’s most compelling outliers is
(ticker: APA), a modest-size Houston firm with a wide-ranging global footprint. It drills in Texas but also happens to be the largest oil producer in Egypt and an offshore driller in Europe.
“We do believe there’s going to be demand for oil and natural gas for several decades,” CEO John Christmann tells Barron’s.
APA’s stock has risen 38% this year, slightly more than the average producer, but investors still value it at a discount to the industry and the broader market. It trades at just 3.8 times expected earnings for the next four quarters, half as much as its peers.
Christmann thinks the discount is caused by the company’s asset mix—offshore projects are often valued at lower multiples than onshore ones, for instance. Neal Dingmann, an analyst at Truist Securities, attributes the discount to the relatively high percentage of the company that’s owned by firms like BlackRock and Vanguard, known for their passive index funds. Investors prefer to see more-active investors, because they’re considered “sticky money” that will hold through ups and downs, he says.
Dingmann likes the company’s geographic diversification and sees the stock headed to $75 from a recent $37. Most U.S. producers concentrate their drilling in one of eight major U.S. shale basins, and have been wary of exploring new areas because it’s considered expensive and risky. That strategy has paid off since the pandemic, but it has its limits. Shale wells are known to dissipate quickly, raising concerns that production will eventually drop.
“The fact of the matter is that U.S. shale is a short-cycle business,” says Dingmann. He covers 35 oil-and-gas companies, and says that he can “count on one hand” the number of producers that have ample acreage to keep producing more than 10 years from now. APA is one of them.
APA’s earnings are set to grow to $9.40 per share this year from $3.90 last year, and then rise again to $10.91 in 2023. Some of that growth is due to high oil and gas prices, but there are other catalysts, too, including promising drilling and a lucrative deal to sell natural gas to energy-strapped Europe.
APA also is buying back shares at a fast pace, retiring 14% of its share count from last October to this July. The board just doubled its dividend and authorized the company to buy back an additional 12% of its shares. Given its shareholder return commitments, APA’s share count could fall 25% from October of 2021 to the end of 2023. Its dividend yield is now a relatively modest 2.7% but could grow.
Doug Campbell, an analyst at money manager Hotchkis & Wiley, has modeled the company’s future based on an oil price around $65 or $70—some 25% below current prices—and its trajectory still holds up. “We don’t need those supernormal prices to continue for the valuation to be attractive on current earnings,” he says. Hotchkis & Wiley owns more than 3% of APA’s shares.
APA is a holding company that owns Apache, a producer that was founded in 1954 and still runs most of APA’s operations. It has shale assets in the Permian Basin of Texas and New Mexico that it recently expanded, and operates in the Gulf of Mexico. But about half of its oil production comes from overseas, including the North Sea off the United Kingdom.
APA has also been exploring for oil off the coast of Suriname, a South American country neighboring Guyana, where
(HES) have begun producing oil from a development likely to pay off for a decade or more. Early results from Suriname are promising, and analysts expect production from wells there sometime in the next few years.
In addition, APA signed a contract with liquefied-natural-gas company
(LNG) to sell natural gas to European and Asian buyers. Starting in the middle of next year, it will earn a portion of the spread between U.S. and overseas prices, which has recently traded at record highs as Russia has stopped supplying gas to most of Europe. The company says the contract would add $750 million to 2023 free cash flow at current futures prices.
Neither the LNG contract nor the Suriname development are presently accounted for in the stock price, Campbell maintains. “Those two items have the potential to be very meaningful to the stock price,” he adds.
APA has struggled to catch the eye of investors. If its bets keep paying off, the stock will be hard to ignore.
Write to Avi Salzman at email@example.com
Read More: APA Corp. Scours the Globe for Oil and Gas. Its Stock Could Surge.