When most people think about oil and gas drillers, they think about integrated majors like ExxonMobil (NYSE: XOM) or maybe a producer whose name they've seen on a gas station, like Hess (NYSE: HES). One most don't think about is Apache Corporation (NYSE: APA).
That's natural: Independent oil and gas exploration and production companies don't exactly need to advertise to the public, since your average consumer doesn't have much need for a barrel of unrefined crude oil or a thousand cubic feet of natural gas. But what really shocks me is how few investors are talking about Apache, which not only looks like one of the best buys in the oil patch right now but has major growth potential.
Here's why you should be thinking about Apache, even if nobody's talking about it.
A screaming bargain
In August 2016, in the depths of the oil price slump, the stock market was valuing Apache at just under $20 billion. At the time, Apache had major operations in the North Sea and Egypt, plus some lower-margin North American assets, including Canadian tar sands projects.
But in September, Apache made a major announcement: It had been quietly picking up acreage in an area of West Texas called the Delaware Basin -- a subset of the large Permian Basin shale formation. Because nobody expected much oil or gas in the region, Apache had been able to grab some 300,000 acres at a bargain price of just $1,300 per acre. The company had done extensive testing in the region and stunned the energy world with its findings.
Far from being empty of oil and gas, Apache's initial testing indicated that there were at least 3 billion barrels of oil and 75 trillion cubic feet of natural gas underneath its play. Almost overnight, Apache's market cap soared to about $24 billion. Land prices in the region shot up as well, with companies paying between $30,000 and $40,000 per acre to get in on the action.
But ironically, Apache's share price -- along with its market cap -- has trended lower since then, even as the company confirmed the existence of more and more oil and gas in the play. Today, the company has a market cap of about $17 billion...less than it did before the West Texas play -- dubbed Alpine High -- was announced.
Here's why that seems completely crazy.
It doesn't add up
As I mentioned, Apache owns about 300,000 acres at Alpine High, and adjacent land has been selling for $30,000 per acre to $40,000 per acre. Let's use the more conservative $30,000 figure. That puts an approximate sale value for Alpine High of $9 billion...just for the land alone. In other words, it's worth more than half of Apache's market cap.
But remember, those sale prices were for undeveloped land, and since its big announcement in 2016, Apache has been devoting a lot of capital to building out the oil and gas infrastructure in the region. By the time 2018 is done, Apache will have spent nearly $1 billion in capital on Alpine High infrastructure. That increases Alpine High's value; even if we say that the capital expenditures are worth half of what Apache paid for them, it implies a market value of about $9.5 billion for Alpine High.
Apache has made other changes to its operations since the Alpine High announcement, notably selling off its underperforming Canadian assets to focus on the Permian Basin. But if Alpine High -- again, just the 300,000 acres of land and existing midstream infrastructure alone -- is worth about $9.5 billion, then that means the market is assigning a value of just $7.5 billion to the entire rest of the company, including its profitable overseas operations, its exploration blocks in Suriname -- which are adjacent to ExxonMobil's and Hess's massive finds in the region -- and the other 2.5 million acres of Apache's Permian Basin holdings.
From a value perspective, Apache looks incredibly cheap.
Leaps and bounds
Of course, Apache isn't going to sell Alpine High: it's going to continue to produce oil and gas from the play. A lot of oil and gas. In fact, Apache is projecting its overall Permian operations -- including Alpine High -- will be generating at least 315,000 barrel of oil equivalents per day (BOE/d) by 2020, about double the 158,000 barrels it produced in 2017. That will help boost companywide production to an estimated 475,000 BOE/d to 510,000 BOE/d, up from 350,000 BOE/d last year, a double-digit compounded annual growth rate (CAGR). At Alpine High, the company is projecting a production CAGR of more than 150% through 2020!
So why isn't the market taking notice? One concern might be that Permian Basin production is ramping up so quickly that it might soon outstrip transportation capacity. Apache, though, is on top of the problem, recently announcing it would form a new $3.5 billion publicly traded midstream corporation with Kayne Anderson Acquisition Corp. that will be called Altus Midstream. Apache will own about 71% of Altus.
Through Altus, Apache is investing in Kinder Morgan's Permian Highway pipeline, which will transport up to 2 billion cubic feet of natural gas per day from the Permian Basin to refining facilities on the Gulf Coast. Apache is also signed on as one of the primary shippers of product through the pipeline (along with ExxonMobil).
Apache's management has been very effective at deploying its capital, to the point that its return on capital employed is the highest in its peer group and even bests ExxonMobil's. These investments in future production growth and transportation should keep the company well positioned for the future.
Why Apache deserves some attention
There are some risks to investing in Apache, of course. If oil prices drop suddenly, like they did in 2014, increased production might not be enough to keep the wolf from the door. But of course, that's a risk for the entire industry, not just Apache. Perhaps the bigger risk is that the market will continue to inexplicably ignore Apache regardless of its performance.
But Apache's excellent value and strong production projections should make the market stand up and take notice. Everyone should be talking about Apache. However, until they do, investors in the know can pick up these shares at a price that looks like an incredible bargain.
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