Apache Continues to Rebalance Its Portfolio

Houston-based oil and gas producer Apache recently said it plans to exit its operations in Kenya in order to focus on more lucrative opportunities elsewhere.

Bob Dye, the company's senior vice president of corporate affairs, told Reuters that the company is giving up its 50% stake in Kenya's offshore L8 Block, which it operated with partners Tullow Oil Plc, Origin Energy Ltd., and Pancontinental Oil & Gas NL, after a well drilled in the block last year failed to yield commercial quantities of gas.

Shell's portfolio rebalancing
The move comes amid the company's renewed efforts to rebalance its global portfolio and focus on its "growth core" assets in North America, especially in the Permian Basin of Texas and the Anadarko Basin in Oklahoma. As part of this strategy, the company has been aggressively selling off noncore assets to raise cash in order to pay down debt, repurchase shares, and fund its North American onshore liquids drilling programs.

Year-to-date, it has announced some $7 billion worth of asset sales and monetizations, including the sale of oil and gas assets in the Gulf of Mexico to private equity firm Riverstone Holdings for $3.75 billion in July; the sale of Canadian properties to Ember Resources, a privately held Canadian company, for $214 million in August; and, most recently, the sale of a third of its Egyptian oil and gas assets to Chinese oil giant Sinopec .

North America focus
With a much more streamlined asset portfolio after these recent divestitures, Apache can now focus a much larger share of its capital on its North American onshore assets, which feature more predictable growth rates and more attractive rates of return. Indeed, North America's share of the company's total production has skyrocketed in recent years, from just 31% in 2009 to an expected 55% this year.

Of the company's planned $10.5 billion capital expenditure budget for the year, roughly $4 billion will be directed toward its onshore U.S. operations, especially in its "growth core" Permian and Central regions. In the second quarter, these regions produced a combined 214,000 barrels of oil equivalent, up 34% from the year-earlier quarter, and now account for about 27% of the company's total production.

Importantly, rates of return from both plays are extremely attractive -- around 30% -- and the company sees further opportunities for improvement, as it continues to drive down drilling and completion costs. At the same time, its international operations continue to generate robust cash flows to fund these ambitious drilling programs. Last year, its North Sea and Egypt operations generated $1.5 billion and $2.7 billion in cash flow, respectively, excluding changes in working capital.

The bottom line
As you can see, Apache's new strategy is vastly different from its approach in previous years. The company now sees most of its growth coming from its onshore North American oil and gas assets, while its international assets in the North Sea and Egypt are mainly for cash flow generation.

Yet despite Apache's enviable position in North American shale, especially in the Permian Basin, where it is currently one of the leading producers and commands 1.6 million net acres, its shares are trading at a huge discount to other Permian producers. Concho Resources , for instance, is trading at 22.6x forward earnings and 10.2x cash flow, while Pioneer Natural Resources trades at a lofty 36x times forward earnings and 13.7x cash flow.

By comparison, Apache's shares are trading at just 10.8x forward earnings and 3.8x cash flow, possibly because investors are still concerned about its exposure to Egypt, which, as I have argued previously, may be overblown. Furthermore, given the speed at which the company is divesting less profitable assets and its solid production growth outlook, especially in North America, I think such a massive discount may be unwarranted.

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