Apache Corporation Equity Valuation and Analysis

131 Pages·2008·1.57 MB·English

Apache Corporation Equity Valuation and
Analysis

Analyst Group
Dillon Blaine [email protected]
Rebecca Wood [email protected]
Ben Gergen [email protected]
Christopher Cotter [email protected]
Dustin Shimek [email protected]
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Table of Contents

Executive Summary 5
Business & Industry Analysis 10
Five Forces Model 14
Rivalry among Existing Firms 15
Threat of Substitute Products 19
Threat of New Entrants 22
Bargaining Power of Buyers 26
Bargaining Power of Suppliers 27
Value Chain Analysis 29
Firm Competitive Advantage Analysis 32
Accounting Analysis 33
Key Accounting Policies 34
Potential Accounting Flexibility 39
Actual Accounting Strategy 41
Quality of Disclosure 42
Qualitative Analysis of Disclosure 42
Quantitative Analysis of Disclosure 44
Sales Manipulation Diagnostic 45
Expense Manipulation Diagnostic 50
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Potential Red Flags 55
Coming Undone (Undo Accounting Distortions) 56
Financial Analyst, Forecast Financials, and Cost of Estimation 56
Financial Analysis 56
Liquidity Analysis 57
Profitability Analysis 66
Capital Structure Analysis 73
IGR/SGR Analysis 77
Financial Statement Forecasting 79
Analysis of Valuation 90
Method of Comparables 90
Cost of Equity 98
Cost of Debt 101
Weighted Average Cost of Capital 101
Intrinsic Valuation 102
Discount Dividend Model 102
Free Cash Flows Model 103
Residual Income Model 104
Abnormal Earnings Growth 106
Long Run Return on Equity Residual Model 108
Credit Analysis 110
Analyst Recommendation 111
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Appendix 113
Liquidity Ratios 113
Profitability Ratios 114
Capital Structure Ratios 115
Method of Comparables 116
Regression Analysis 118
Discount Dividends Model 124
Free Cash Flow Model 125
Residual Income Model 126
Intrinsic Valuation Model 127
Abnormal Earnings Growth Model 128
Altman Z-Score 129
References 130

Executive Summary

Investment Recommendation: Overvalued, Sell (11/1/06)
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APA- NYSE(11/1/06): $99.18 Altman’s Z-Score:
52 Week Range: $63.01-$107.73 2002 2003 2004 2005 2006
Revenue: $8868.994M 3.51 3.97 2.72 3.13 3.32
Market Capitalization: $32.72B Valuation Estimates:
Shares Outstanding: 330.737M Actual Price (11/1/06): $99.18
Percent Institutional
Ownership: 82% Financial Based Valuations:
Book Value per Share: $39.88 Trailing P/E: $82.02
ROE: 18.60% Forward P/E: $93.41
ROA: 9.95% P.E.G.: $59.88
P/B: $103.29
Cost of Capital Est. R2 Beta Ke P/EBITDA: $75.65
Estimated: P/FCF: N/A*
3-month .19 1.6 4.01 EV/EBITDA: $97.24
6-month .19 1.6 4.22
2-year .19 1.6 4.03 Intrinsic Valuations:
5-year .19 1.59 4.22 Discount Dividend: $6.62
7-year .19 .14 4.33 Free Cash Flows: $126.84
10-year .19 .14 4.52 Residual Income: $37.72
LR ROE: *N/A
Published Beta: .76 AEG: $19.23
Kd(AT): 4.74%
WACC(BT): 8.52% WACC(AT): 5.54%
*Irrelevant due to negative cash flows

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Industry Analysis
Apache was formed in 1954 in Minneapolis, Minnesota by Truman Anderson,
Raymond Plank, and Charles Arnao. They have grown to be one of the leading
independent oil and gas exploration companies in the United States. The company
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currently has 24.3 billion in assets and sold 10.6 billion dollars worth of oil and gas in
2006. Apache currently has operations on 37.6 million acres in 6 different countries
around the globe.
Apache’s main competitors consist of Occidental Petroleum, Anadarko, XTO
Energy, and Devon Energy. They compete in a very competitive industry where
commodities are sold. This means the products they sell are virtually identical, making
price a deciding factor with their customers. In an industry with high entry barriers, it is
impossible to build a corporation with 24.3 billion in assets overnight. Brand name and
reputation are imperative in this industry since all products are identical.
The key success factors upon which firms compete are economies of scale,
successful exploration, tight cost controls, and retention of employees. These key
success factors are the building blocks to gaining market share, and maintaining
profitability and competitive advantages over their competitors. In an industry with low
product differentiation and almost zero substitute products, these key success factors
are all the more important to each company.

Accounting Analysis
Being successful in the oil and gas industry strongly relies on the key success
factors relating to key accounting policies. Accounting policies are important to
recognize due to the fact that managers are allowed flexibility under GAAP and can use
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option to make financial statements appear more appealing than they really are.
Managers are motivated to do this because keeping shareholders around is important to
their jobs.
Apache, when thoroughly looking over their financial statements, showed a high
level of disclosure of their business practices and accounting policies. Any bit of
information was found in the company’s 10-K and annual report of various years with
small amounts of searching.
Apache included much information about their operating leases, the full amounts
owed and the discount rates used to value payments on the leases at future dates.
Discount rates for pension liabilities and other long term liabilities were also revealed.
Discount rates for these items are an area that flexibility is used a lot. However, when
reviewing and performing the accounting analysis, no outlying ratios and numbers
caught our eyes. Everything was pretty much with the industry norms. Overall, Apache
did a good job of making transparent financial statements that disclose information
desired by analysts and investors.

Financial Analysis, Forecast Financials, and Cost of Capital Estimation
There are many financial ratios that analysts use to dissect a company’s financial
statements so they are able to compare them to their competitors. These ratios look at
the firm’s liquidity, profitability, and capital structure. These ratios are used to forecast
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out a firm’s financial statements so analysts can determine the value of a company, and
see the changes in the firm through time. Analysts also run a regression of the
company to determine a beta, cost of equity, cost of debt and a weighted average cost
of capital.
The liquidity ratios computed were the current ratio, quick asset ratio, inventory
turnover, receivables turnover, and working capital turnover ratios. The ratios
determine the firm’s ability to have enough near-cash assets to meet their debts and
obligations as fast as possible. These ratios show that Apache is in line with the
industry. The profitability ratios determine a company’s operating efficiency, asset
productivity, rate of return on assets, and rate of return on equity. Apache’s
profitability ratios show that Apache is, again, in line with the industry. The only
exception is the inventory turnover ratio, because not many of Oil Corporations in the
industry have inventory, so Apache is unusually high. Finally, the capital structure
ratios refer to the sources of financing used to acquire assets. This is shown by the
owner’s equity and liabilities sections of the balance sheet. All of Apache’s ratios are in
the same range as their competitors.
We then forecasted out Apache’s balance sheet, income statement, and
statement of cash flows for the next ten years. We forecasted using industry averages,
Apache’s past growth rates, and ratios. We took into consideration recent asset
acquisitions and natural disasters when forecasting so the future numbers were realistic
and reliable.

Valuations
Analysts have several tools when trying to value a company’s stock price per
share. Before using these tools, analysts must have a good understanding of the
company as well as its business environment. After completing an overall industry
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analysis, accounting strategies, and determining key success factors of the company,
the analyst is familiar enough with the company to value it. The Method of
Comparables and the Intrinsic Valuation model are important in determining if a firm is
overvalued, overvalued, or fairly valued.
The method of comparables is a measure of a company’s stock price per share.
This model is unique because it is based on the competitors in the industry. The
industry average does not include the company you are valuing. This can potentially
create problems when trying to accurately value a stock. Under this model, many
assumptions such as all companies in the industry are the same size and they operate
in the same way. After the industry average is found, it is used in several calculations
to determine the stock price per share. From here, it is clear if a firm is overvalued,
undervalued, or fairly valued. Clearly, this model is not the most reliable or accurate
because of the assumptions it makes. According to this valuation model, Apache’s
stock price was overvalued based on all but two of the models. The Forwarding Price
to Earnings and Enterprise Value to EBITDA ratios reported Apache as having a stock
price as fairly valued. This should not be the only valuation measurement for a
company, due to the inconsistency of the model.
The Intrinsic Valuation model is a more complete and detailed form of valuing a
company’s stock price per share. In total there are five intrinsic valuation models that
focus on different areas of the company. The Discount Dividend model is not the most
reliable out of these valuations. Dividends must be forecasted out using a constant
growth rates. It is not likely that a company’s dividends will grow at a constant rate for
an indefinite period. According to this model, Apache’s stock price per share is
overvalued. The Free Cash Flow model is another valuation that is not always accurate.
This model basis its valuations off of forecasted cash flows from operations and cash
flows from investing. The result of this valuation was that Apache’s stock price per
share was overvalued. Next, the Residual Income valuation is the most reliable
because the overall value of the firm includes a high percentage of the present value of
residual income. Based on this model, again, Apache’s stock price per share is highly
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overvalued. Apache’s stock price valued using the Abnormal Growth Model and the
Long Run Residual Income model was overvalued. Therefore, the valuation models
support that Apache’s stock is overvalued.

Business & Industry Analysis
Overview of Firm
Apache Corporation is an independent oil and gas company that was created in
1954. The company’s interest is in exploration and production of crude oil, natural gas,
and natural gas liquids. Apache is one of the largest independent oil and gas companies
in the nation and has operations in six countries including the United States, Canada,
Egypt, Australia, Argentina, and the United Kingdom. Apache has a variety of
operations ongoing on and offshore in these countries. The company went public in
1969 and its shares were first listed on the New York Stock Exchange under the symbol
APA. Apache Corporation is headquartered in Houston, Texas.
Apache operates in an industry where acquisitions of property from other
exploration companies are the norm in the way of purchasing prospects for drilling and
exploration. Seldom is land acquired that is undeveloped or not yet been looked over by
other firms. Apache acquires prospective properties through buying other larger firms’
drilling interests and by bidding for offshore blocks of water from governments. These
bids and purchases of other firm’s drilling rights initiate much competitiveness
throughout the industry. Consequently, firms with more capital to work with generally
have a better chance of acquiring lands and deepwater blocks. Apache competes with
vast numbers of companies that have more capital and resources to work with. In
recent times, many major integrated oil companies have focused more on exploration
worldwide instead of just on their home turf. This has left many opportunities for
acquisitions for smaller independent oil and gas companies. “There are about 5000
independent oil and natural gas producers in the U.S. Independents drill 90 percent of
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