Market Analysis: Anadarko Petroleum’s Outlook Is Looking Decent

Anadarko Petroleum has posted a 74% increase in profits for 4Q18, but since then, oil prices have tumbled and may average $61/bbl in 2019, as per BNP Paribas.

Dip in prices will drag Anadarko Petroleum’s earnings and cash flows, but it can still generate a profit and free cash flows (incl. dividends) if oil stays above $54/bbl.

Beyond 2019, Anadarko Petroleum expects to further reduce its costs and begin working on the Mozambique LNG project.

However, Anadarko Petroleum continues to carry a large debt load of $16.4 billion with a D/E ratio of 150% (136% as adj.), which is one of the highest in large-cap E&P space.

This year is turning out to be a challenging one for oil prices, but Anadarko Petroleum Corporation (APC) will still generate free cash flows. The company also plans to reward shareholders with dividends and buybacks while meaningfully reducing debt. That should have a positive impact on the company’s stock. But, remember, this is a high-beta play which may not appeal to some investors.

Anadarko recently released its fourth quarter results in which it posted a 73.6% increase in adjusted earnings from a year ago to $184 million, or $0.38 per share. The company benefited from a 14.4% increase in total production to 701,000 boe per day and higher average sales prices of oil (up 6.3%) and natural gas (up 19.4%). The company also generated $1.63 billion of operating cash flows (unadjusted) which easily funded $982 million of capital expenditure (ex. Western Gas Partners (WES) CapEx).

The above-mentioned performance, however, came at a time when the price of the US benchmark WTI crude averaged $59 a barrel. Since then, the price has fallen and is hovering at $52 at the time of this writing, thanks in part to growing US production which has threatened to offset production cuts by the Organization of Petroleum Exporting Countries and its partners and concerns over slowing global economic growth amid the ongoing US-China trade war. Most analysts have forecast weaker oil prices for 2019 as compared to last year. As per the Paris-based bank BNP Paribas, the WTI will average $61 a barrel in 2019, down from $65 in 2018.

The dip in oil prices will have a negative impact on Anadarko’s earnings and cash flows, which will be partly offset by production growth. Anadarko is targeting around a 9.3% increase in production to 726,000 boe per day in 2019, including oil production of 422,500 bpd. However, the company has shown in its Q4-2017 results that it can generate a decent profit at $55 oil and substantially higher levels of earnings at $60. Moreover, the company expectsto generate strong levels of free cash flows at $60 oil, but even if prices were to fall to $50, the company will raise enough cash flow from operations (as adj.) to self-fund its entire 2019 capital budget of between $4.3 billion and $4.7 billion (midpoint $4.5 billion).

Anadarko has a cash flow breakeven price of $50 a barrel. After including dividends, this breakeven level climbs to $54 a barrel. This means that if oil prices average $50 a barrel in 2019, then Anadarko will earn discretionary cash flows of roughly $4.5 billion which will fully cover its capital expenditure. But the company will rely on its liquidity or asset sales or additional borrowings to pay dividends of $600 million. At the current oil prices of $52 a barrel, investors should expect Anadarko to self-fund all of its CapEx and some of its dividends from internally generated cash flows.

However, at $54 oil, Anadarko’s discretionary cash flows will climb to $5.2 billion, as implied by the company’s guidance, allowing it to fully fund its CapEx as well as dividends. The company’s guidance also implies that at $60 oil, Anadarko will generate $5.9 billion of discretionary cash flows, which will translate into strong levels of free cash flows of $1.4 billion. In this case, the company will be left with $800 million of cash flows in excess of CapEx and dividends. The company can then use the excess cash to buy back shares, reduce debt, or increase dividends. The company expects to repurchase $1.25 billion of shares and reduce debt by $1.25 billion by mid-2020.

I believe Anadarko is well positioned to hit cash flow neutrality at $50 WTI (ex. dividends) and generate strong free cash flows at a higher oil price. The company owns a diverse portfolio of assets, including high-margin conventional oil producing properties that generate strong levels of cash flows in a $50 a barrel oil price environment and offset relatively higher cash costs related to the onshore US projects, particularly at Delaware Basin. However, Anadarko expects to reduce its cost structure at Delaware Basin by increasing operatorship, enhancing midstream footprint, and capturing superior prices as compared to 2018-19. As a result, the company expects Delaware Basin to also start generating positive cash flows at $50 WTI from next year. This puts Anadarko in a good position to achieve its target of improving overall cash flow breakeven (with dividends) to $49 a barrel in 2020 and $45 a barrel by 2021.

Anadarko also expects to make a final investment decision on the Mozambique LNG project in the first half of the current year. The company has already signed sales and purchase agreement for more than 7.5 million tonnes of LNG per annum, including its latest contract with a subsidiary of Royal Dutch Shell (RDS.A)(RDS.B) for 2 MTPA for a period of 13 years, and expects to sign another 2 MTPA of agreements in the coming months (before FID). These agreements will cover around three quarters of the project’s total nameplate capacity of 12.88 MTPA. A project of this size and scale could take four years or longer to develop, but it could become a key source of sustainable cash flows for Anadarko once it becomes fully operational. Anadarko is the operator of the Mozambique LNG project with a 26.5% working interest.

Anadarko Petroleum stock has fallen by 28% in the last three months and is at $42 at the time of this writing, close to 52-week lows of $40.42. It may look appealing since the company expects to generate free cash flows, buy back shares, continue paying dividends, and reduce debt, which should have a positive impact on the stock. But remember that Anadarko has a weak balance sheet since it carries above-average levels of debt.

At the end of last year, the company had a total of $16.4 billion of debt which translated into a lofty debt-to-equity ratio* of 150% – one of the highest among all large-cap independent oil producers (total debt of $16.42 billion/ total equity of $10.94 billion). The leverage metric comes down to 136% (total debt of $11.6 billion/ total equity of $8.49 billion) if we exclude the debt associated with its MLP, but that’s still one of the highest in the industry. By comparison, Anadarko’s rival ConocoPhillips’ (COP) debt-to-equity ratio was 47% at the end of 2018.

The high levels of debt have a negative impact on Anadarko’s valuation, limiting its ability to withstand weak oil prices for an extended period. The associated interest payments drag its earnings and cash flow and make it a relatively risky stock in the large-cap E&P universe. I believe those investors who have adopted a defensive approach in an uncertain oil price environment should avoid Anadarko Petroleum stock.


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