FANG - APA Corporation: Reasonable Results For Current Times Set Up For Better H2

2023-08-10 16:35:23 ET

Summary

• APA Corporation beats analyst expectations in its Q2, 2023 earnings results.
• Lower energy prices adversely impact financial performance, but rising crude oil prices may benefit the company going forward.
• APA Corporation's stock price appears to be more expensive than its peers despite a weaker balance sheet.
• The company's balance sheet will likely improve a bit due to the higher cash flows from higher energy prices.

On Wednesday, August 2, 2023, independent crude oil and natural gas exploration and production giant APA Corporation ( APA ) announced its second-quarter 2023 earnings results. At first glance, these results were quite good, as APA managed to beat the expectations of its analysts in terms of both top line revenues and bottom line earnings. The market seemed to be reasonably impressed as well, as the company’s stock price continued on the upward trajectory that it has been on for the past month:

In fact, as we can clearly see above, APA’s stock price has delivered a 26.52% return over just the past month. That is the kind of return that just about any investor will greatly appreciate. With that said though, much of the traditional energy sector has been rising over the period due to crude oil prices finally starting to break out of their former range-bound pricing. There are reasons to believe that this will continue going forward as most of the fundamentals are pointing to higher crude oil prices than were seen over the first half of the year. This will not have benefited APA’s second-quarter results though, as oil prices did not start to rise until mid-July.

For most of the second quarter, crude oil prices were under $80 per barrel. The improving price environment will benefit the company going forward, however, so we will probably see its third-quarter performance come in a bit better than it did in the second. The biggest disappointment here is that the company’s stock price may have gotten ahead of itself as APA Corporation currently looks to be more expensive than many of its peers.

Earnings Results Analysis

As regular readers are no doubt well aware, it is my usual practice to share the highlights from a company’s earnings report before delving into an analysis of its results. This is because these highlights provide a background for the remainder of the article as well as serve as a framework for the resultant analysis. Therefore, here are the highlights from APA Corporation’s second quarter 2023 earnings report :

• APA Corporation brought in total revenue of $1.910 billion in the second quarter of 2023. This represents a 38.07% decline over the $3.084 billion that the company brought in during the prior-year quarter.
• The company reported an operating income of $830.0 million in the most recent quarter. This compares very unfavorably to the $1.549 billion that the company reported in the year-ago quarter.
• APA Corporation produced an average of 398,930 barrels of oil equivalent per day in the reporting period. That represents a 3.72% increase over the 384,627 barrels of oil equivalent per day that the company produced on average during the corresponding quarter of last year.
• The company reported an adjusted EBITDAX of $1.217 billion in the current quarter. That represents a fairly substantial 37.81% decline over the $1.957 billion that it reported in the equivalent quarter of last year.
• APA Corporation reported a net income of $381 million in the second quarter of 2023. This compares very unfavorably to the $926 million that the company reported in the second quarter of 2022.

It seems essentially certain that the first thing that anyone reviewing these highlights will notice is that every measure of financial performance declined compared to the prior-year quarter. This is not exactly surprising as it is in line with the reports that have been coming in from across the energy sector. The biggest reason for this is that energy prices were substantially lower during the second quarter of 2023 than they were in the second quarter of 2022. This chart shows the spot market price for West Texas Intermediate crude oil over the period from April 1, 2022, to June 30, 2023:

As is immediately visible, the price of the commodity was much lower during the quarter. APA’s second-quarter results were affected by this as well. Here are the company’s realized prices for the products that it sells:

The realized price is the average amount that the company received for each unit of production that it sold during the period. As we can clearly see, these numbers were substantially lower across the board. It should be fairly obvious why this would have an adverse impact on the company’s financial performance. After all, if it receives less money for each unit of product that it sells, then its total revenue will be lower, all else being equal. The lower revenue means that less money is available to cover the company’s fixed expenses and make its way down to the bottom-line profit and cash flow.

Naturally, all else is rarely equal with a company in this industry. This was the case here, as APA Corporation’s production came in higher than during the same quarter of last year. We can see this in the highlights. During the second quarter of 2023, APA Corporation produced an average of 398,930 barrels of oil equivalent compared to 384,627 barrels of oil equivalent in the same quarter of last year. This helped to offset the impact of lower prices. After all, the higher production means that APA Corporation had more products to sell in exchange for money. As is usually the case with an oil company though, the higher production was unable to fully offset the impact of the lower energy prices.

As I have mentioned in various previous articles, crude oil prices generally held up much better than natural gas prices over the past year. Over the trailing twelve-month period, West Texas Intermediate is down 6.70% but natural gas at Henry Hub is down a whopping 62.20%. That was caused mostly by natural gas oversupply in the United States due to a warmer-than-normal winter (that resulted in lower-than-usual consumption) and an outage at a major liquefaction plant that would have ordinarily purchased billions of cubic feet of natural gas per day to export overseas. West Texas Intermediate crude oil was lower during the second quarter than it is now, however. In fact, over the past month, crude oil prices have gone up by 14.30%:

The current West Texas Intermediate price of $83.14 per barrel is hovering right around its year-to-date high. There are reasons to believe that this positive trend will continue going forward. One reason for this is that the Federal government can no longer flood the market with crude oil in a bid to suppress prices. From about the start of April until the first week of July, Administration officials were selling crude oil from the Strategic Petroleum Reserve into the market:

That was almost certainly intended as a way to offset the supply shortage that would have otherwise resulted from the cuts implemented by the Organization of Petroleum Exporting Countries back in April. This is similar to the tactic that officials used to try and manipulate energy prices downward last summer and fall. However, the government never filled up its stockpiles like it said that it would. Therefore, when it started draining the Strategic Petroleum Reserve in April, it only had a very limited supply of oil that could be sold before the government’s reserves were empty. It appears that we may have hit that point in early July.

When the Department of Energy released its crude oil inventory report yesterday, it showed that the amount of oil in the Strategic Petroleum Reserve went up by 995,000 barrels, which is shown in the chart above. That is the largest weekly build since June 2020, and it could be a sign that the Administration is finally starting to refill the nation’s crude oil stockpile. If this continues, not only will we not have an increased supply from the national stockpiles being sold onto the market, but we will also have a significant new source of demand. That could very easily worsen the tight supply-demand balance that already exists in the market due to the OPEC production cuts and drive crude oil prices up.

If that scenario plays out, it will certainly prove to be a net positive for APA Corporation. The company stated in its earnings conference call that 50% of its second quarter 2023 production was crude oil:

As stated earlier, APA Corporation had an average production of 398,930 barrels of oil equivalent per day in the second quarter of 2023. Its crude oil production alone was 198,831 barrels per day, which represents 49.84% of the total average production so the 50% estimate is certainly a fair estimate. As such, APA will benefit more from crude oil price increases than it will from either natural gas or natural gas liquids because crude oil accounts for the largest percentage of the products that it sells.

With that said, natural gas liquids prices typically track crude oil prices, so we could see some near-term increases there. APA’s guidance is for a very slight production increase over the remainder of the year so it should be well-positioned to deliver stronger results in the second half of this year than it did in the first half. That is something that investors in the company should appreciate.

Financial Considerations

It is always important to investigate the way that a company finances its operations before making an investment in it. This is because debt is a riskier way to finance a company than equity because debt must be repaid at maturity. This is typically accomplished by issuing new debt and using the proceeds to repay the existing debt because very few companies have the ability to completely pay off their debt with cash as it matures. This can cause a company’s interest expenses to go up following the rollover depending on the conditions in the market. As interest rates are currently higher than they have been in more than twenty years, that is a very real concern today.

In addition to interest-rate risk, a company must make regular payments on its debt if it is to remain solvent. Thus, an event that causes a company’s cash flows to decline could push it into financial distress if it has too much debt. As APA Corporation is highly exposed to fluctuations in commodity prices, which can be quite volatile, this is a risk that we should not ignore.

One ratio that we can use to analyze a company’s financial structure is the net debt-to-equity ratio. This ratio tells us the degree to which a company is financing its operations with debt as opposed to wholly-owned funds. The ratio also tells us the degree to which a company’s equity will cover its debt obligations in the event of bankruptcy or liquidation, which is arguably more important.

As of June 30, 2023, APA Corporation had a net debt of $5.5360 billion compared to $1.6960 billion of shareholders’ equity. This gives the company a net debt-to-equity ratio of 3.26 today. Here is how that compares to some of the company’s peers:

As we can clearly see, APA Corporation is the only company here whose net debt is higher than its shareholders’ equity. That could be a sign that the company is relying far too heavily on debt to finance its operations. This is something that could pose a real risk to shareholders, particularly as it has to start rolling over debt and paying higher interest rates.

Ultimately, a company’s ability to carry its debt is more important than the sheer amount of debt in its financial structure. The usual way that we evaluate this is by looking at its leverage ratio, which is also known as the net debt-to-EBITDAX ratio. This ratio essentially tells us how many years it would take the company to completely pay off its debt if it were to devote all of its pre-tax cash flow to that task.

As mentioned in the introduction, APA Corporation reported an EBITDAX of $1.217 billion in the second quarter of 2023. That works out to $4.868 billion annually, which gives it a leverage ratio of 1.14x based on its annualized EBITDAX. This is a reasonable ratio, although the best companies in the sector have a ratio that is less than 1.0x. Thus, APA Corporation is a bit more levered than we really want to be comfortable. Fortunately, the fact that its EBITDAX will almost certainly increase in the near future as already discussed will help here since that will give the company more money to use to reduce its net debt.

Valuation

It is always critical that we do not overpay for any assets in our portfolios. This is because overpaying for any asset is a surefire way to earn a suboptimal return on that asset. In the case of an upstream exploration and production company like APA Corporation, we can value it by looking at the price-to-earnings growth ratio. This is a modified version of the familiar price-to-earnings ratio that takes a company’s forward earnings per share growth into account. A price-to-earnings growth ratio of less than 1.0 is a sign that the stock may be undervalued relative to the company’s forward earnings per share growth and vice versa.

According to Zacks Investment Research , APA Corporation will grow its earnings per share at a 1.19% rate over the next three to five years. That gives the company a price-to-earnings growth ratio of 9.29 at the current price. Here is how that compares to the company’s peers:

As we can see here, it appears that APA Corporation is incredibly expensive relative to its peers. Admittedly, we could argue that a 1.19% earnings per share growth rate is far too low of an estimate given the trajectory of energy prices. I would even agree with that, and I do expect that this company will be able to deliver a better performance. However, keep in mind that every single company on this list will also benefit from rising crude oil prices. Thus, we can still conclude that APA Corporation is a bit expensive today compared to its peers.

Conclusion

In conclusion, APA Corporation reported fairly solid second-quarter 2023 earnings results. These results beat the expectations of analysts, but they were still worse than what the company delivered last year. That was expected as energy prices were significantly lower than they were in the prior-year quarter. This could be about to reverse though, as the fundamentals are pointing to rising energy prices going forward and APA is positioned to take advantage of this. The only real negatives here are that APA Corporation remains expensive relative to its peers, despite having a weaker balance sheet . There may still be some reasons to consider it for a portfolio, though.

For further details see: