Apache Remains a Compelling Buy

Apache (NYSE: APA  ) , the Houston-based oil and gas producer, recently reported an 86% year-over-year increase in earnings, led by double-digit production growth from its North American onshore assets and higher realized crude oil prices. Yet shares have barely budged, ostensibly because investors remain concerned about the company's exposure to Egypt.

Let's take a closer look at where Apache's future growth will come from and why the company may be significantly undervalued.

Quarterly highlights
Apache reported third-quarter earnings of $300 million, or $0.75 per diluted common share, up 86% from $161 million, or $0.41 per diluted common share, during the same period last year. Revenue slipped 4% to $4 billion due to lower gas sales volumes and a $422 million derivatives loss.

The company's total oil production grew 22% year over year to 73,000 barrels per day, while North American oil production surged 51% year over year to more than 25,000 barrels per day, led by solid performance from the company's Permian and Central regions.

Growth from U.S., cash flow from abroad
Apache's third-quarter results highlight the company's continued strong progress in rebalancing its portfolio and growing production from "growth core" assets in the Permian and Central regions, which accounted for 35% of its total global liquids production, up from 27% a year ago.

In the Permian, Apache reported record production of 132,000 barrels of oil equivalent per day, up 7% sequentially and 18% year over year, while its Central region operations delivered production of 95,000 BOE per day, up 4% sequentially and 31% year over year. Importantly, liquids accounted for more than half of total production in both regions.

With tens of thousands of drilling locations between the two basins, where wells are generating strong rates of return in excess of 30%, Apache has a huge runway for continued double-digit growth in these plays. This year, it plans to allocate roughly $4 billion of its $10.5 billion capital budget toward its onshore U.S. operations, where it hopes to drill 800 wells in the Permian and 500 in the Central region.

Meanwhile, the company's international assets, which are located primarily in Egypt, the U.K. North Sea, Australia, and Argentina, will be used primarily for cash flow generation to fund domestic growth -- a sharp reversal from the company's strategy in previous years, which sought growth through expanding internationally.

Valuation remains attractive
Due to concerns about the company's exposure to Egypt, which I believe are likely overblown, Apache trades at just 3.8 times cash flow and 11.1 times forward earnings, significantly cheaper than the majority of its peers. It also trades at just a fraction of other Permian-focused producers, such as Concho Resources (NYSE: CXO  ) and Pioneer Natural Resources (NYSE: PXD  ) , which respectively trade at 24.7 times and 35.6 times forward earnings.

Furthermore, Apache is possibly the cheapest midmajor out there on an enterprise value to EBITDA basis. The company's EV/EBITDA ratio is just 3.5, roughly half the EV/EBITDA of peers Anadarko Petroleum (NYSE: CHK  ) and EOG Resources (NYSE: EOG  ) , and even lower than Devon Energy's (NYSE: DVN  ) EV/EBIDTA of roughly 5.5.

Foolish takeaway
As part of its global portfolio rebalancing strategy, Apache has been divesting slower-growth, noncore assets in order to raise cash for paying down debt, buying back shares, and funding its North American onshore liquids drilling programs. As a result, the company is left with a much more streamlined and balanced asset portfolio that features high-growth opportunities in the U.S. complemented by cash-generative assets abroad.

I believe the market is not giving enough credit to Apache's growth potential in the Permian and Central regions and remains overly skeptical of its exposure to Egypt -- two reasons why the company is trading at such a deep discount to its peers. Investors looking for a deeply undervalued E&P would do well to give Apache a second look.

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