Will Apache's New Strategy Pay Off?

Over the past couple of years, Apache (NYSE: APA  ) has significantly underperformed its peers and the broader market, with shares down about 25%, as compared to a more than 30% gain for the S&P 500 Index (SNPINDEX: ^GSPC  ) . Relatively weak production growth and concerns about the company's exposure to geopolitical risk in Egypt have been two of the main reasons behind the underperformance.

But Apache's new strategy of cutting costs and concentrating the bulk of its capital on its most profitable opportunities, while divesting riskier international assets, should lead to stronger, more profitable growth in the years ahead. Let's take a closer look.

Photo credit: Flickr/Paul Lowry.

Asset sales draw to a close
In order to pay down debt, return more cash to shareholders, and raise funds to focus on its onshore U.S. assets, Apache has sold off more than $7 billion of assets over the past year. Major transactions last year included the sale of its Gulf of Mexico shelf assets for $3.75 billion, its Canadian assets for $214 million, and a third of its Egyptian oil and gas assets to China's Sinopec (NYSE: SHI  ) for $3.1 billion.

But the company said on Wednesday that its recently announced sale of Argentinian assets to state-owned YPF (NYSE: YPF  ) for $800 million in cash essentially marked the end of its asset disposal program, as the company has accomplished what it set out to achieve with the strategy.

In addition to reducing Apache's exposure to geopolitical risk in Egypt and Argentina, asset sales have significantly improved its financial health and allowed it to return more cash to shareholders. The company reduced its debt by $2.6 billion last year and entered 2014 with $1.9 billion of cash on its balance sheet. It has also repurchased some $1.2 billion of its own shares thus far and raised its quarterly dividend by 25% to $0.25 per share this year.

Several of Apache's peers have also shed riskier international assets to focus on lower-risk, higher-return North American opportunities. ConocoPhillips (NYSE: COP  ) , for instance, has shed billions of dollars' worth of international assets to finance increased activity in the Bakken, Eagle Ford, and Permian Basin, while Occidental Petroleum (NYSE: OXY  ) is marketing a minority stake in its Middle East business as it zeroes in on the Permian Basin, its most profitable asset.

Greater focus on onshore U.S. assets
With asset sales out of the picture, Apache can now focus on its onshore U.S. assets, which feature relatively low development costs, strong rates of return, and highly visible, repeatable and predictable production growth. This year, the company plans to devote nearly two-thirds of its capital budget to its onshore U.S. drilling program, which is generating after-tax returns in excess of 30%.

These assets, mainly located in Texas' Permian Basin and Oklahoma's Anadarko Basin, drove 34% year-over-year growth in onshore North American liquids production last year, as Permian production surged 13% to a record 134,000 barrel of oil equivalent per day (boe/d), while Anadarko Basin volumes grew by 18% year over year to 93,000 boe/d.

Over the past few years, the company's North American portfolio has become a much larger share of its total production, currently accounting for about 60% of companywide production. That's up from just 34% in 2009. Further, since Permian and Anadarko Basin drilling is strongly weighted toward liquids, Apache's production mix has improved greatly and now consists of 58% liquids, up from 50% in 2009.

What's more is that Apache's onshore U.S. drilling program in still in relatively early stages of development. The company estimates that it has more than 60,000 remaining drilling locations across the Permian and Anadarko Basin, which represents decades worth of drilling inventory at current activity levels and gives the company a massive runway for continued growth.

The bottom line
Though Apache's asset sales have weighed on production, they have greatly improved its financial health and allowed it to focus on its most profitable opportunities in the U.S. As the company's Permian and Anadarko basin assets account for an even larger share of companywide production and earnings in the years ahead, cash flow growth should accelerate, allowing for continued dividend growth.

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