Is Anadarko Petroleum Overvalued?

During 2014, shares of Anadarko Petroleum (NYSE: APC  ) jumped by over 38%. Other oil and gas producers such as Chesapeake Energy (NYSE: CHK  ) and Devon Energy (NYSE: DVN  ) also rallied during the year, but they haven't done as well as Anadarko. What has driven Anadarko Petroleum's stock higher? And is the company's current valuation inflated? 

Beating expectations
The company exceeded its first-quarter guidance in terms of oil and natural gas output. This news contributed to the sharp rise in Anadarko Petroleum's stock. Moreover, oil and natural gas prices rallied during 2014 and are currently at a much higher level than in 2013. These elevated prices have pulled up shares of oil and gas producers such as Anadarko Petroleum, Devon Energy, and Chesapeake Energy. 

Besides the rise in prices and higher than anticipated output, the company's hedging system also increased its revenue. 

Higher realized prices
Anadarko is engaged in hedging against the fluctuations of the prices of oil and natural gas. As a result, it purchased futures and options contracts on oil and natural gas prices. These hedges led to gains of $1.5 billion in the first quarter of 2014. Moreover, based on the current market prices and the current hedges the company holds, it may have recorded additional gains in the second quarter, which may have further expanded its quarterly revenue. Nonetheless, the company's hedging system may also lead to a surge in financial losses, which could come to fruition in future quarters. 

Less natural gas, more oil
The company's decision to expand its oil operation and cut down its natural gas production is contributing to the company's rise in valuation. The table below shows the company's output in the past couple of years and its expected production in 2014. 

Data source: Anadarko Petroleum

As you can see, the company's natural gas production is expected to fall by 6% this year, while its oil and NGL production are projected to rise by 10% and 18%, respectively, year over year. 

In the first quarter, Anadarko Petroleum's oil output grew by 5%, year over year. Conversely, its natural gas production remained nearly unchanged. The company also expanded its NGL operations by 12.5% compared to the first quarter last year.

In comparison, during this year, Chesapeake Energy plans to increase its oil output by an average of 3% compared to 2013. Moreover, during the first quarter, oil accounted for 44% of its production sales. 

Anadarko Petroleum's oil operations accounted for 60% of its revenue. Therefore, the sharp rise in the price of oil had a stronger impact on Anadarko Petroleum's revenue compared to Chesapeake Energy. And since Anadarko Petroleum plans to expand its oil output at a faster pace than Chesapeake Energy, the rise in the price of oil will have a strong impact on Anadarko. 

This move could also be a double-edged sword, because natural gas made a comeback this year, and prices are currently higher than they were last year. Thus, in the coming quarters, the high prices of natural gas are likely to have a lower impact on Anadarko Petroleum's sales compared to Chesapeake Energy. 

Is the price right?
Anadarko Petroleum's current enterprise value to EBITDA ratio is 6.9. In comparison, Chesapeake Energy and Devon Energy have lower ratios of 5.61 and 5.65, respectively. Anadarko expected high growth in sales and a slightly lower debt burden could partly explain this premium. But even so, these factors aren't enough to explain the 23% gap between these valuations. 

Bottom line
Anadarko Petroleum has done better than its peers and is likely to show high growth in sales in the second quarter. But the company's current value is a bit high, which makes this stock less attractive as an investment.

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Lior Cohen

Lior has been a contributor for the Fool since 2012. His main interests are in commodities, and energy and materials companies.You can follow him on Twitter to stay up to date with his industry analysis. @tradingnrg

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