Apache Corporation Equity Valuation and...
Transcript of Apache Corporation Equity Valuation and...
1
Apache Corporation Equity Valuation and Analysis
Analyst Group
Dillon Blaine [email protected]
Rebecca Wood [email protected]
Ben Gergen [email protected]
Christopher Cotter [email protected]
Dustin Shimek [email protected]
2
Table of Contents
Executive Summary 5
Business & Industry Analysis 10
Five Forces Model 14
Rivalry among Existing Firms 15
Threat of Substitute Products 19
Threat of New Entrants 22
Bargaining Power of Buyers 26
Bargaining Power of Suppliers 27
Value Chain Analysis 29
Firm Competitive Advantage Analysis 32
Accounting Analysis 33
Key Accounting Policies 34
Potential Accounting Flexibility 39
Actual Accounting Strategy 41
Quality of Disclosure 42
Qualitative Analysis of Disclosure 42
Quantitative Analysis of Disclosure 44
Sales Manipulation Diagnostic 45
Expense Manipulation Diagnostic 50
3
Potential Red Flags 55
Coming Undone (Undo Accounting Distortions) 56
Financial Analyst, Forecast Financials, and Cost of Estimation 56
Financial Analysis 56
Liquidity Analysis 57
Profitability Analysis 66
Capital Structure Analysis 73
IGR/SGR Analysis 77
Financial Statement Forecasting 79
Analysis of Valuation 90
Method of Comparables 90
Cost of Equity 98
Cost of Debt 101
Weighted Average Cost of Capital 101
Intrinsic Valuation 102
Discount Dividend Model 102
Free Cash Flows Model 103
Residual Income Model 104
Abnormal Earnings Growth 106
Long Run Return on Equity Residual Model 108
Credit Analysis 110
Analyst Recommendation 111
4
Appendix 113
Liquidity Ratios 113
Profitability Ratios 114
Capital Structure Ratios 115
Method of Comparables 116
Regression Analysis 118
Discount Dividends Model 124
Free Cash Flow Model 125
Residual Income Model 126
Intrinsic Valuation Model 127
Abnormal Earnings Growth Model 128
Altman Z-Score 129
References 130
Executive Summary
Investment Recommendation: Overvalued, Sell (11/1/06)
5
APA- NYSE(11/1/06): $99.18 52 Week Range: $63.01-$107.73 Revenue: $8868.994M Market Capitalization: $32.72BShares Outstanding: 330.737M Percent Institutional Ownership: 82% Book Value per Share: $39.88 ROE: 18.60% ROA: 9.95% Cost of Capital Est. R2 Beta Ke Estimated: 3-month .19 1.6 4.01 6-month .19 1.6 4.22 2-year .19 1.6 4.03 5-year .19 1.59 4.22 7-year .19 .14 4.33 10-year .19 .14 4.52 Published Beta: .76 Kd(AT): 4.74% WACC(BT): 8.52% WACC(AT): 5.54%
Altman’s Z-Score: 2002 2003 2004 2005 2006 3.51 3.97 2.72 3.13 3.32 Valuation Estimates: Actual Price (11/1/06): $99.18 Financial Based Valuations: Trailing P/E: $82.02 Forward P/E: $93.41 P.E.G.: $59.88 P/B: $103.29 P/EBITDA: $75.65 P/FCF: N/A* EV/EBITDA: $97.24 Intrinsic Valuations: Discount Dividend: $6.62 Free Cash Flows: $126.84 Residual Income: $37.72 LR ROE: *N/A AEG: $19.23
*Irrelevant due to negative cash flows
http://moneycentral.msn.com http://moneycentral.msn.com
Industry Analysis
Apache was formed in 1954 in Minneapolis, Minnesota by Truman Anderson,
Raymond Plank, and Charles Arnao. They have grown to be one of the leading
independent oil and gas exploration companies in the United States. The company
6
currently has 24.3 billion in assets and sold 10.6 billion dollars worth of oil and gas in
2006. Apache currently has operations on 37.6 million acres in 6 different countries
around the globe.
Apache’s main competitors consist of Occidental Petroleum, Anadarko, XTO
Energy, and Devon Energy. They compete in a very competitive industry where
commodities are sold. This means the products they sell are virtually identical, making
price a deciding factor with their customers. In an industry with high entry barriers, it is
impossible to build a corporation with 24.3 billion in assets overnight. Brand name and
reputation are imperative in this industry since all products are identical.
The key success factors upon which firms compete are economies of scale,
successful exploration, tight cost controls, and retention of employees. These key
success factors are the building blocks to gaining market share, and maintaining
profitability and competitive advantages over their competitors. In an industry with low
product differentiation and almost zero substitute products, these key success factors
are all the more important to each company.
Accounting Analysis
Being successful in the oil and gas industry strongly relies on the key success
factors relating to key accounting policies. Accounting policies are important to
recognize due to the fact that managers are allowed flexibility under GAAP and can use
7
option to make financial statements appear more appealing than they really are.
Managers are motivated to do this because keeping shareholders around is important to
their jobs.
Apache, when thoroughly looking over their financial statements, showed a high
level of disclosure of their business practices and accounting policies. Any bit of
information was found in the company’s 10-K and annual report of various years with
small amounts of searching.
Apache included much information about their operating leases, the full amounts
owed and the discount rates used to value payments on the leases at future dates.
Discount rates for pension liabilities and other long term liabilities were also revealed.
Discount rates for these items are an area that flexibility is used a lot. However, when
reviewing and performing the accounting analysis, no outlying ratios and numbers
caught our eyes. Everything was pretty much with the industry norms. Overall, Apache
did a good job of making transparent financial statements that disclose information
desired by analysts and investors.
Financial Analysis, Forecast Financials, and Cost of Capital Estimation
There are many financial ratios that analysts use to dissect a company’s financial
statements so they are able to compare them to their competitors. These ratios look at
the firm’s liquidity, profitability, and capital structure. These ratios are used to forecast
8
out a firm’s financial statements so analysts can determine the value of a company, and
see the changes in the firm through time. Analysts also run a regression of the
company to determine a beta, cost of equity, cost of debt and a weighted average cost
of capital.
The liquidity ratios computed were the current ratio, quick asset ratio, inventory
turnover, receivables turnover, and working capital turnover ratios. The ratios
determine the firm’s ability to have enough near-cash assets to meet their debts and
obligations as fast as possible. These ratios show that Apache is in line with the
industry. The profitability ratios determine a company’s operating efficiency, asset
productivity, rate of return on assets, and rate of return on equity. Apache’s
profitability ratios show that Apache is, again, in line with the industry. The only
exception is the inventory turnover ratio, because not many of Oil Corporations in the
industry have inventory, so Apache is unusually high. Finally, the capital structure
ratios refer to the sources of financing used to acquire assets. This is shown by the
owner’s equity and liabilities sections of the balance sheet. All of Apache’s ratios are in
the same range as their competitors.
We then forecasted out Apache’s balance sheet, income statement, and
statement of cash flows for the next ten years. We forecasted using industry averages,
Apache’s past growth rates, and ratios. We took into consideration recent asset
acquisitions and natural disasters when forecasting so the future numbers were realistic
and reliable.
Valuations
Analysts have several tools when trying to value a company’s stock price per
share. Before using these tools, analysts must have a good understanding of the
company as well as its business environment. After completing an overall industry
9
analysis, accounting strategies, and determining key success factors of the company,
the analyst is familiar enough with the company to value it. The Method of
Comparables and the Intrinsic Valuation model are important in determining if a firm is
overvalued, overvalued, or fairly valued.
The method of comparables is a measure of a company’s stock price per share.
This model is unique because it is based on the competitors in the industry. The
industry average does not include the company you are valuing. This can potentially
create problems when trying to accurately value a stock. Under this model, many
assumptions such as all companies in the industry are the same size and they operate
in the same way. After the industry average is found, it is used in several calculations
to determine the stock price per share. From here, it is clear if a firm is overvalued,
undervalued, or fairly valued. Clearly, this model is not the most reliable or accurate
because of the assumptions it makes. According to this valuation model, Apache’s
stock price was overvalued based on all but two of the models. The Forwarding Price
to Earnings and Enterprise Value to EBITDA ratios reported Apache as having a stock
price as fairly valued. This should not be the only valuation measurement for a
company, due to the inconsistency of the model.
The Intrinsic Valuation model is a more complete and detailed form of valuing a
company’s stock price per share. In total there are five intrinsic valuation models that
focus on different areas of the company. The Discount Dividend model is not the most
reliable out of these valuations. Dividends must be forecasted out using a constant
growth rates. It is not likely that a company’s dividends will grow at a constant rate for
an indefinite period. According to this model, Apache’s stock price per share is
overvalued. The Free Cash Flow model is another valuation that is not always accurate.
This model basis its valuations off of forecasted cash flows from operations and cash
flows from investing. The result of this valuation was that Apache’s stock price per
share was overvalued. Next, the Residual Income valuation is the most reliable
because the overall value of the firm includes a high percentage of the present value of
residual income. Based on this model, again, Apache’s stock price per share is highly
10
overvalued. Apache’s stock price valued using the Abnormal Growth Model and the
Long Run Residual Income model was overvalued. Therefore, the valuation models
support that Apache’s stock is overvalued.
Business & Industry Analysis
Overview of Firm
Apache Corporation is an independent oil and gas company that was created in
1954. The company’s interest is in exploration and production of crude oil, natural gas,
and natural gas liquids. Apache is one of the largest independent oil and gas companies
in the nation and has operations in six countries including the United States, Canada,
Egypt, Australia, Argentina, and the United Kingdom. Apache has a variety of
operations ongoing on and offshore in these countries. The company went public in
1969 and its shares were first listed on the New York Stock Exchange under the symbol
APA. Apache Corporation is headquartered in Houston, Texas.
Apache operates in an industry where acquisitions of property from other
exploration companies are the norm in the way of purchasing prospects for drilling and
exploration. Seldom is land acquired that is undeveloped or not yet been looked over by
other firms. Apache acquires prospective properties through buying other larger firms’
drilling interests and by bidding for offshore blocks of water from governments. These
bids and purchases of other firm’s drilling rights initiate much competitiveness
throughout the industry. Consequently, firms with more capital to work with generally
have a better chance of acquiring lands and deepwater blocks. Apache competes with
vast numbers of companies that have more capital and resources to work with. In
recent times, many major integrated oil companies have focused more on exploration
worldwide instead of just on their home turf. This has left many opportunities for
acquisitions for smaller independent oil and gas companies. “There are about 5000
independent oil and natural gas producers in the U.S. Independents drill 90 percent of
11
the wells in the U.S. and produce 68 percent of America’s oil and 82 percent of
domestic natural gas” (www.ipaa.org). Apache distributes its crude oil to larger
integrated oil companies, refineries, and other purchasers. Natural gas products are
sold to Local Distribution Companies, integrated oil companies, utilities, and certain end
users. Apache focuses on distributing to markets that are most economically feasible for
them to supply because they will bring the most revenue. Oil and natural gas are
commodities and that causes buyers of this industry’s product to always search for the
cheapest product. Therefore, one of Apache’s main objectives is to maintain efficient and
low cost production. Apache, like the industry, depends heavily on the current price of oil and
gas for profits. Being commodities, oil and gas are subject to severe price volatility. This has
lead firms in the industry to engage in hedging activities to protect themselves against price
fluctuations, and also exchange rate risks when converting foreign money back to U.S. dollars.
Being smart about hedging is very important to Apache because it can make the difference
between losing money and/or missing out on additional profits. From the tables below, it is
noticeable that Apache’s revenues and assets rose substantially in the past few years while the
company kept its production of oil and gas at relatively the same level. This represents how
dependent Apache and the industry’s profits are upon fluctuating prices worldwide.
Apache Corporation Annual Revenues
2002 2003 2004 2005 2006
$2,560 Million $4,190 Million $5,333 Million $7,584 Million $8,289 Million
Apache Corporation Total Assets
2002 2003 2004 2005 2006
12
$9,460 M $12,416 M $15,502 M $19,272 M $24,308 M
Apache Oil and Gas Produced Daily Worldwide (avg.)
2004 2005 2006
Oil 231,519 barrels 234,070 barrels 224,577 barrels
Natural Gas 1,235,108 Mcf 1,263,823 Mcf 1,589,065 Mcf
In the past 5 years, Apache, along with the industry, has grown significantly due
to elevated global oil prices. High prices mean larger profit margins, and this has given
many companies the capital and additional boost to explore in more places and indulge
in more high-risk/high-return ventures.
Since 2002, the company has made many acquisitions in several different
countries, adding to their assets and assisting revenues. In 2003, Apache acquired the
Forties Field from British Petroleum for $630 million. The Forties Field is one of Apache’s
largest assets and continues to be a top producer of oil in the world. Also in 2003, a
natural gas well discovered in Egypt proved to be the largest discovery in the
company’s history. In 2003 and 2004, several large acquisitions in the Gulf of Mexico
from BP, Anadarko, and Shell Oil provided oil producing properties, facilities, and
prospects. In 2004 and 2005, Apache signed two separate farm-in agreements with
Exxon-Mobil totaling over 1 million acres of promising, undeveloped land in Alberta,
Canada. Apache has acquired many lands in Egypt on and offshore in the past few
years producing $1.66 billion in revenue, accounting for nearly half of the company’s
international revenue. (2006 Apache 10-K)
The company also tries to strategize by not only acquiring new prospects, but by
selling off current properties and land interests that produce that the company feels the
13
proceeds from would benefit the company more elsewhere. These sell offs, known as
divestitures, occur often and become acquisitions of other firms in the industry.
http://moneycentral.msn.com
Since September of 2002, Apache’s stock has risen significantly to a price of
$83.19 in September 2007 from an adjusted split price of around $28 per share
accounting for 2 stock splits in those five years. The industry on average is doing just
as well and some of Apache’s immediate competitors’ stock performances have done
reasonably better. This could partially be due to Apache having a smaller market
capitalization than some industry competitors such as Devon Energy and Occidental
Petroleum, and therefore less capital and funds to work with in competing for drilling
and exploration rights.
Other competitors have a slightly smaller market capitalization, an example being XTO
Energy, and the stock is outperforming Apache’s. Anadarko Petroleum Company is a
competitor whose market capitalization is slightly smaller than Apache’s and their stock
14
has been running right below Apache’s. Occidental has a market cap of $50.77 billion,
Devon with $35.48 billion, Anadarko with $23.7 billion, and XTO Energy with $23.37
billion. Each company’s reserves also play a big role in adding value to the company
and influencing the stock price. Reserves are an asset that has a value that is always
subject to change. A change in the price of oil will cause an asset change and affect
future cash flows to the company. Competition in oil and gas is very strong.
Understanding the nature of this industry and the way in which Apache operates is
crucial to being able to evaluate and value Apache in this analysis.
Five Forces Model
Porter’s Five Forces model is a business tool used to assess the competitiveness
and value drivers in any given industry. The model gives outside analysts the ability to
analyze the industries that certain companies operate in and therefore can better
understand significant market share builders. The five forces used to analyze any
industry are rivalry among existing firms, the threat of new entrants, the threat of
substitute products, the bargaining power of suppliers, and the bargaining power of
customers. Each aspect of the model differs from one industry to the next and will
affect the industries in varying degrees. Understanding the degree of competition in a
given industry is imperative when analyzing how effective a company is at operating in
the industry.
Oil and Gas Industry
15
Rivalry Among Existing Firms High
Threat of New Entrants Low
Threat of Substitute Products Moderate
Bargaining Power of Buyers Low
Bargaining Power of Suppliers Low
Rivalry among Existing Firms
The independent oil and natural gas production and exploration industry
operates in a highly competitive environment. Many factors affect the degree that
companies are forced to compete within the industry. These factors include the industry
growth rate, concentration and balance of competitors, switching costs, differentiation,
excess capacity, and exit barriers. Each company must confront these factors in order
to stay competitive and profitable in the market. The companies that are able to deal
with these factors effectively will have the best chance of success.
Industry Growth Rate
Oil and natural gas production growth began to slow over the past two years. In
2006 the world produced only 0.04% more oil than it had in 2005. This decline can be
attributed to the discovery of most of the conventional sources of oil. The relative
stagnant growth in the industry will force companies in the industry to compete more
aggressively for the remaining known oil reserves. As the discovery of “easy” oil begins
to decline companies in the industry will be forced to compete to find sources of oil
which are considered unconventional, such as heavy crude oil, tar sands, and oil shale.
16
The cost associated with producing oil from such sources is substantially higher than
production of conventional sources. Also, as production growth begins to slow the
market price of oil and natural gas rises. This increase in price increases the cost of
acquiring new properties for the production of these resources.
World Oil Production
17
Concentration and Balance of Competitors
The level of concentration in the industry has risen over the past few years as
major integrated companies such as Exxon and Mobil have merged. The increase in
concentration gives larger companies the ability to set and enforce the rules of
competition. It also gives the leaders more of an opportunity to influence worldwide
prices which are set by the market. The leaders in the industry have access to much
larger financial and other resources which puts them at a comparable advantage to the
rest of the industry. The advantaged leaders have made it more difficult for the rest of
the industry to acquire drilling rights and land especially in countries where they have
established strong relationships with the government. These events have made it much
more difficult for the independent companies in the industry to compete directly with
the major integrated companies. Yet, independents drill 90 percent of our nation’s
wells, produce 68 percent of the United States’ oil and 82 percent of America's natural
gas. (Independent Petroleum Association of America, ipaa.com)
Differentiation
18
Differentiation in the oil and natural gas production and exploration industry does
not exist. All companies in the market are producing the same commodities, crude oil
and natural gas. The difference comes from how efficient a company is at producing
these resources. The costs incurred by buyers when switching suppliers is low in the oil
and gas industry. This is directly affected by the fact that oil and natural gas prices are
set by the world markets.
Excess Capacity and Exit Barriers
The world demand for oil and natural gas is very high and is expected to
increase in the future. World oil consumption increased by more than 817,000 barrels
from 2005 to 2006. From the graph below we can see that the Energy Information
Administration forecasts show that the demand for oil will continue to grow at a steady
pace for the near future. Since there is such a high demand on oil exiting such a
profitable industry should not be very difficult. If a company wanted to leave the
industry they should be able to sell their assets to competing firms or private investors.
Competing firms in the industry are always looking to buy oil reserves and rights from
known sources currently held by other companies.
19
Threat of Substitute Products
The threat of substitute products in the oil industry has only become a problem in
recent years. Since gas prices are a necessity and also very expensive, a substitute
seems ideal. Potential substitutes include ethanol fuel, solar powered vehicles, electric
powered vehicles, and hybrid vehicles. The most direct substitute for gasoline is
ethanol fuel. Though technology has not yet perfected its uses, in the future, the oil
industry will have a potentially large threat of substitution. The other substitutes are
only available to replace gasoline in cars. Technology has not developed energy
storage as a use of power for larger machinery, such as planes or semi-trucks. This has
an effect on the oil industry, but not enough to cause permanent harm.
Buyers Willingness to Switch
With the constant rise of gasoline prices, drivers often hope for a cheaper
substitution. The current substitutions for gasoline are not perfected and not practical.
Ethanol appears to be a great substitute for the high gas prices customers’ deal with
everyday. The reason ethanol is not a huge threat to oil companies is because of its
major drawbacks. In order for a car to run on pure ethanol fuel (E100), a new engine
is required. Also, in order for an engine using ethanol to produce the same amount of
energy as an engine using gasoline, the engine would require a substantially larger
amount of ethanol than gasoline. Another drawback to using ethanol instead of
gasoline is, depending on where you are located, it is hard to find. “Because E85 is
primarily sold in the upper Midwest, most drivers in the country have no access to the
fuel, even if they want it” (www.ConsumerReports.org). This does not allow drivers in
certain areas to even have the option of switching.
A substitution for gasoline that is only available for cars is solar power. “A solar
car is an electric vehicle powered by solar energy obtained from solar panels on the
surface of the car” (www.Wikipedia.com). Technology has not developed far enough
for the use of solar cars to be practical for daily use. In order for a solar car to meet
the safety standards and comfort level of standard gasoline powered cars, it would
20
require the vehicles to be much heavier and larger than standard solar powered cars to
reach the same speeds. Technology has not yet perfected the use of solar power to
run cars efficiently and effectively. This is why solar powered cars might become a
potentially large threat of substitution of gasoline, but currently is only a small portion
of the oil business that will be taken away.
Another substitution for gasoline only available for cars is electricity. “The electric
car, EV, or simply electric vehicle is a battery electric vehicle (BEV) that utilizes chemical
energy stored in rechargeable battery packs. Electric vehicles use electric motors and
motor controllers instead of internal combustion engines” (www.Wikipedia.com). The
electric car has many benefits, such as it is more energy efficient, gives off less
pollution, and is quieter than conventional gasoline powered vehicles. Although electric
powered cars may seem more beneficial, there are drawbacks as well. Some problems
include, “high battery costs, limited travel distance between battery recharging,
charging time, and battery lifespan, which have limited widespread adoption”
(www.Wikipedia.com). Also, “ownership costs for battery electric cars are higher than
for their petrol or diesel equivalents, primarily because their purchase price is higher to
begin with. Typically for a new car, or a small van, the price is increased by up to 80%”
(www.Wikipedia.com). While electric cars have benefits and could potentially replace
gasoline powered cars, the likelihood of the entire driving population to purchase an
entirely new vehicle is not foreseeable, and as of now does, not post a large threat to
the oil industry.
The hybrid vehicle is partially a substitution for gasoline, because it is still required to
use a smaller amount to power a car. “A hybrid vehicle (HV) is a vehicle that uses two
or more distinct power sources to propel the vehicle” (www.Wikipedia.com). These
power sources include gasoline and stored energy, such as solar power, or battery
power. The threat of substitution with hybrid vehicles is existent, but not threatening
to the oil industry. Although hybrid vehicles significantly cut down on the use of
gasoline, gasoline is still used. Hybrid vehicles would only become a large threat if the
entire driving population purchased hybrid vehicles, which due to their high cost is not
21
likely to happen.
Relative Price and Performance
The performance of gasoline and ethanol fuel is relatively the same, although the
prices of gasoline and ethanol fuel are not. Ethanol fuel is much more expensive than
current gasoline prices. “With the retail pump price of E85 averaging $2.91 per gallon
in August, according to the Oil Price Information Service, which tracks petroleum and
other fuel prices, a 27 percent fuel-economy penalty means drivers would have paid an
average of $3.99 for the energy equivalent of a gallon of gasoline”
(www.ConsumerReports.org). Also, ethanol fuel requires a different kind of engine
than standard cars already have, which is another required expense.
The performance of gasoline and solar power are only interchangeable when it
comes to cars. Solar powered cars can be a direct substitution of gasoline powered
cars, but require extra money and effort. The drawbacks to solar powered vehicles
have not been corrected and also cost a lot more money than filling up a tank on a
standard gasoline powered car. The relative performance of solar cars can be
compared to gasoline powered cars, but cannot directly be switched without extra
investments. Prices of solar power and gasoline are also substantially different,
because a new vehicle is required in order to run solely on solar power.
Similarly to solar power, using electricity as a substitute for gasoline can only be
used for small vehicles. There is really no price similarity between gasoline and
electricity because to be able to switch to electricity, a new car is required. The
performance of electricity compared to gasoline has many drawbacks as well.
Finally, a hybrid vehicle reduces the amount of gasoline required, but does not
completely replace it. The performance of a hybrid car can be compared to the
performance of a gasoline powered car, but cannot be compared in price. Hybrid cars
22
are much more expensive than standard gasoline powered cars, so they cannot directly
substitute it; just minimize the amount of gasoline required.
Conclusion
Although there are potentially many threats of substitution of gasoline, the
likelihood of being able to completely stop using gasoline is slim to none. The
substitutes are too expensive and not easily accessible to the entire driving population.
Also, technology has not yet perfected the uses of substitute products for day to day
use. Currently, the oil industry is not posed with a major threat of substitution. Some
day, when technology has developed these gasoline alternatives more, the threat will
become very great and the oil industry will greatly suffer. Fortunately that day is far
into the future and the only readily available, accessible, and affordable fuel is
gasoline.
Threat of New Entrants
The oil and gas industry is comprised of a handful of large corporations as well
as several smaller, more competitive firms. The large oil and gas corporations have
found ways to stay on the cutting edge of new technology which enables them to
produce oil and gas more efficiently. Newer and smaller firms entering the market will
have several obstacles to overcome because they have considerably less market share
and initial capital. For example, Apache oil Corporation has been operation for 54 years
and has the experience and knowledge necessary to remain a dominate player in the oil
and gas industry. A few of the hurdles that new competitors might face include
economies of scale, establishing relationships with customers, and legal barriers to
name a few. New firm survival is not likely in this industry due to several dominate
companies already in existence.
23
Economies of Scale
New firms that generate enough start up capital to enter the industry still face
many challenges. The survival of these firms is still minimal because of major
corporations’ ability to purchase large quantities of resources and land at one particular
time. This leaves the smaller firms to fend for themselves which in many cases leads to
their extinction. Another reason many new firms cannot survive the industry is because
existing corporations have established often exclusive relationships with long time
clients and distributors. Another key factor in the oil and gas industry is a firm’s
location, because it has a direct impact on the quality and quantity of resources
acquired. “The oil and gas industry is highly competitive. As an independent oil and
gas company, the Company frequently competes for reserve acquisitions, exploration
leases, licenses, concessions and marketing agreements against companies having
substantially larger financial and other resources than the Company possesses. To the
extent the Company's capital budget is lower than that of certain of its competitors, the
Company may be disadvantaged in effectively competing for certain reserves, leases,
license, and concession” (www.secinfo.com/dsvRu.9266.htm). Also, competitive pricing
among established firms is almost impossible for new firms to compete.
The factors listed above give existing firms a clear cut advantage in the
industry. It has been proven in the oil and gas industry that larger, more dominate
firms have an advantage. The chart below shows some of the leading oil and gas
exploration companies and their total assets per year. “A market dominated by a few
large corporations, such as the oil refining market, can be particularly difficult for small
companies to enter. It can be difficult because larger companies benefit from
economies of scale and can conduct such a competitive pricing policy that it is
impossible for a new entrant to make a profit” (www.encyclopedia.farlex.com). In the
chart below, it demonstrates how volatile oil companies’ assets are as a result of
fluctuating oil prices. In recent years, many of these companies’ total assets have more
than tripled, not being necessarily due to an increase in quantity of assets, but value of
assets. Total assets in this industry are often difficult to correctly value because most
24
of a company’s long term assets are reserves. The reserves are estimated by outside
private companies as to the total amount of oil in each reservoir that is able to be
extracted in the future. Because there are millions of acres of reserves and the price is
constantly changing, often total assets are grossly over or understated.
Total Assets
2002 2003 2004 2005 2006
Apache Oil Corporation 9,459 12,416 15,502 19,272 24,308
Anadarko Petroleum
Corporation
18,248 20,546 20,192 22,588 58,844
Devon Energy 16,225 27,162 30,025 30,273 35,063
Occidental Petroleum
Corporation
16,548 18,168 21,391 26,108 32,355
XTO Energy 1,118 1,252 2,043 9,857 12,885
*in millions
Distribution Access and Supplier Relationships
One of the biggest problems facing relatively new firms entering the oil and
gas industry is loyalty among customers. Large firms in this industry have established
relationships with customers. Keeping customers satisfied is a major consideration of
large companies. Customer base is difficult to establish and often contracts are drawn
to insure customer loyalty. Both the oil company and the customer use this to their
advantage when it comes to distribution and supplier terms and conditions. Since,
Apache Oil Corporation is the supplier to many firms there is no direct supplier
relationship between Apache Oil Corporation and any other firm. However, Apache Oil
Corporation and other firms must establish and maintain relationships with distributors.
25
“Apache Corporation sells its natural gas to local distribution companies, utilities, end-
users, integrated major oil and gas companies, and marketers; and crude oil to
integrated oil companies, purchasers, transporters, and
refiners”(www.investing.businessweek.com). So, a good relationship with distributors is
a invaluable tool when it comes to the success of a firm.
Legal Barriers
The oil exploration industry has many barriers for entry. New or existing
corporations must gain approval from many agencies, including regulation from state
and federal governments. In order to begin the often lengthy exploration process
drilling must be regulated by state and federal environmental laws. When looking for
new exploration sites, firms can often receive criticism from groups like the Energy and
Natural Resources Committee, which is extremely influential. Obstacles such as this can
completely halt all operations of a firm. Firms can also face opposition from
conversationalists who fight against the negative effects oil and oil spills can have on
the environment. Drilling in Alaska has been a hot topic for some time now.
Established exploration companies have faced harsh criticism among opponents of oil
exploration in the western Artic Ocean. “Climate change, caused by burning oil, coal
and gas, is causing the western Arctic to warm three times faster than any other part of
the globe. The survival of many species; such as polar bears, walrus, and reindeer, is
currently threatened by retreating ice and unseasonably warm weather”
(www.cnn.com). Firms who wish to get out of the oil and gas industry face little
barriers to exit. They simply sell their equipment and supplies to another firm wishing
to acquire more assets. However, oil and gas exploration is a global effort, so firms
must keep in mind international laws and regulations.
Conclusion
The oil and gas exploration industry is highly competitive. This makes it
extremely difficult for new firms to enter the industry and be successful. In order to
enjoy economies of scale, firms must properly manage their resources and other assets.
Relationships with distributors are also a key factor in keeping or establishing a
26
successful firm. There are many legal barriers to entry such as state and federal
environmental laws, and resistance from conversationalists groups. These factors make
new entry extremely hard, and most of the time the attempts to enter are not
successful.
Bargaining Power of Buyers
In the oil industry, consumers do not have much say. The only bargaining power
that consumers have is if the product is not necessary to their daily lives, or if
consumers have the power to force the price down. Nearly everyone in the United
Stated needs oil and the prices are predetermined, so US consumers are forced to live
with the standards the oil industry set.
Price Sensitivity
Price sensitivity results from the customers’ willingness to negotiate on price.
The majority of people in the United States are drivers. “Overall, there were an
estimated 243,023,485 registered passenger vehicles in the United States according to
a 2004 DOT study” (www.Wikipedia.com). Because most of the US population does
drive a car, gasoline is a commodity. In a commodity market, the only possibility of
straying away from that commodity is to switch. The likelihood for drivers to spend
extra funds to change to a gasoline alternative is very small, because the extra funds
necessary are very large.
Relative Bargaining Power
Relative bargaining power is the success that a consumer can achieve when
trying to force the price down. In the oil industry, consumers do not have the
advantage of relative bargaining power because the price of oil is preset. Gas prices are
“determined largely by the Organization of Petroleum Exporting Countries, or OPEC.
The amount of crude oil produced by OPEC determines the price of a barrel of oil”
(www.cnn.com). Relative bargaining power depends on the cost of not doing business
with the other party. Since oil is a commodity and the majority of US citizen cannot live
27
without it, there is no option of not doing business with the oil industry. In 2004, the
total crude oil and petroleum products sold in the United States were 7,587,601,000
barrels. The likelihood for all consumers of oil products to put in extra funds and switch
is not expected.
Conclusion
Although US consumers would be much happier given the power to refuse to buy
gasoline or to force the prices down, the probability of that happening is slim to none.
The oil industry has a strong grip on consumers because oil is a commodity. Until the
day oil is no longer market determined in the US economy, the market will continue to
sell and set the price of oil.
Bargaining Power of Suppliers
The amount of bargaining power suppliers have can have a huge impact on the
market as a whole. Bargaining power is where the firm has the ability to set prices.
The oil and gas industry is unique in the since that there is no close substitute for their
product. In an industry with low bargaining power, the firm has little to no say when it
comes to setting prices for the market. The firm also has no bargaining power when it
comes to the terms and conditions set by suppliers. In contrast, a firm in an industry
with high bargaining power has more control over price setting in that particular
market. Firms are also in control of terms and conditions because the supplier wants to
create and maintain a long relationship with the firm. For example, firms in the oil and
gas industry have low bargaining power since each firm is extracting the same product.
However, in an industry with a lot of competition, such as the oil and gas industry, no
one firm can set the market price.
In the oil and gas exploration industry, the oil and gas companies are the
actual suppliers. Since oil does not have a direct substitute, the companies in this
28
industry have a lot of power, even though their bargaining power is low. The
companies in the industry may have a lot of power, but since there is so much
competition the firms must keep their prices, term and conditions, etc. similar to their
competitors.
Price Sensitivity
One of the most important aspects to consider when choosing a supplier is
price. Firms mainly compete on low cost and quality, making suppliers who can meet
those demands stand out among the rest. The degree of switching power among firms
varies based on their sensitivity to price. In an industry with low switching costs, firms
have little or no bargaining power. This is because firms are able to switch suppliers
frequently to find the lowest price and best quality. In this type of industry, there is no
customer loyalty which makes developing relationships with suppliers difficult.
However, in an industry with high switching costs, firms stay with suppliers due to the
high cost of switching. In this industry, customer loyalty and relationships with
suppliers are formed. Given that the oil and gas industry is so competitive, and each
firm is creating basically the same product, switching costs are rather low. A firm is
able to find the same product from any of the other firms within the oil and gas
industry.
Relative Bargaining Power
Relative bargaining power is what sets one product apart from another. If a
product is extremely unique and there are no close substitutes, then that firm has a
high level of relative bargaining power. If a product has many close substitutes, then
that firm has little to no relative bargaining power.
The companies in the oil and gas industry extract the same product and there
is little differentiation among firms. This means, suppliers in this industry have a low
amount of relative bargaining power. Competitors in the industry such as Anadarko
Petroleum Corporation, Devon Energy, Occidental Petroleum Corporation, and XTO
Energy all extract and supply the same product. For example, when a customer wants
29
oil or gas and contacts Anadarko Petroleum Corporation, if they are not satisfied with
the price or service, they can easily switch to Apache Oil Corporation and receive the
same product.
The oil and gas industry is not an industry that competes based on
differentiation. The industry competes with other firms on the basis of price and
availability of resources. Firms in the industry are always looking to expand and acquire
new land for exploration. This is where the competition is found in this particular
industry, not on differentiation of products.
Conclusion
Bargaining power of suppliers in the industry can have a huge effect not only
on customers, but on the market as a whole. Firms in the oil and gas industry have low
bargaining power because all the firms are extracting the same resource. Price
sensitivity is a major factor when a customer selects an initial supplier. Firms in the oil
and gas industry compete mainly on low price. Switching costs are relatively low,
considering competitors produce products that are the same. Firms in this industry try
and differentiate themselves by acquiring more land and reserves. For example, a firm
that is drilling in several parts of the world is going to be more powerful than a firm that
is concentrated in only one region. Most of the suppliers in this industry can supply the
same product. This is why the overall bargaining power of suppliers is considerably
low, even though there is no close substitute for oil.
Creating value in the Oil and Natural Gas Industry
In order to gain value and market share in the oil and natural gas industry there
are a few important qualities or in some cases imperfections in an organization’s
corporate strategy which can have a big effect on the company’s value and long term
success. Like most corporations in the industry, Apache’s mission is to “profit from our
growing business that unites our (Apache’s) employees, partners, suppliers and
30
shareholders in the fulfillment of our long term mission” (www.api.org). In common
terms the goal is to increase profit and shareholder wealth. Creating value in this
industry relies on exploration, transportation costs, mergers/acquisitions, and complying
with the ever changing global environmental regulations to combat global warming.
This industry is one with low bargaining power as there is no current substitute
for oil and gas and as a result no one firm in the industry can set and establish the
market price. What this creates is a rush by all the competing firms to most effectively
manage the costs of exploration, licensing, and complying with environmental
regulations in order to get the product to the customers at a cheaper price. In this
industry the costs of switching from one supplier to the next are non-existent. What
Apache has, Devon Energy (a main competitor), can supply at a cheaper price of
pennies to the dollar and as a result force Apache to either lower prices or lose
customers and the millions of dollars that come with it.
While the U.S. is the 2nd largest oil producer in the world, it is no longer able to
supply its own needs for crude oil. What this means to the industry is that the key to
gaining value and market share is to find the large oil reservoirs. After a firm spends
money on exploring and finding the reservoirs they need to determine who owns the
mineral rights to the reserves. If privately owned, these reserves are acquired by a
lump sum of money and in most cases a percentage of the royalties from the gas or oil
pumped from the reserve. In the US, if mineral rights are owned by the federal
government, they are put on the auction block and sold to the highest bidder. A key
component of this system is that these auctions involved sealed envelopes with each
companies bid. After opening all of the bids, the government gives the reserves to the
highest bidder. This can make it very hard for an emerging corporation to gain market
share as companies with already established markets can outbid and increase their
reserves.
Unlike companies that are integrated refiners, a corporation that owns both a
refinery and a branded presence in the gasoline retail market (Exxon, Shell, BP),
31
Apache and its competitors have the most risk due to the vast majority of their revenue
coming from acquiring, drilling, and refining. These non-integrated refiners ultimate
desire is to get its product to market, “from the refinery, through a pipeline, or other
method of transportation, to a terminal, via truck to a station, and then sold to a
customer” (www.api.org). As a result the incentives are clear for the companies, the
more efficient the distribution, the lower the end cost of gasoline distribution.
Apart from lowering the end costs of distribution, marketing and managing a
companies brand name is also very important in gaining value in the industry. “In
economic terms, the value of a brand is represented by the amount consumers are
willing to pay producers for an implicit promise of value. The promise of value deals
with goods whose quality is not obvious upon inspection. The branding of a product
also implies product consistency—that the product will have the same quality each and
every time it is purchased by a consumer” (www.api.org). Establishing a respected
brand name in the industry creates almost as much value as the competition for
reserves. To establish a brand you have to sell quality services and substances for an
extended period of time which builds a positive reputation in the consumers mind. This
makes it difficult for other firms to try and enter this market. Furthermore it makes it
more expensive to advertise against competitors and establish the most trusted brand
name in the industry.
Conc lus ion
As this is a highly competitive industry with very little bargaining power, gaining
value and maintaining and expanding market share are even more important. The
corporate strategies which create value and competitive advantages are in advertising
and maintaining brand reputation. Also it is very important to find reservoirs before the
competitors and be able to afford the high level of risk involved in drilling and
exploration. Lastly the most important factor in value creation which creates the
greatest competitive advantage is to go from reserve to the end consumer most
efficiently and as a result be able to provide the cheapest product on the market.
32
Firm Competitive Advantage Analysis
Since 1954, the goal of Apache Oil Corporation has been to acquire resources
and get the most out of remaining reserves. For example, in 2006, Apache Oil took
over Exxon’s shares of the North Sea, which is 20% of the known Mineral licenses of
the United Kingdom. In the past, it has been difficult for Apache to acquire lands
because the industry was primarily dominated by major integrated oil companies. They
made a successful move in 1980, by engaging in a joint venture with Shell Oil Company
in the Gulf of Mexico. This got their foot in the door and helped establish their
credibility among the industry. In the years following, the major companies began to
leave the United States in search of international success. Independent oil companies
began acquiring major oil companies’ U.S. assets. Presently, Apache Oil Corporation is
the largest held by production lease holder, and fourth largest producer on the off
shore continental Shelf in the Gulf of Mexico. Apache has also made several key
acquisitions world wide in countries such as Egypt, Canada, The North Sea, United
States, and Argentina. Apache is known for their ability to acquire lands, and this is a
definite competitive advantage over competing firms. As long as they continue this
trend, they should be successful in the future.
Proven acquisitions are coupled with Apache’s ability to successfully find
promising prospects. For example, in 2006, 87% of new wells drilled were producers.
Apache does a good job of exploration by hiring exceptionally skilled geologists and
petroleum engineers. They maintain employee retention by paying competitive salaries.
Employee retention is important because of the diminishing number of qualified
employees in the industry. For the past 21 years, Apache’s reserves have been steadily
increasing, creating a need for more qualified employees.
Since Apache went public in 1969, stock prices have increased and split multiple
times. This is a reflection of the company’s reputation as well as its success. In an
industry where you can not tell one product from another, brand name is vital to a
33
companies continued success. Apache established their name years ago, and has
continued to maintain it through normal operations. Their reputable name will continue
to ensure their future sales to customers.
Accounting Analysis
Shareholders and investors rely on a company’s financial statements to give
them a more in-depth look into the company. Financial statements are important in
determining the value of a company. They are beneficial in identifying problems within
the company and identifying areas of improvement. The information contained in the
income statement, balance sheet, and statement of cash flows helps investors
determine whether or not to invest in the company. Generally Accepted Accounting
Policies (GAAP) are the standards of accounting in the United States. These standards
make comparing financial statements more efficient due to the consistency GAAP
creates. However, GAAP allows choice, or more than one way in reporting of the same
transaction. GAAP allows for firms to disclose their true economic circumstances rather
than a strict universal code of reporting. Because of GAAP’s flexibility, accounting
analysts need to be conservative when determining the value of a company because it
can result in overstating and/or understating account balances. Management is given
the responsibility of using their own judgment when it comes to the valuation of their
company. This can potentially lead to overestimations to make the company and
themselves look better. One job of financial analysts is to correct management’s over
or underestimation of business valuations. Shareholders and investors rely on
accounting analysts to determine the true value of the business.
Accounting analysis evaluates the quality of the firm’s accounting. The first step
in the accounting analysis is to identify principal accounting policies. This step is crucial
because it measures critical factors and risks. The second step is assessing accounting
flexibility. Not every firm has the same accounting flexibility because of conventions
and accounting standards. Because GAAP allows for some flexibility, the third step is to
evaluate the accounting strategy implemented under GAAP by the firm. Managers with
34
accounting flexibility have the ability to disclose as much or as little information as they
would like. This can be problematic because managers can abuse this privilege by
hiding the firm’s true performance. The next step is to evaluate the quality of
disclosure. Due to the power that managers hold when it comes to releasing
information, this step focuses on the quality of information released. The fifth step is to
identify potential red flags. This step is implemented when unexplained or odd
accounting entries are made in financial statements. The analyst should examine these
entries extremely closely. The last step is to undo accounting distortions. In the event
that the firm’s numbers in the financial statements are deceptive, it is the analyst’s job
to correct these numbers to the best of their ability.
Key Accounting Policies
When deciding a company’s key accounting policies to use, it is important to
base these off of the key success factors of the firm. The key success factors of
Apache are economies of scale, industry growth and importance of product, derivative
instruments and hedging activities. Competition in the oil exploration industry is high
because it is basically impossible to differentiate their product. Companies in the oil
industry try to achieve a competitive advantage through price and quality of product.
By maintaining low costs, Apache achieves its biggest competitive advantage. GAAP
allows flexibility as far as the information that managers can disclose, leaving room for
misleading information being disclosed to shareholders and investors. This limited
disclosure can make a company more appealing to these shareholders and investors
and therefore lead to higher profit and overstated net income.
Constant Growth
Cash flow from operating activities increased but was offset by higher production
costs due to increasing commodity prices, as well as Hurricanes Katrina and Rita, and
increasing exchange rates with Canada. Fluctuating commodity prices are very
common and are historically the primary reason for short-term changes in cash flow
from operating activities. Sales volume changes also pose an effect to short-term cash
35
flow, but are obviously not as volatile as the fluctuating commodity price. “Apache’s
long term cash flow from operating activities is not only dependent on commodity
prices, but on reserve replacement and the level of costs and expenses required for
continued operations. (Apache’s 10-K, March 1, 2007)”
Constant growth relates to Apache’s first key success factor, economies of scale,
which in layman’s terms means as the firm increases its scale of operations, long run
costs per unit decline. By using the full cost method and therefore overstating yearly
net income, it not only increases outside investment, but allows for the products costs
to remain lower. This in turn keeps Apache competitive with the competition which
helps ensure not only higher profitability in the future, but also a firm hold on their
current market share with room to expand operations.
By expanding operations at their current rate, the company is maximizing the
benefits that come with economies of scale. Internal costs from years 2004-2006 have
been capitalized in order to extend the costs over a longer period of time. “Apache
capitalized $146 million, $141 million and $107 million of these internal costs in 2006,
2005, and 2004 respectively” (Apache Oil Corporation 2006 10-K). Apache uses funds
from sales of proven reserves to reduce the balance left on capitalized assets. “Unless
a significant portion of the Company’s proved reserve quantities in a particular country
are sold (greater than 25 percent), proceeds from the sale of oil and gas properties are
accounted for as a reduction to capitalized costs, and gains and losses are not
recognized” (Apache Oil Corporation 2006 10-K).
Apache calculates depreciation, depletion, and amortization using the unit of
production method every quarter. This depreciation method is useful because it
calculates the amount of reserves used with a fixed rate, over the useful life of the
reserve. “The costs to be amortized include estimated future expenditures to be
incurred in developing proved reserves as well as estimated dismantlement and
abandonment costs, net of salvage value, that have not yet been capitalized as asset
retirement costs” (Apache Oil Corporation 2006 10-K).
36
Derivative Instruments and Hedging Activities
Apache enters into derivative contracts to manage exposure to foreign currency
and commodity price risk. Apache normally hedges around 10% of its operations and
these derivatives take the form of contracts, future contracts, swaps or options. “The
oil and gas reference prices, on which the commodity derivative contracts are based,
reflect various market indices that have a high degree of historical correlation with
actual prices received by the Company for its oil and gas production” (p. F-10, Apache
10-K, March 1, 2007). After tax, as a result of hedging activities, Apache gained an
after-tax net of 83.5 million dollars. This acts as an insurance policy that is used to
ensure that the company receives a certain price for a commodity and is extremely
effective in creating stability within the firm and adding value.
This accounting policy is relevant to Apache’s key success factors because
derivative instruments and hedging are necessary to ensure that even only 10% of the
commodity will be sold at a certain price, locking in profit. Everyone is dependent upon
oil, so there is always a demand, and with fluctuating demand comes the need for
companies to likewise protect themselves from the resulting fluctuation in prices.
Foreign Currency Risk
As an American based company dealing with billions of dollars in assets
overseas, it is important to note that the cash flow streaming to certain international
operations is based on the U.S. dollar equivalent of cash flows measured in foreign
countries. “The functional currency is determined country by country based on relevant
facts and circumstances of the cash flows, commodity pricing environment, and
financing arrangements in each country” (Apache Oil Corporation 2006 10-K). For
example, in Australia, oil production is sold under U.S. dollar contracts while gas
production is sold under fixed-price Australian dollar contracts. In Canada, the majority
of oil and gas production is sold under Canadian dollar contracts, and the majority of
costs incurred are paid in Canadian dollars. The North Sea production is sold under
U.S. dollar contracts and the majority of costs incurred are paid in British pounds.
37
However, in Egypt all oil and gas production is sold for U.S. dollars and the majority of
costs incurred are denominated in U.S. dollars. In Argentina revenues and
expenditures are denominated in U.S. dollars but translated into Argentinean pesos at
the then current exchange rate. No matter the unit of currency, whether the British
pound, or Australian and Canadian dollars, it is very important to note that they are all
converted into U.S. dollar equivalents based on the exchange rates on the day that the
transaction takes place.
An example of how volatile these translations affect the income statement, “A 10
percent strengthening or weakening of the Australian dollar, Canadian dollar, British
pound…as of December 31, 2006, would result in a foreign currency net loss or gain of
approximately 112 million (p. 44, Apache’s 10-K, March 1, 2007).” This statistic helps
illustrate the importance of the “insurance” provided by hedging activities, as the 83.5
million dollars gained as a result of hedging would help negate the net loss resulting
from a 10 percent weakening of the U.S. dollar.
Use of Estimates
The oil and gas industry is required by GAAP to have reliability among financial
statements. This is important because an overestimation of reserves can increase the
present value of long term cash flows coming from sales of petroleum products. This is
something that could drive up the stock price if Apache knowingly overestimated their
reserves. This is why reservoir sizes and contents are estimated by outside companies
to ensure these numbers remain unbiased and not grossly overestimated.
Post-Retirement Benefit Plans
There are many retirement and deferred compensation plans offered by Apache.
These include a 401(k) savings plan, a money purchase retirement plan, a non-qualified
retirement/savings plan, pension plan, and postretirement benefit plan. “In Apache’s
410(k) plan, employees are given the option to contribute as much as 25% of their
salaries, and Apache will match the contributions up to 6% of the employee’s salary”
38
(Apache Oil Corporation 2006 10-K). In 2006, Apache had 90 million dollars in benefit
obligations for the pension plan. 4.7% is the discount rate that is applied to the
pension benefits in 2006. Post-retirement benefits are discounted at a rate of 5.5%.
Apache plans on contributing 6 million dollars to its pension plan and 402,000 dollars to
its post-retirement benefits plan in 2007. In contrast, in 2007 Apache expects to pay
out 822,000 dollars in pension benefits and 402,000 dollars in post retirement benefits
to employees. Government restrictions are accounted for annually to adjust how much
employee input is allowed. “The non-qualified retirement/savings plan permits the
delay of up to 50% of each employee’s salary, and which accepts employee
contributions and the Company’s matching contributions in excess of the above
referenced restrictions on the 401(k) savings plan” (Apache Oil Corporation 2006 10-K).
Apache’s pension plan is not offered to recently hired employees and offers specific
benefits based on their average salary and total years of service. “The postretirement
benefit plan provides medical benefits up to the age of 65, it is contributory with
participant’s contributions adjusted annually, and covers substantially all of Apache’s US
employees” (Apache Oil Corporation 2006 10-K).
Goodwill
Goodwill is recorded as an intangible asset on the balance sheet. It usually
comes from mergers and acquisitions when the buying company pays in excess of the
book value of the company being bought out. It is an asset that does not contribute to
helping the company receive cash flow. Having a large amount of assets being goodwill
is not to a company’s advantage even though it boosts their assets. Apache has
goodwill on their books recorded at 189 million dollars. This is not a significant amount
in comparison with their total assets of 24 billion. This is less than 1 percent of their
total assets.
39
Conclusion
With more firms manipulating numbers to make a company more attractive to
investors, knowing how firms use accounting policies to dress their books is becoming
more and more important. As with most firms, these accounting policies are chosen
because they are the ones that help the firm better achieve their key success factors.
Apache provides investors with relatively high levels of disclosure as compared with the
rest of the industry. The level of disclosure in Apache’s annual reports is helpful to the
investor because it gives them a snapshot of the company and highlights the
progression of many of the company’s key success factors such as economies of scale
and derivative instruments and hedging.
Potential Accounting Flexibility
Financial statements provide investors with the information needed to determine
the value of a company. Investors need to be able to rely on the information given in
the statements in order to make a more informed decision. There is a certain amount
of flexibility within the GAAP system, giving companies room to stretch the truth to
make the firm more attractive to investors. Below are the ways that Apache can be
flexible while staying in line with GAAP regulations.
Full Cost vs. Successful Efforts Methods
Apache Oil Corporation uses the full cost accounting method when valuing their
assets. Under this method, all costs are capitalized when drilling wells, successful or
not. As opposed to operating expenses where expenses used to run a business are
entered as they are incurred, capitalization is used to acquire long-term assets which
results in the depreciation of the asset over its useful life. To better understand the
upside to the full cost method, it is important to also understand the successful efforts
method. Unlike the full cost method, the successful efforts method chooses to only
amortize successful projects in contrast to expensing all successful and unsuccessful
projects. According to Apache’s most recent 10-K, “The company capitalizes all
40
acquisition, exploration, and development costs incurred for the purpose of finding oil
and gas reserves, including salaries, benefits, and other internal costs directly
attributable to these activities” (Apache Oil Corporation 2006 10-K). Why capitalizing is
so important is because instead of taking out of the company’s bottom line at one time,
they are gradually expensed. This leads to a more inflated bottom line and resulting
higher net profits on the income statement, which in turn makes the company more
attractive to investors.
Capital and Operating Leases
Operating leases are contracts that allow a company to use an asset for a
segment of its useful life. Operating leases do not transfer the title of an asset to
another company, and is not capitalized. It is recognized on the income statement as
an operating expense. No obligations are recognized on financial statements though.
The operating lease is shown off the balance sheet not viewable to someone looking
purely at financial statements. In a capital lease, the lease is recorded on the balance
sheet as a liability similar to a mortgage. The lessee has benefits of ownership such as
depreciation and tax write offs.
Apache has operating and international leases. The company leases from
governments, plots of land offshore controlled by the governments of different
countries. “The Company, through its subsidiaries, has acquired or has been
conditionally granted exploration rights in Egypt, Australia, the North Sea and
Argentina. In order to comply with the contracts and agreements granting these rights,
the Company, through various wholly-owned subsidiaries, is committed to expend
approximately $240 million through 2010” (Apache Oil Corporation 2006 10-K).
Through operating leases, Apache has the right to explore for new oil acquisitions, and
is not in contract for the next 3 years. In 2006, Apache paid 1.36 billion dollars in lease
operating costs. This number has been steadily increasing from 865 million in 2004 to
1 billion roughly in 2005 and more in 2006 as stated above. This is due to all the
41
acquisitions that Apache has made in the past couple years. Apache has rented these
areas to search for new oil and potentially expand their business. “Apache also has
leases for buildings, facilities, and equipment with various expiration dates through
2035, and has purchase commitments in Egypt for pipeline and gas plant construction
totaling $390 million through 2008” (Apache Oil Corporation 2006 10-K).
Conclusion
Apache uses the flexibility within GAAP to give investors the most effective
information needed to value the company. This flexibility allows managers to estimate
the assets and liabilities, as well as chose what type of lease to use. This allows Apache
to provide the most effective and accurate financial statements with good disclosure
within.
Actual Accounting Strategy
Generally accepted accounting strategies allow companies to choose whether to
make their financial statements appear aggressive, conservative, or both. Aggressive
accounting overstates the company’s net income, whereas conservative accounting
understates net income. Firms will often use a mixture of both accounting strategies,
however, after examining Apache’s financial statements, it shows they use a mixture of
both aggressive and conservative accounting.
An example of Apache’s aggressive accounting strategy would be their use of the
full cost method. As aforementioned, this expenses all drilling projects gradually rather
than letting the full brunt of their force affect net income. All projects, successful or
unsuccessful are depreciated which is more aggressive because not only are they
gradually taken out of net income, but also make it harder to see the ratio of successful
to unsuccessful projects. This use of the full cost method is aggressive because it
42
overstates the net income and potentially makes the company more appealing to
outside investors.
Apache holds multiple operating leases, as do many other oil and gas companies.
Apache’s 2006 value of all operating leases totals a little over 1.3 billion. This is a
relatively small number, which is disclosed in the 10-K, in comparison to their total
assets. This shows analysts that Apache has a good level of disclosure, showing a
conservative accounting approach, proving that Apache does use a mixed accounting
strategy.
Quality of Disclosure
Managers have a choice in deciding how difficult or simple it is to determine the
value of a company for the investors. This depends on the quality of information given
in the financial statements. Ultimately, managers have the final say in what information
is revealed, although accounting standards require a minimum amount of information
necessary.
Qualitative Analysis of Disclosure
The information given to investors about a company should be relative and
reliable information. This information should tell enough about the company to provide
analysts with the information needed to value the company, as well as keep the
information competitors would find beneficial concealed. It is crucial for the company
to supply information that investors find trustworthy so they have confidence in the
company’s financial statements and the company as a whole. Apache does a good job
of disclosing relevant information to investors. Not only do they supply relevant
information, but everything we wanted to know about the company was found in the
company’s 10-K or annual report.
43
Pensions
Apache discloses all of their information about pensions throughout their
financial statements, making the company seem more credible. Information given on
the financial statements about pension plan is important not only to employees, but
also to investors and shareholders. This is important because managers can manipulate
these numbers to make the company look better. Apache’s 10-K provides adequate
information for investors to successfully value the company. This is shown through the
graphs with numerical values of the pension plans over the past 2 years, paragraphs
explaining the distribution of employee salaries and the eligibility of employees for these
pension plans. Apache also includes the total cost of their pension plan, which have
increased steadily, for the past 3 years. As a whole, the information contained in
Apache’s financial statements is relevant and useful to investors.
Environmental Issues
Environmental concerns are important to investors when determining the value
of an oil and gas company. The information that Apache discloses in their 10-K about
their environmental concerns reassures investors that the company is adhering to all
rules and regulations associated with protecting the environment. “The Company, as
an owner or lessee and operator of oil and gas properties, is subject to various federal,
provincial, state, local, and foreign country laws and regulations to discharge of
materials into, and protection of, the environment” (Apache Oil Corporation 2006 10-K).
Apache makes periodic checks of their reserves to make sure that they are in
compliance with all stated laws. They maintain their reserves by checking them
frequently to ensure they are in conformity with environmental regulations. “The
Company also conducts periodic reviews, on a company wide basis, to identify changes
in its environmental risk profile. These reviews evaluate whether there is a probable
liability, its amount, and the likelihood that the liability will be incurred” (Apache Oil
Corporation 2006 10-K). Apache is committed to continuously maintaining their
reserves in order to keep up with ever changing environmental laws. All of this
44
information is clearly stated in the 10-K and is available for investors as well as the
general public.
Insurance Claims
In case of natural disasters, insurance policy information gives investors
peace of mind about the company’s stability. Disclosure of this information helps
investors know that a company is protected and the initial investment will be safe. For
example, during hurricane Katrina, one of Apache’s reserves was damaged. “Apache
has filed claims with OIL Insurance Ltd. Who provided Apache’s first level of property
damage insurance coverage (“OIL coverage”)” (Apache Oil Corporation 2006 10-K).
Not only does Apache have a first layer of insurance coverage, it also has a second
layer for added protection. Insurance makes investors more confident in the company
they are investing in, because in essence, their investment is safer with the insurance.
Conclusion
The information provided in Apache’s financial statements is very thorough and
conclusive. This information is crucial to investors, making them aware of the extra
efforts of Apache to disclose all relevant information. Not only does this show Apache’s
commitment to its investors, but also its ethical responsibility. After reviewing Apache’s
10-K, the information received satisfied all questions and concerns about the company.
Quantitative Analysis of Disclosure
Managers are provided with a certain amount of flexibility when producing
financial statements for investors. GAAP allows this since they have standards for all
industry’s financial statements, and not all industries are the same. Managers can be
tempted to inflate or deflate estimates in order to make their company look better to
potential investors. The possibility of incorrect estimates should persuade investors and
analysts take a close look at all financial statements and numbers. A considerable
45
change in numbers should alert investors and analysts to closely examine these
changes.
Two ways to successfully assess revenues and expenses are expense
manipulation and sales manipulation diagnostics. Expense manipulation compares
asset turnovers, cash flows, sales, accruals, and other expenses on a year to year basis.
Sales manipulation compares net sales, cash from sales, accounts receivables, unearned
revenues, and warranty liabilities also on a year to year basis. Analysts should look for
any unusual increases or decreases in ratios to signal incorrect numbers. These
numbers could show misleading estimates by managers when creating financial
statements.
Sales Manipulation Diagnostics
Sales manipulation diagnostics is a valuable tool when searching for any
inaccurate numbers in financial statements. Management has the ability to distort net
income. This is done in two different ways. One is by overstating revenues; the other is
understating expenses. Analysts or investors can also compare these ratios to those of
their competitors to look for any unusually high or low ratios in relationship to their
competitors. Below are the sales manipulation diagnostic ratios for Apache and its
competitors, Devon, XTO, Occidental, and Anadarko.
46
Net Sales/ Cash From Sales
The ratio of net sales to cash from sales consists of gross sales minus returns,
discounts, and allowances divided by cash received from the sale. In this industry, there
are not much, if any returns or discounts. There is allowance for doubtful accounts
because whenever making sales on credit, it is a must to allow for bad debts. A
favorable ratio is 1:1 because this means that the company is liquid, and doesn’t accept
credit sales. This ratio is hard to achieve. The full sale is not listed as cash until the full
payment is received, making the company less liquid. The industry has maintained a
ratio fairly consistent between 1:1 and 1:1.1. This shows that for the most part,
companies in this industry try to keep less than 10 percent of their sales on credit.
Approaching 2006, with the exception of Anadarko, the industry seemed to tolerate
fewer sales on credit and therefore improved towards a 1:1 ratio.
47
Net Sales/ Net Accounts Receivable
The ratio of net sales to net accounts receivable shows that Apache is
consistently average within the industry. This shows that Apache’s balance in accounts
receivable is lower than their competitors, and their sales from accounts receivable
have been consistently paid off. In 2006, Apache had a ratio of a hair under 5. This
tells you that for every dollar of net sales, there is only about 20 cents in accounts
receivable. Anadarko, Devon, and XTO’s accounts receivable rations remained relatively
constant throughout the 5 years, although they were much higher than Apache’s.
48
Net Sales/ Inventory
The ratio of net sales to inventory tells how well the company can turnover its
inventory to produce revenue. There are only two companies out of Apache and its
competitors that show inventory on their financial statements. This is due to the fact
that the other companies do not report their reserves as an inventory. They will report
it in other accounts such as a reserves account. Apache’s ratio in 2006 tells us that it
turned over its reported yearend inventory 25 times with the amount of sales achieved.
Occidental’s ratio of inventory turnover throughout the last 4 years has been relatively
consistent. However, Apache’s ratio made a sudden increase in 2003, remained stable
for 2 years, and then almost returned to the 2002 level. The sudden decrease in 2005
is due to hurricanes Katrina and Rita, which caused a severe reduction in Apache’s
inventory and ability to produce petroleum.
49
Sales Manipulation Diagnostics
2002 2003 2004 2005 2006 Apache
Net Sales/Cash from Sales 1.05 1.03 1.06 1.07 1.03
Net Sales/Net Accounts
Receivable 4.85 6.57 5.65 5.16 4.89
Net Sales/Inventory 23.44 33.36 33.75 35.57 25.20
XTO Net Sales/Cash
from Sales 1.04 1.05 1.08 1.11 1.01 Net Sales/Net
Accounts Receivable
5.57 6.00 5.69 5.18 6.34
Net Sales/Inventory NA NA NA 123.73 66.40
Anadarko Net Sales/Cash
from Sales 1.02 1.00 1.04 1.09 1.16 Net Sales/Net
Accounts Receivable
3.48 4.64 4.49 3.70 3.10
Net Sales/Inventory NA NA NA NA NA
Devon Net Sales/Cash
from Sales 1.04 1.04 1.04 1.02 .98 Net Sales/Net
Accounts Receivable
6.75 7.77 6.88 6.78 7.59
Net Sales/Inventory NA NA NA NA NA
Occidental Net Sales/Cash
from Sales .80 1.00 1.00 1.02 .99 Net Sales/Net
Accounts Receivable
6.72 8.01 4.87 4.65 5.31
Net Sales/Inventory 18.91 18.89 19.96 20.39 21.40
50
Expense Manipulation Diagnostics
Expense manipulation diagnostics are also an important tool when determining
any discrepancies in financial statements. Analysts and investors can compare these
ratios to determine if any of the ratios are unusually large or small in comparison to
previous year’s ratios or other competitors’ ratios within the industry. Below are the
expense manipulation diagnostic ratios for Apache and its competitors, Devon, XTO,
Occidental, and Anadarko.
Sales / Assets
Asset turnover is the ratio of sales divided by assets. This ratio essentially tells
investors and analysts the sales which derived from a corporation’s assets. Looking at
the chart above, it shows that Occidental consistently has the highest asset turnover
ratio. In the oil and gas industry this tells investors that Occidental gets the most from
51
their assets, which in this industry can mean having the most successful exploration
and drilling. Apache’s ratio is most in line with the industry norm as represented on the
chart by their other three competitors. In 2006, Apache’s ratio was approximately 0.3.
This represents 30 cents in sales for every dollar of assets a corporation holds. The oil
and gas industry is very dependent on commodity prices, and as the price of oil has
increased over the past 4 years, it has increased the asset turnover ratio for the
industry. In the last 2 years as corporations have spent more money on acquisitions,
increasing their assets, it is normal to have a steady decline in the short term. This is
represented by the declining ratio from 2005 to 2006. In the future, as these
companies start to reap the benefits of their acquisitions, the ratio should start to
increase again as it did from 2002 to 2005.
52
Cash Flows From Operating Activities/ Operating Income
The ratio of cash flows from operating activities to operating income shows the
relationship between the cash provided by operating activities to the amount of
operating income. When a firm has a lower ratio they are more productive because the
cash they receive is more from operating activities instead of things that are not their
normal course of business. Starting in 2002, oil prices started rising which was
increasing the cash flows from operating activities in relation to operating income. As oil
prices reached their peak and started leveling off, there was not as much change in
operating income and which caused this ratio to taper off steadily.
53
Cash Flows From Operating Activities/ Net Operating Assets
The ratio of cash flows from operating activities to net operating assets shows
the relationship between cash flows from operating activities to fixed assets, and
property, plant and equipment. When a firm has a higher ratio, it means the firm is
being productive by generating more income per fixed asset. In the oil and gas
industry, most of the assets are capitalized, making the ratios relatively low. Once
again, in 2002 oil prices jumped up and cash flows from operating activities increased.
This balanced out the ratio to become positive and then taper back down slightly in
2005. This is due to oil companies investing in more acquisitions which increases net
operating assets. Apache moved right along with the industry raising no red flags as to
the questionability of Apache’s reporting.
54
Expense Manipulation Diagnostics
2002 2003 2004 2005 2006 Apache
Declining Asset Turnover .27 .34 .34 .39 .33
Changes in CFFO/OI -.61 .25 .39 .25 -.0046
Changes in CFFO/NOA -.07 0.12 0.04 0.07 -.001
Total accruals/change in
sales 2.14 -.48 -.35 .10 -.15
Devon Declining Asset
Turnover .27 .27 .31 .35 .30 Changes in CFFO/OI -.11 .55 .51 .42 .25
Changes in CFFO/NOA -.03 .10 .08 .11 .07
Total accruals/change in
sales -.98 -.37 -.61 -.47 9.57
Anadarko Declining Asset
Turnover 0.21 0.25 0.3 0.31 0.17 Changes in CFFO/OI -0.93 0.46 0.07 0.27 0.15
Changes in CFFO/NOA -0.07 0.05 0.01 0.05 0.02
Total accruals/change in
sales -.17 -.66 -.34 -.13 -.003
Occidental Declining Asset
Turnover .44 .51 .51 .56 .55 Changes in CFFO/OI -0.47 0.64 0.31 0.28 0.24
Changes in CFFO/NOA -.02 .05 .03 .05 .03
Total accruals/change in
sales -.005 .05 .22 .29 .60
XTO Declining Asset
Turnover .31 .33 .32 .36 .36 Changes in CFFO/OI -0.15 0.60 0.46 0.45 0.28
Changes in CFFO/NOA -.022 0.09 0.08 0.10 0.07
Total accruals/change in
sales 4.9 -.77 -.39 -.08 -.18
55
Conclusion
The inconsistencies within the oil and gas industry are usually explainable.
Examples of this are new acquisitions and natural disasters. Even though these are
usually explainable, they need to be thoroughly examined by analysts and investors to
insure accurate accounting practices.
Generally, Apache follows the industry averages for the sales and expense
manipulation diagnostic ratios. Even though this industry has the potential to be
inconsistent, all of the companies examined proved to be stable. Financial statements
should not be read as fact; the analyst should question the information given to make
an unbiased evaluation of the company.
Potential “Red Flags”
When looking over graphs and ratios of the industry, there is nothing that
significantly catches the eye concerning Apache. We were mainly looking for outlying
distortions in the graphs pertaining to Apache. Apache’s data was in line with the
named competitors throughout the industry. The only thing that was noticeable was the
Net Sales/Inventory ratio. Apache and Occidental did have inventories at the end of the
year for 2002 through 2006 while other companies researched had no inventories. This
could possibly mean that these two companies produced an excess amount of oil and
gas that did not sell off completely. Obviously, this isn’t necessarily a good thing
because in an ideal situation, you sell off everything you produce keeping inventory to a
minimum. This could mean that Apache doesn’t have as good of ties with buyers as
other companies throughout the industry, and the buyers already had filled their
purchase quotas with other producers’ petroleum products. What stood out the most is
the 10 point increase in the Net Sales/Inventory ratio between 2002 and 2003, and the
10 point decrease in the ratio between 2005 and 2006. When the ratio goes up, it
means that inventory has decreased. Likewise, when inventory goes up, the Net
56
Sales/Inventory ratio decreases. Looking back over the past year this can be attributed
to sky high gas prices along with disasters such as Hurricane Katrina. Studying the
data shows that as gas prices stayed relatively stable between 2003 and 2005, the ratio
stayed steady. However as gas prices peaked in the past year and a half, there has
been less demand and as a result an increase in Apache’s inventory.
Once again, Apache does a good job of disclosing information in the notes to the
financial statements. They give detailed data regarding operating leases, when and how
much is due in every year into the future. Discount rates for all of their long term debt
were disclosed as well.
Coming Undone (Undo Accounting Distortions)
The amount of information contained in Apache’s financial statements gives
investors all relevant and necessary information to value the company. After examining
Apache’s 10-K, we have determined that their numbers are reliable and there are no
accounting distortions that need to be corrected.
Financial Analysis, Forecast Financials, and Cost of Capital Estimation
Financial Analysis
When comparing firms to each other, one consistent way of comparing them to
each other is to use financial ratios. Investors and analysts have come up with many
ratios to measure the success of companies. Success can be measured in many
different ways using different ratios. The most common types of ratios are liquidity
ratios, profitability ratios, and capital structure ratios. In this part of the analysis, we will
view and discuss many of these ratios and what they portray about the firm and how it
stands against its competitors within the industry. Then we will discuss the forecasting
of financials for Apache and how we came to estimate its future performance.
57
Liquidity Analysis
Liquidity ratios measure a firm’s ability to meet its short term liability obligations.
Lenders and creditors often look at these ratios to determine whether companies are
credit worthy, what rates to lend at, and other loan terms when borrowing money. The
more liquid a firm is, the more likely banks and other lenders are to loan money
because the firm appears to be able to generate money quickly compared to its short
term debt.
Current Ratio
The current ratio describes the company’s ability to meet its short term debt
obligations immediately if the situation calls for it. The situation would involve the
58
company having current debt suddenly due and to pay it off the company would use its
current assets to do so either by using cash or selling off other current assets. The
current ratio compares a company’s current assets to its current liabilities. If the ratio
was 2:1, that would mean the company has 2 dollars in assets for every one dollar in
liabilities. This ratio is good, and as the first number keeps going up, it means the ratio
gets better and better.
In the independent oil and gas industry, Apache stands around normal compared
to its competitors. Current ratios in the industry range from .6 to 1.6 over the past five
years. Apache has steadily declined over the past five years along with a few other
companies. This could be due to the way business has been over the past five years
and due to large industry growth. Since companies know business is growing, they
might be willing to take on more debt to acquire more prospects in the field knowing
that they will be able to pay it off with ease.
59
Quick Ratio
The quick ratio compares the same things as the current ratio except that it
excludes inventory out of the current assets portion of the ratio. By doing this, it gives a
more realistic picture of how quick a company could pay off short term debts and
payables. This is because inventory is sometimes hard to sell off.
Once again, Apache stands about normal or slightly lower than the industry
when comparing quick asset ratios over the last five years. They are ranging from
around .4 to about 1.3 on the upper end. Obviously, anything below 1 is not ideal
because there are fewer assets than liabilities. Then again, it is hard to judge these
companies against each other when many of the companies do not have inventories on
their balance sheets, or at least not for all five years.
60
Receivables Turnover
The Account Receivables Turnover ratio represents the relationship between a
company’s net sales (or Revenue) and its accounts receivables. The higher the ratio
the more efficiently the company either collects its accounts receivables or operates on
a cash basis. In our case in 2006 Apache’s turnover ratio is 5.02; this means that for
every one dollar of credit, Apache generated $5.02 in revenue.
For Apache and our four competitors you can see that they all have around the
same turnover ratios for the 5 year period for which we sampled data and graphed. If
you look at the graph you can see that after 2003 each company’s turnover ratio began
to decline. For Devon, XTO, and Occidental the ratio increased after 2005. For Apache
and Anadarko however, the ratio continues to decline. One of the possible explanations
for this decline in turnover ratio is that since the petroleum and natural gas industries
61
have been growing rapidly since 2002, they have been increasing their liabilities and
henceforth are using more credit than in previous years.
Day Sales Outstanding
Days sales outstanding measures how long it takes for a company to collect their
accounts receivables. Obviously in this case a lower number is better because it means
a company is collecting their receivables in a more timely fashion. Our ratios represent
the number of days it takes to recover a company’s receivables versus the number of
times in a year that the receivables are turned over. Again Apache’s data is right in the
middle of our five company’s data.
This shows that Apache is doing a fairly decent job of collecting their accounts
receivables in a timely manner. Apache’s average days outstanding over the past 5
62
years are right around 65. This means that it takes around 65 days to collect on our
accounts receivables. This is right in line with the industry average.
Inventory Turnover
Inventory turnover is a ratio that measures and describes the connection
between a company’s cost of goods sold in a year and its inventory. If the inventory is
10000 and cost of goods sold is 10000, then the ratio is 1 meaning that they only
bought inventory once during the year and sold all of it. Having inventory on hand ties
up money that can be used for other investments and opportunities. So, you want to
have inventory turning over many times within a year but not too many times because
then you probably don’t have enough inventory on hand when needed.
63
Apache’s inventory turnover seems to be in line with the companies in the
industry that have inventory. Apache, Devon, and Occidental are the only companies
which have held inventories over the past five years. It is difficult to measure inventory
turnover in the oil and gas industry because most everything that is produced in this
industry is sold before or while it is being produced; hence there is not much, if any,
inventory on hand.
Days’ Supply of Inventory
Days’ supply of inventory measures the amount of days that it takes to
completely sell off one batch of inventory. It is the first half of going through the cash
to cash cycle and going through the process of collecting cash back to the firm. Once
again, it is really difficult to even apply this ratio to the oil and gas industry because so
many companies do not keep inventory on hand. Of the companies that do have
inventory, Apache seems to be right in line with Occidental. Devon was the outlier
64
because it only had inventory for two years out of the five year span. As talked about
earlier in our valuation of Apache, having inventory in this industry is probably not a
good sign. There is obviously a reason as to why not the entire product produced was
sold off. Maybe relations between Apache and their buyers aren’t as good as the rest of
the industry’s relations with buyers resulting in Apache having to work harder to sell off
their product. Buyers could have also already met their purchase quotas. Either way,
Apache has consistently maintained a sufficient level of inventory over the five year
stretch which raises eyebrows.
The money merry-go-round determines the amount of time it takes for money to
go out and then come back into the company. Keeping track of this is beneficial for the
company because it is also a measure of efficiency.
65
Working Capital Turnover
Working capital turnover is equal to Sales / (Current Assets-Current Liabilities).
In other words working capital turnover is the relationship between sales and the
money on hand that is used to fund operations. Though the higher working capital
turnover you have the better, it is obvious when looking at Apache’s data that this ratio
is not imperative to running a successful corporation. Not only is Apache’s working
capital turnover highly sporadic, but in 2005 it is -300. This means that for every dollar
of working capital Apache had in 2005, it lost $300. This is not necessarily correct
however as in 2005 Apache made some major acquisitions which caused its current
liabilities to basically serve as a severe outlier in comparison to the rest of their data.
Apart from a few years of negative turnover, the average for our company and
competitors is right around 10-15. This means that for every dollar of working capital,
the industry averaged about 10-15 dollars in sales.
66
Conclusion
Apache’s liquidity stands with the industry on average except for the working
capital turnover and the fact that Apache has inventory, which only Occidental has as
well. The atrocious -300 working capital ratio in 2005 is mainly attributed to Apache’s
acquisitions which sent their current liabilities skyrocketing.
Profitability Analysis
Profitability analysis is composed of six ratios: gross profit margin, operating
profit margin, net profit margin, asset turnover, return on assets, and return on equity.
The objectives of these ratios are to evaluate four different important factors that are
related to profits. These factors are operating efficiency, asset productivity, rate of
return on assets, and rate of return on equity. Gross profit margin, operating profit
margin, and net profit margin are necessary to measure a firm’s operating efficiency.
Asset turnover, return on assets, and return on equity are also necessary for measuring
a firm’s asset productivity, return on equity, and return on assets.
67
Gross Profit Margin
The gross profit margin is found by dividing gross profit for the year by the total
amount of revenue for the year. Gross profit is found by subtracting cost of goods sold
from the total amount of revenue. The gross profit margin ratio is given in a
percentage and shows what is left from revenues after deducting cost of goods sold. A
higher percentage is better when looking at the gross profit margin and is a clear
indication of the financial health of the company. Even though Apache’s gross profit
margin is considerably lower than its competitors we can see that it has been growing
with the rest of the industry. Keeping pace with the rest of the industry is a good sign
of the health of Apache. We attribute the lower percentage to the size of Apache
compared to its competitors.
68
Operating Profit Margin
The operating profit margin is found by dividing operating profit for the year by
sales for the year. This ratio shows what is left over from revenues after paying the
companies variable costs. The higher the operating profit margin the more efficiently
the company is running. Apache has been very good at efficiently producing their
products and keeping half of their revenues as profit. Apache is consistently at the top
of the industry when it comes to operating efficiency. They did have a decrease in their
operating profit margin in the last year after steady growth for the four years prior.
This decrease is consistent with the industry as Anadarko and Devon both had
decreases of the same magnitude.
69
Net Profit Margin
Net profit margin is found by dividing net income for the year by sales for the
year. Net income is the amount of money left over from revenues after subtracting
costs and expenses. Net profit margin shows how much money the company actually
keeps from the revenues they produce. The higher the percentage the more money
the company is keeping from their revenues. Apache had been at the top of the
industry for the years prior to 2006. In the last year Apache had a decrease in its net
profit margin after four years of consistent growth. This shows that Apaches costs have
increased over the last year. This decrease is consistent with many in the industry as
Occidental also had a decrease and Devon’s growth slowed.
70
Asset Turnover
Asset turnover is computed by dividing sales for the year by total assets at the
end of the year. This ratio shows how well a company is generating sales compared to
the amount of assets they hold. It is also a good indicator at how efficiently their
assets are being used. A higher percentage is better and shows a higher level of
efficiency. Apache had a decrease in its asset turnover in the last year after peaking in
2005 at 0.39. This decrease is consistent with the rest of the industry as Apaches
competitors all had decreases except XTO whose growth slowed. Up until last year
Apache had been in the middle of the mix with the rest of the industry and had been
growing at a steady rate. This decrease should not be surprising as the rest of the
industry was moving in the same direction. We also believe that the large amount of
acquisitions Apache had directly affected their asset turnover.
71
Return on Assets
The return on assets ratio is computed by dividing net income by the previous
year’s total assets. Return on assets is affected by asset turnover and the net profit
margin. The ratio tells that with every one dollar of assets used, the company is
generating that much net income, so the bigger the ratio the better. In 2005, XTO’s
return on assets ratio declined to below one percent because for as many assets that
were being used, they were producing very little net income. Also, Occidental’s return
on assets ratio rose quite rapidly, because their net income doubled from 2003 to 2005.
The other company’s ratios do not have as large of jumps or falls as the others. This is
because for the assets those companies used or sold, they still produced enough net
income.
72
Return on Equity
Return on equity is found by dividing net income for the year by total owner’s
equity of the previous year. This ratio measures the profitability of the shareholder’s
prospective. It shows that for every one dollar of owner’s equity, the company has that
much net income, so the bigger the ratio, the better. Return on equity is influenced by
the profit margin, asset turnover, and debt to equity ratios. In 2005, XTO’s return on
equity greatly declined, because its net income drastically fell. The other company’s
return on equity ratios remain somewhat steady compared to XTO.
73
Conclusion
Apaches profitability looks to be right in line with the rest of the industry. For
the years 2002 through 2005 Apache’s profitability had been growing at a steady rate.
Last year was the first year in the last five that they have shown a decrease in all of the
ratios associated with profitability. We attribute this decline to the large amount of
assets that came with their acquisitions over the past year.
CAPITAL STRUCTURE ANALYSIS
The capital structure of a firm shows which portion of the firm is financed by debt and
which portion is financed by equity. These portions are all shown on the balance sheet
in the financial statements. It is important to be able to service all of the debt a
company owes compared to the amount of equity outstanding. It is imperative to
maintain a good balance of debt to equity as well to be versatile in changing economic
conditions. Times interest earned, Debt Service Margin, and the debt to equity ratio
measure the credit risk to which a company is exposed, whether or not income from
operations is able to cover interest charges, and the ability of the company’s cash from
operations to cover the annual installment payments on the principals of the company’s
long-term liabilities.
74
Debt to Equity
Debt to equity is computed by dividing a company’s total liabilities by its total
owner’s equity. This ratio is a sign that there could be the possibility that interest and
debt repayment cannot be fulfilled by the company’s cash flows. So companies should
pay special attention to this ratio in order to stay away from potential credit risk. All of
the industry seems to be in the range of .5 to 1.5 in the past five years. This keeps a
pretty reasonable level of debt to equity. As the ratio goes above 1, there is more debt
and below 1; more equity. Apache’s ratio has been the steadiest since 2002 at just
under 1 showing Apache’s ability to balance their financing between debt and equity,
keeping them both relatively steady.
75
Times Interest Earned
Times interest earned is calculated by dividing a company’s income from
operations by its interest expense. Before there can be any profits to the stockholders
of a company, that company’s interest expense must be covered by income from
operations. Time interest earned shows that for every dollar of interest expense a
company has, they are producing that much more income from operations to cover the
expense. The reason that XTO’s times interest earned ratio in 2005 is zero, is because
they did not have an interest expense in that year, so the ratio could not be computed.
Apache continues to lead the industry on average for times interest earned. Over the
past five years, they have been the most consistent of the five studied competitors.
Not only is Apache making more money for each dollar of interest expense, but they
are the only company to have the dollars earned per dollar of interest expense increase
each year since 2002.
76
Debt Service Margin
Debt to Service Margin
The debt service margin is an explanation of how well a company is able to cover
their debt with the cash acquired from operations. The industry average is relatively
low with the exception of XTO. Since 2003, most of the companies are at about the
same debt to service margin which means that is the norm for the industry. Apache is
in the industry norm area. One reason the industry average is so low is because many
of these companies in the past 5 years or so have made large acquisitions and are
having to pay them off. These acquisitions will most likely pay off in the future and the
low debt to service margin is most likely temporary and should not be looked upon as
strictly poor performance.
77
Conclusion
When looking over the capital structure graphs, Apache is in a pretty good state as
compared to the rest of the oil and gas industry. They have maintained a good debt to
equity ratio. Their times interest earned has been no less than stellar compared to the
rest of the industry, and the debt to service margin is right along with most of their
competitors.
IGR/SGR Analysis
IGR as well as SGR are important ratios because they tell investors valuable
information about the growth of a company. The Internal Growth Rate, or IGR, is the
amount of growth that the company can sustain internally without having to seek
outside financial assistance. On the other hand the Sustainable Growth Rate, or SGR, is
the amount of growth a company can sustain without borrowing more money.
Internal Growth Rate
Apache’s IGR is much lower than the industry average IGR. This is an indicator
that Apache has trouble financing projects with funds only generated within the
company. This shows that Apache is using outside sources to aid in their asset
acquisition as well as project undertakings. This could possibly be troublesome for the
company, because a good balance between internal and external funding is favorable.
Sustainable Growth Rate
Apache’s SGR is also much lower than the industry average SGR. This indicates
that Apache is borrowing a lot of money to fund its asset acquisiton and projects. This
is not favorable because in order for Apache to grow, they will have to borrow
significant funds to sustain their growth rate. Once Apache has finished its mass
expansion and acquisitions, the SGR as well as the IGR should be more on target with
the industry averages because they will be able to generate their own funds.
78
IGR/SGR
The IGR and SGR are important because they tell potential investors the limit to
potential growth. After reaching this cap, the company cannot continue to grow
without outside financial help. This is unattrative because they are not generating
enough revenue within the company. Companies who increase debt to expand and
grow, decrease their future profits because they have to repay that debt. A large IGR
and SGR, unlike Apache’s, tells investors the company is set to do well in the future. In
Apache’s case the low IGR and SGR are indicators the company is expanding and
79
acquiring more reserves. When the acquisitions of these reserves are complete,
Apache will have higher IGR and SGR similar to that of the industry averages.
Financial Statement Forecast
Financial statement forecasting predicts a firm’s future productivity by using past
financial statements provided by the 10-K. It is a process that measures valuation in
the future for a particular firm. Apache’s income statement, balance sheet, and
statement of cash flows provided the basis for our predictions. For the income
statement, the forecasting was primarily based on assumptions provided by past growth
rates, as well as industry growth rates. The balance sheet was forecasting was based
off of the certain liquidity ratios as well historical growth rates. The most influential
ratios when forecasting include current ratios, inventory turnover, accounts receivable
turnover, and asset turnover. Manipulation diagnostics served as the main forecasting
tool for the statement of cash flows. The primary assumption comes from CFFO, the
basis for the entire statement of cash flows. The manipulation diagnostics that we used
include CFFO/OI, CFFO/NI, and CFFO/Sales.
Income Statement Analysis
In order to forecast the income statement, we divided each item on the income
statement by sales in order to get a common size income statement. Although the
information overall was useful, there were fluctuations due to a large increase in assets
as well as the effects of natural disasters. “The 2005 hurricane season set many
records and caused unprecedented damage to the energy industry. Most of the
damage was due to Hurricane Katrina (landfall on Aug. 29) and Hurricane Rita (landfall
on Sep. 24). These hurricanes not only destroyed or damaged production facilities in
the Central Gulf of Mexico, they also damaged critical facilities on land”
(www.apachecorp.com). In 2004, Apache made a large acquisition in the North Sea
which greatly increased their assets as well as their reserves. This acquisition was a
80
major one for Apache because it is supposed to begin exploration drilling in 2006.
These events led us to forecast the income statement based on historical growth rates
rather than Apache’s growth rate between 2005 and 2006. The growth rate between
2005 and 2006 was so large due to the acquisitions; there was no way that Apache
could sustain this growth rate over a long period of time. The industry growth rate
seemed to produce more conservative forecasts. The industry average includes Apache
as well as, XTO, Occidental, Anadarko, and Devon Energy Corporations.
Every item on the income statement that showed consistency was forecasted out
for 10 years. The industry average is 9.5%, and we felt a lower more conservative
growth rate was appropriate because of the setbacks of recent hurricanes. We felt a
7% growth rate was suitable for Apache’s revenue. Due to Apache’s recent
acquisitions, their revenue has the ability to grow at a constant 7% rate per year. From
2006 to 2007, revenue grew $580,215. The growth rate for XTO Energy was 27.4%,
making the industry average unusually high. Because of this, we felt a 7% growth rate
would be more realistic for Apache. This high rate was because XTO acquired many
more reserves than competitors in the industry.
All of the remaining forecasted line items were determined by industry averages
as well as Apache’s growth rates. We took into account any large jumps in industry
averages in order to forecast in a conservative manner. Because we took the
conservative approach, we believe that our forecasts are realistic and show steady
growth over the next 10 years.
81
APACHE CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED OPERATIONS Actual Financial Statements Forecast Financial Statements2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
2002 2003 2004 2005 2006
REVENUES AND OTHER:Oil and gas production revenues 2,559,748 4,198,920 5,308,017 7,457,291 8,074,253 Gain on China divestiture - - 173,545 Other 125 (8,621) 24,560 126,953 40,981
Total Revenue 2,559,873 4,190,299 5,332,577 7,584,244 8,288,779 8,868,994 9,489,823 10,154,111 10,864,898 11,625,441 12,439,222 13,309,968 14,241,666 15,238,582 16,305,283
OPERATING EXPENSES:Depreciation, depletion and amortization 843,879 1,073,286 1,222,152 1,415,682 1,816,359 Asset retirement obligation accretion - 37,763 46,060 53,720 88,931 International Impairments 19,600 12,813 Lease operating costs 457,903 699,663 864,378 1,040,475 1,362,374 Gathering and transportation costs 38,567 60,460 82,261 100,260 104,322 Severance and other taxes 67,309 121,793 93,748 453,258 553,978 General and administrative 104,588 138,524 173,194 198,272 211,334 China litigation provision 71,216 Financing costs:Interest expense 155,667 169,090 168,090 175,419 217,454 Amortization of deferred loan costs 1,859 2,163 2,471 3,748 2,048 Capitalized interest (40,691) (52,891) (50,748) (56,988) (61,301) Interest income (4,002) (3,290) (3,328) (5,856) (16,315)
Total Operating Expenses 1,644,679 2,259,374 2,669,494 3,377,990 4,279,184 4,707,102 5,177,813 5,695,594 6,265,153 6,891,669 7,580,835 8,338,919 9,172,811 10,090,092 11,099,101
Operating Income 71,315 857,639 1,440,931 2,790,572 2,193,236 2,394,628 2,562,252 2,741,610 2,933,523 3,138,869 3,358,590 3,593,691 3,845,250 4,114,417 4,402,426
PREFERRED INTERESTS OF SUBSIDIARIES............... 16,224 8,668
INCOME BEFORE INCOME TAXES 898,970 1,922,257 2,663,083 4,206,254 4,009,595 Provision for income taxes 344,641 827,004 993,012 1,582,524 1,457,144
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE 554,329 1,095,253 1,670,071 2,623,730 2,552,451 Cumulative effect of change in accounting principle,net of income tax 26,632 (1,317)
NET INCOME 554,329 1,121,885 1,668,754 2,623,730 2,552,451 2,483,318 2,657,150 2,843,151 3,042,172 3,255,124 3,482,982 3,726,791 3,987,666 4,266,803 4,565,479 Preferred stock dividends 10,815 5,680 5,680 5,680 5,680
INCOME ATTRIBUTABLE TO COMMON STOCK 543,514 1,116,205 1,663,074 2,618,050 2,546,771
BASIC NET INCOME PER COMMON SHARE:Before change in accounting principle $1.83 $3.38 $5.10 $7.96 $7.72Cumulative effect of change in accounting principle $0.00Principle $0.08
$1.83 $3.46 $5.10 $7.96 $7.72
DILUTED NET INCOME PER COMMON SHARE:Before change in accounting principle $1.80 $3.35 $5.04 $7.84 $7.64Cumulative effect of change in accounting principlePrinciple $0.08 ($0.01)
$1.80 $3.43 $5.03 $7.84 $7.64
Actual Financial Statements Industry
For the Year Ended December 31,
(In thousands, except per common share data)
82
Common Size Income Statement Actual Financial Statements2002 2003 2004 2005 2006 AVG 05-06 AVG
REVENUES AND OTHER:Oil and gas production revenues 100.00% 100.21% 99.54% 98.33% 97.41% 99.10% 97.87%Gain on China divestiture 0.00% 0.00% 0.00% 0.00% 2.09% 0.42% 1.05%Other 0.00% -0.21% 0.46% 1.67% 0.49% 0.49% 1.08%
Total Revenue 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
OPERATING EXPENSES:Depreciation, depletion and amortization 32.97% 25.61% 22.92% 18.67% 21.91% 24.42% 20.29%Asset retirement obligation accretion 0.00% 0.90% 0.86% 0.71% 1.07% 0.71% 0.89%International Impairments 0.77% 0.31% 0.00% 0.00% 0.00% 0.21% 0.00%Lease operating costs 17.89% 16.70% 16.21% 13.72% 16.44% 16.19% 15.08%Gathering and transportation costs 1.51% 1.44% 1.54% 1.32% 1.26% 1.41% 1.29%Severance and other taxes 2.63% 2.91% 1.76% 5.98% 6.68% 3.99% 6.33%General and administrative 4.09% 3.31% 3.25% 2.61% 2.55% 3.16% 2.58%China litigation provision 0.00% 0.00% 1.34% 0.00% 0.00% 0.27% 0.00%Financing costs:Interest expense 6.08% 4.04% 3.15% 2.31% 2.62% 3.64% 2.47%Amortization of deferred loan costs 0.07% 0.05% 0.05% 0.05% 0.02% 0.05% 0.04%Capitalized interest -1.59% -1.26% -0.95% -0.75% -0.74% -1.06% -0.75%Interest income -0.16% -0.08% -0.06% -0.08% -0.20% -0.11% -0.14%
Total Operating Expenses 64.25% 53.92% 50.06% 44.54% 51.63% 52.88% 48.08%
PREFERRED INTERESTS OF SUBSIDIARIES............... 0.63% 0.21% 0.00% 0.00% 0.00% 0.17% 0.00%
INCOME BEFORE INCOME TAXES 35.12% 45.87% 49.94% 55.46% 48.37% 46.95% 51.92%Provision for income taxes 13.46% 19.74% 18.62% 20.87% 17.58% 18.05% 19.22%
INCOME BEFORE CHANGE IN ACCOUNTING PRINCIPLE 21.65% 26.14% 31.32% 34.59% 30.79% 28.90% 32.69%Cumulative effect of change in accounting principle,net of income tax 0.00% 0.64% -0.02% 0.00% 0.00% 0.12% 0.00%
NET INCOME 21.65% 26.77% 31.29% 34.59% 30.79% 29.02% 32.69%
83
Balance Sheet Analysis
In order to accurately determine the future success of Apache, we began by
creating a common size balance sheet. This gave us an idea of how Apache preformed
in comparison the industry. By using industry averages, we were able to have a point
of reference when comparing the numbers to Apache. The results gave us a better
idea of which ratios would give the best estimations in forecasting. When creating our
common size balance sheet, we compared all of the assets portion’s line items to total
assets to base our estimations. The industry average did not seem reliable because
there is little consistency within the oil industry. Based on this, we decided to use our
own growth rate to remain consistent with Apache’s acquisitions and losses from
natural disasters.
We fist decided to forecast out total assets, and then determine what portions
should go to current and non current assets. Our asset turnover ratio was a consistent
.34 through the past 5 years. Due to the consistency, we decided to use this number
when forecasting out total assets. Total assets were forecasted out by dividing the
already forecasted sales from the income statement by our asset turnover percentage.
With our reliable forecasted total assets, we then determined the amount of total assets
that should be allotted into total current and non current assets.
Current assets were forecasted out using a 9.5% growth rate, which is on target
with the industry average. This industry average is consistent with inventory and
accounts receivable forecasts. Accounts receivable was forecasted using the accounts
receivable turnover ratio. We used our forecasted sales from the income statement as
a basis for the forecasting. Accounts receivable turnover was 5.1 because it was the
average of the last two years. Forecasted sales divided by a consistent 5.1 gave us the
most reliable forecast. For inventory, we used a inventory turnover rate of 7. This was
the average of the last two years, and seemed to be a good fit for the company. The
reason we based forecasting off the last two years was because of several hurricanes
as well as acquisitions which made the ratios fluctuate greatly. The past two years
84
proved to be a more stable benchmark for our company. Property, plant, and
equipment was forecasted at a consistent percentage as well as total non current
assets. This was based on the percentage left over from total assets minus total
current assets.
For the equity section of the balance sheet, we first forecasted out the retained
earnings section. We did this by adding the previous year’s retained earnings to that
year’s net income and then subtracting out the dividends paid. Stockholder’s equity
was then forecasted out based on the retained earnings. We took the previous year’s
equity and added that year’s retained earnings less the previous year’s retained
earnings.
We then found liabilities based on assets equals total liabilities plus total
stockholder’s equity. This equation states that liabilities must be equal to equity
subtracted from assets and therefore, total liabilities should balance. We forecasted
current liabilities using the current ratio. Because of Apache’s rapid growth in the past
few years, long-term debt had a consistently high percentage. Based on this, we
determined this percentage should be used to forecast because of our rapid growth
plan. Once we found current liabilities, we were able to determine the amount of non-
current liabilities.
85
APACHE CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEET
Actual Financial Statements Forecast Financial Statements2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
December 31,
2002 2003 2004 2005 2006ASSETS (In thousands)CURRENT ASSETS:Cash and cash equivalents 51,886 33,503 111,093 228,860 140,524 Receivables, net of allowance 527,687 639,055 939,736 1,444,545 1,651,664 1,739,018 1,860,750 1,991,002 2,130,372 2,279,498 2,439,063 2,609,798 2,792,483 2,987,957 3,197,114 Inventories 109,204 125,867 157,293 209,670 320,386 1,266,999 1,355,689 1,450,587 1,552,128 1,660,777 1,777,032 1,901,424 2,034,524 2,176,940 2,329,326 Drilling advances 45,298 58,062 82,889 146,047 78,838 Prepaid assets and other 32,706 42,585 57,771 132,955 139,756
159,103 Total Current Assets 766,781 899,072 1,348,782 2,162,077 2,490,271 2,726,847 2,985,897 3,269,557 3,580,165 3,920,281 4,292,708 4,700,515 5,147,064 5,636,035 6,171,458
PROPERTY AND EQUIPMENT:Total PP&E 8,465,585 11,260,085 13,860,359 16,791,340 21,346,252 21,559,715 21,775,312 21,993,065 22,212,995 22,435,125 22,659,477 22,886,071 23,114,932 23,346,081 23,579,542
OTHER ASSETS:Goodwill, net 189,252 189,252 189,252 189,252 189,252 Deferred charges and other 38,233 67,717 104,087 129,127 282,400
Total Non-Current Assets 227,485 256,969 293,339 318,379 471,652 650,880 898,214 1,239,535 1,710,559 2,360,571 3,257,588 4,495,472 6,203,751 8,561,177 11,814,424
Total Assets 9,459,851 12,416,126 15,502,480 19,271,796 24,308,175 24,378,762 26,085,275 27,911,244 29,865,031 31,955,584 34,192,475 36,585,948 39,146,964 41,887,252 44,819,359
Working Capital 234,546 78,694 65,891 (24,487) (1,321,341)
LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIES:Accounts payable.......................................... 214,288 300,598 542,074 714,598 644,889 Accrued operating expense................................. 47,382 72,250 80,741 66,609 70,551 Accrued exploration and development....................... 146,871 212,028 341,063 460,203 534,924 Accrued compensation and benefits......................... 32,680 56,237 83,636 125,022 127,779 Accrued interest.......................................... 30,880 32,621 32,575 32,564 30,878 Accrued income taxes...................................... 44,256 18,936 78,042 120,153 2,133 Oil and gas derivative instruments........................ - 63,542 21,273 Current Debt 274 1,802,094 Asset retirement obligation 93,557 376,713 Derivative instruments 256,115 70,128 Other..................................................... 15,878 64,166 103,487 317,469 151,523
Total Current Liabilities 532,235 820,378 1,282,891 2,186,564 3,811,612 3,895,495 4,265,567 4,670,796 5,114,522 5,600,402 6,132,440 6,715,021 7,352,949 8,051,479 8,816,369
LONG-TERM DEBT...................................(notes)........ 2,158,815 2,326,966 2,588,390 2,191,954 2,019,831 2,221,814 2,443,996 2,688,395 2,957,235 3,252,958 3,578,254 3,936,079 4,329,687 4,762,656 5,238,921 Total Long Term Liabilities 1,407,895 2,735,984 3,426,778 4,352,063 5,285,679 5,814,247 6,395,672 7,035,239 7,738,763 8,512,639 9,363,903 10,300,293 11,330,322 12,463,355 13,709,690
PREFERRED INTERESTS OF SUBSIDIARIES......................... 436,626 - - - -
Total Liabilities 4,535,571 5,883,328 7,298,059 8,730,581 11,117,122 8,529,100 7,376,713 6,131,323 4,788,271 3,342,573 1,788,896 121,534 (1,665,619) (3,579,097) (5,625,890)
COMMITMENTS AND CONTINGENCIES (Note 11)SHAREHOLDERS' EQUITY:Preferred stock, no par value, 5,000,000 sharesauthorized -- Series B, 5.68% Cumulative PreferredStock, 100,000 shares issued and outstanding............ 98,387 98,387 98,387 98,387 98,387 Common stock, $0.625 par, 430,000,000 shares authorized,332,509,478 and 310,929,080 shares issued,respectively............................................ 194,331 207,818 209,320 210,623 212,365 Paid-in capital........................................... 3,427,450 4,038,007 4,106,182 4,170,714 4,269,795 Retained earnings......................................... 1,427,607 2,445,698 4,017,339 6,516,863 8,898,577 11,557,186 14,416,086 17,487,445 20,784,284 24,320,534 28,111,102 32,171,937 36,520,107 41,173,872 46,152,773 Treasury stock, at cost, 8,012,302 and 8,422,656 shares,respectively............................................ (110,559) (105,169) (97,325) (89,764) (256,739) Accumulated other comprehensive loss...................... (112,936) (151,943) (129,482) (365,608) (31,332)
Total Shareholders Equity 4,924,280 6,532,798 8,204,421 10,541,215 13,191,053 15,849,662 18,708,562 21,779,921 25,076,760 28,613,010 32,403,578 36,464,413 40,812,583 45,466,348 50,445,249
Total Liability and Equity 9,459,851 12,416,126 15,502,480 19,271,796 24,308,175 24,378,762 26,085,275 27,911,244 29,865,031 31,955,584 34,192,475 36,585,948 39,146,964 41,887,252 44,819,359
86
Common Size Balance Sheet Actual Financial Statements2002 2003 2004 2005 2006 AVG 05-06 AVG
ASSETSCURRENT ASSETS:Cash and cash equivalents 0.55% 0.27% 0.72% 1.19% 0.58% 0.66% 0.88%Receivables, net of allowance 5.58% 5.15% 6.06% 7.50% 6.79% 6.22% 7.15%Inventories 1.15% 1.01% 1.01% 1.09% 1.32% 1.12% 1.20%Drilling advances 0.48% 0.47% 0.53% 0.76% 0.32% 0.51% 0.54%Prepaid assets and other 0.35% 0.34% 0.37% 0.69% 0.57% 0.47% 0.63%
0.00% 0.00% 0.00% 0.00% 0.65% 0.13% 0.33%Total Current Assets 8.11% 7.24% 8.70% 11.22% 10.24% 9.10% 10.73%
PROPERTY AND EQUIPMENT:
Total PP&E 89.49% 90.69% 89.41% 87.13% 87.82% 88.91% 87.47%
OTHER ASSETS:Goodwill, net 2.00% 1.52% 1.22% 0.98% 0.78% 1.30% 0.88%Deferred charges and other 0.40% 0.55% 0.67% 0.67% 1.16% 0.69% 0.92%
Total Non-Current Assets 2.40% 2.07% 1.89% 1.65% 1.94%
Total Assets 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
Working Capital
LIABILITIES AND SHAREHOLDERS' EQUITYCURRENT LIABILITIES:Accounts payable.......................................... 4.72% 5.11% 7.43% 8.18% 5.80% 6.25% 6.99%Accrued operating expense................................. 1.04% 1.23% 1.11% 0.76% 0.63% 0.96% 0.70%Accrued exploration and development....................... 3.24% 3.60% 4.67% 5.27% 4.81% 4.32% 5.04%Accrued compensation and benefits......................... 0.72% 0.96% 1.15% 1.43% 1.15% 1.08% 1.29%Accrued interest.......................................... 0.68% 0.55% 0.45% 0.37% 0.28% 0.47% 0.33%Accrued income taxes...................................... 0.98% 0.32% 1.07% 1.38% 0.02% 0.75% 0.70%Oil and gas derivative instruments........................ 0.00% 1.08% 0.29% 0.00% 0.00% 0.27% 0.00%Current Debt 0.00% 0.00% 0.00% 0.00% 16.21% 3.24% 8.11%Asset retirement obligation 0.00% 0.00% 0.00% 1.07% 3.39% 0.89% 2.23%Derivative instruments 0.00% 0.00% 0.00% 2.93% 0.63% 0.71% 1.78%Other..................................................... 0.35% 1.09% 1.42% 3.64% 1.36% 1.57% 2.50%
Total Current Liabilities 11.73% 13.94% 17.58% 25.04% 34.29% 20.52% 29.67%
LONG-TERM DEBT...................................(notes)........ 47.60% 39.55% 35.47% 25.11% 18.17% 33.18% 21.64%
DEFERRED CREDITS AND OTHER NONCURRENT LIABILITIES:Total Long Term Liabilities 31.04% 46.50% 46.95% 49.85% 47.55% 44.38% 48.70%
PREFERRED INTERESTS OF SUBSIDIARIES......................... 9.63% 0.00% 0.00% 0.00% 0.00% 1.93% 0.00%
Total Liabilities 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
COMMITMENTS AND CONTINGENCIES (Note 11)SHAREHOLDERS' EQUITY:Preferred stock, no par value, 5,000,000 sharesauthorized -- Series B, 5.68% Cumulative PreferredStock, 100,000 shares issued and outstanding............ 2.00% 1.51% 1.20% 0.93% 0.75% 1.28% 0.84%Common stock, $0.625 par, 430,000,000 shares authorized,332,509,478 and 310,929,080 shares issued,respectively............................................ 3.95% 3.18% 2.55% 2.00% 1.61% 2.66% 1.80%Paid-in capital........................................... 69.60% 61.81% 50.05% 39.57% 32.37% 50.68% 35.97%Retained earnings......................................... 28.99% 37.44% 48.97% 61.82% 67.46% 48.94% 64.64%Treasury stock, at cost, 8,012,302 and 8,422,656 shares,respectively............................................ -2.25% -1.61% -1.19% -0.85% -1.95% -1.57% -1.40%Accumulated other comprehensive loss...................... -2.29% -2.33% -1.58% -3.47% -0.24% -1.98% -1.85%
Total Shareholders Equity 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
87
Statement of Cash Flows
The statement of cash flow forecasting process was started by creating a common size
statement of cash flows. From here, we were able to spot any patterns and identify consistency
within the statement. We computed the manipulation diagnostic ratios which consisted of: CCFO/NI,
CFFO/OI, and CFFO/Sales. After examining these ratios, we found the most consistency in
CFFO/Sales. We then used this to aid in our forecasting of net cash provided by operating activities,
and net income. Cash flows from investing activities was forecasted out by the percentage of change
in property, plant and equipment, PP&E. This is a more accurate forecast because the balance sheet
generalized total assets and PP&E was more specific. Free cash flows was then determined by
comparing cash flows from operations and cash flows from investing activities. Free cash flows to
the firm were forecasted out negative out until 2011, and then went positive. This signals the mass
acquisitions are now paying off, and the company is benefiting financially. After forecasting these
cash flows out, we noticed a trend which proves reliability and legitimacy.
88
APACHE STATEMENT OF CASH FLOWS Actual Financial Statements Forecast Financial Statements2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
(IN THOUSANDS)CASH FLOWS FROM OPERATING ACTIVITIES:Net income 554,329 1,121,885 1,668,754 2,623,730 2,552,451 2,807,696 3,088,466 3,397,312 3,737,044 4,110,748 4,521,823 4,974,005 5,471,405 6,018,546 6,620,401 Adjustments to reconcile net income to netcash provided by operating activities:Depreciation, depletion and amortization 843,879 1,073,286 1,222,152 1,415,682 1,816,359Provision for deferred income taxes 137,672.00 546,357 444,906 598,927 751,457Asset retirement obligation accretion - 37,763 46,060 53,720 88,931Amortization of deferred loan costs 1,859 2,163 2,471 3,748 (173,545)International impairments 19,600 12,813 - - Cumulative effect of change in accountingprinciple, net of income tax - (26,632) 1,317 - Other 9,531 32,923 39,694 48,526 32,380Changes in operating assets and liabilities,net of effects of acquisitions:(Increase) decrease in receivables (122,830) (94,295) (296,383) (504,038) (153,616)(Increase) decrease in inventories 717 (4,216) (659) 11,295 10,238(Increase) decrease in drilling advancesand other (26,116) (19,881) (35,761) (144,154) 66,323(Increase) decrease in deferred charges andother 496 (29,520) (35,328) (26,454) (126,869)Increase (decrease) in accounts payable 32,219 68,176 182,454 97,447 (136,663)Increase (decrease) in accrued expenses -16595 11,227 28,431 214,491 (475,021)Increase (decrease) in advances from gas (14,574) (25,601)purchasers (16,246) (18,331) (22,108)Increase (decrease) in deferred credits andnoncurrent liabilities (39,469) (9,903) (18,258) (38,542) 86,082
NET CASH PROVIDED BY OPERATINGACTIVITIES 1,380,718 2,705,900 3,231,519 4,332,270 4,312,906 4,724,604 5,055,326 5,409,199 5,787,843 6,192,992 6,626,502 7,090,357 7,586,682 8,117,749 8,685,992
CFFO/Sales 0.5394 0.6458 0.6060 0.5712 0.5203 CFFO/Operating Income 19.3608 3.1551 2.2427 1.5525 1.9665 CFFO/Net Income 2.4908 2.4119 1.9365 1.6512 1.6897
CASH FLOWS FROM INVESTING ACTIVITIES:Additions to property and equipment (1,616,936) (2,456,488) (3,715,856) (3,891,639)Acquisition of ExxonMobil properties - - (348,173) - Acquisition of Anadarko properties - - (531,963) - Acquisition of BP properties (1,140,156) - - (833,820)Acquisition of Shell properties (203,033) - - Acquistion of Pioneers Argentine Operations (704,809)Acqustition of Amerada Hess Properties (229,134)Acquistion of Pan American Properties (396,056)Proceeds from China Divestiture 264,081Proceeds from sales of oil and gas properties 7,043 58,944 4,042 79,663 4,740 Proceeds from Egypt 409,203Additions to gas gathering, transmition, and processing facilities (248,589)Other (37,520) (57,576) (78,431) (95,649) (149,559)
NET CASH USED IN INVESTING ACTIVITIES (1,236,007) (2,958,757) (3,411,013) (3,731,842) (5,775,582) (5,891,094) (6,008,916) (6,129,094) (6,251,676) (6,376,709) (6,504,243) (6,634,328) (6,767,015) (6,902,355) (7,040,402)
CASH FLOWS FROM FINANCING ACTIVITIES:Long-term borrowings 1,467,929 1,780,870 544,824 153,368 1,779,963Payments on long-term debt (1,553,471) (1,613,362) (283,400) (549,530) (150,266)Dividends paid (68,879) (72,832) (90,369) (117,395) (154,143)Common stock activity 30,708 583,837 21,595 18,864 31,963Treasury stock activity, net 1,991 4,378 12,472 6,620 (166,907)Cost of debt and equity transactions (6,728) (5,417) (2,303) (861) (2,061)Repurchase of preferred interests ofsubsidiaries - (443,000) - - Other - 54,265 6,273 35,791
Free Cash Flows to Firm 144,711 (252,857) (179,494) 600,428 (1,462,676) (1,166,490) (953,589) (719,895) (463,833) (183,717) 122,258 456,028 819,667 1,215,394 1,645,590
NET CASH PROVIDED BY (USED IN) FINANCINGACTIVITIES (128,450) 234,474 257,084 (482,661) 1,374,340
NET INCREASE (DECREASE) IN CASH AND CASHEQUIVALENTS 16,261 (18,383) 77,590 117,767 (88,336)CASH AND CASH EQUIVALENTS AT BEGINNING OF Y 35,625$ 51,886 33,503 111,093 228,860
CASH AND CASH EQUIVALENTS AT END OF YEAR 51,886$ 33,503$ 111,093$ 228,860$ 140,524$
89
COMMON SIZE STATEMENT OF CASH FLOWS Actual Financial Statements2002 2003 2004 2005 2006 AVG 05-06 AVG
CASH FLOWS FROM OPERATING ACTIVITIES:Net income 40.15% 41.46% 51.64% 60.56% 59.18% 50.60% 59.87%Adjustments to reconcile net income to netcash provided by operating activities:Depreciation, depletion and amortization 61.12% 39.66% 37.82% 32.68% 42.11% 42.68% 37.40%Provision for deferred income taxes 9.97% 20.19% 13.77% 13.82% 17.42% 15.04% 15.62%Asset retirement obligation accretion 0.00% 1.40% 1.43% 1.24% 2.06% 1.22% 1.65%Amortization of deferred loan costs 0.13% 0.08% 0.08% 0.09% -4.02% -0.73% -1.97%International impairments 1.42% 0.47% 0.00% 0.00% 0.00% 0.38% 0.00%Cumulative effect of change in accountingprinciple, net of income tax 0.00% -0.98% 0.04% 0.00% 0.00% -0.19% 0.00%Other 0.69% 1.22% 1.23% 1.12% 0.75% 1.00% 0.94%Changes in operating assets and liabilities,net of effects of acquisitions:(Increase) decrease in receivables -8.90% -3.48% -9.17% -11.63% -3.56% -7.35% -7.60%(Increase) decrease in inventories 0.05% -0.16% -0.02% 0.26% 0.24% 0.07% 0.25%(Increase) decrease in drilling advancesand other -1.89% -0.73% -1.11% -3.33% 1.54% -1.10% -0.89%(Increase) decrease in deferred charges andother 0.04% -1.09% -1.09% -0.61% -2.94% -1.14% -1.78%Increase (decrease) in accounts payable 2.33% 2.52% 5.65% 2.25% -3.17% 1.92% -0.46%Increase (decrease) in accrued expenses -1.20% 0.41% 0.88% 4.95% -11.01% -1.19% -3.03%Increase (decrease) in advances from gas -1.06% 0.00% 0.00% 0.00% -0.59% -0.33% -0.30%purchasers 0.00% -0.60% -0.57% -0.51% 0.00% -0.34% -0.26%Increase (decrease) in deferred credits andnoncurrent liabilities -2.86% -0.37% -0.56% -0.89% 2.00% -0.54% 0.55%
NET CASH PROVIDED BY OPERATINGACTIVITIES 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%
90
Conclusion
After forecasting, we determined that the profitability of Apache realigned itself
with the industry average. The hurricane in 2005 and the large acquisition in 2004,
threw off their consistency in assets. Overtime, our forecasts have determined that it
will eventually catch up to that of the industry. Apache is maintaining consistent
growth throughout the years, making the company overall more profitable for the next
10 years.
Analysis of Valuations
Valuations are essential when determining the stock price of a company. The
accuracy of the stock price depends on the valuation method used. Some valuations
are based on industry averages, while others are based on forecasted figures. The
method of comparables uses the industry average of firm’s competitors in order to
value the stock price. Intrinsic valuations use forecasting and assumptions to
determine the stock price per share. Overall, the intrinsic valuation is the most reliable
because it examines many different angles of the company.
Method of Comparables
Price
Trailing Price / Equity $82.20
Forwarding Price / Equity $93.41
Price / Book $103.29
Dividend / Yield $72.92
Price Earnings Growth $59.88
Price / EBITDA $75.65
Enterprise Value / EBITDA $97.24
Price/Free Cash Flows N/A
91
The method of comparables is a technique that measures the price per share of
a company’s stock. Under this method, we computed the ratios in the summary table
and then found the industry averages of Apache’s competitors. Apache’s competitors
consist of Occidental, Anadarko, Devon, and XTO. The industry averages are then used
in several calculations to determine Apache’s price per share of stock. After this,
evaluating Apache’s stock as overvalued, undervalued or fairly valued is obvious. The
outcome of our method of comparables calculations are discussed below.
TRAILING PRICE TO EARNINGS PRICE EPS P/E
AVERAGE P/E
APA SHARE PRICE
Apache 99.18 7.51 10.68 10.95 82.20
Occidental 66.76 4.8 12.02
Anadarko 57.24 10.39 4.84
Devon 91.31 6.41 13.08
XTO 65.68 5.01 13.84
Trailing Price to Earnings
To find the trailing Price to Earnings we first had to compute Earnings per Share
and Price to Earnings for Apache and its competitors. To compute these ratios we used
the stock prices, number of shares outstanding, and net income from each of the
company’s most recent 10K. After computing each company’s price to earnings ratio
we took an average of our competitor’s ratios by adding the four ratios together and
92
then dividing this number by four. To find the value of Apaches stock based on the
trailing price to earnings model we multiplied the average Price to Earnings ratio of our
competitors by Apaches Earnings per Share. This gave us a value price of $82.20 per
share of Apaches stock. This model implies that Apaches current stock price per share
of $99.18 is overvalued as of November 1, 2007. Apaches Price to Earnings ratio of
10.68 is also close to the average Price to Earnings of our competitors of 10.95, but if
Anadarko’s outlier were taken out the average would be higher. This would imply that
investors are expecting Apaches earnings growth to be lower than the rest of the
industry.
FORWARD PRICE TO EARNINGS PRICE EPS P/E
AVERAGE P/E
APA SHARE PRICE
Apache 99.18 6.67 14.15 14.01 93.41
Occidental 66.76 5.77 12.32
Anadarko 57.24 12.124 18.28
Devon 91.31 6.356 11.25
XTO 65.68 4.382 14.17
Forwarding Price to Earnings
In order to calculate the Forwarding Price to Earnings ratio we needed to find
each company’s Earnings per Share as well as their Price to Earnings ratio. All of this
information was found on Yahoo Finance. Apache’s November 1, 2007 price per share
93
along with all competitors was also found on Yahoo Finance. To find the Price to
Earnings ratio we simply divided the Price per Share by Earnings per Share. After
finding the Price to Equity ratios for each company, we were able to compute the
industry average. The industry average consisted of adding all of Apache’s competitors
Price to Earnings ratio and dividing the sum by four. After this, we computed Apache’s
price per share by multiplying the industry average by Apache’s Earnings per Share.
This resulted in a stock price of $93.41, when compared to Apache’s stock price on
November 1, 2007 of $99.18; one can see the two are very close. By way of the
Forwarding Price to Earnings model, we are able to conclude that Apache’s stock is
fairly valued.
PRICE TO BOOK PPS BPS P/B INDUSTRY AVERAGE
APA SHARE PRICE
Apache 99.18 43.81 2.26 2.36 103.29
Occidental 66.76 26.43 2.53
Anadarko 57.24 34.56 1.66
Devon 91.31 46.84 1.95
XTO 65.68 19.91 3.30
94
Price to Book
The price to book ratio, is used to measure a stocks market value to its book
value. The stock price per share was located using the price as of November 1, 2007.
We found these values for our company as well as our competitors using Yahoo
Finance. In order to find the Price to Book value we divided the price per share by the
book value per share. This gave us the price to book value. After this, we took the
industry average, which included the average of our four competitors and did not
include Apache’s price to book ratio. Finally, we multiplied the industry average by
Apache’s Book value per share. This computation gave us a result of $82.20 for the
price per share of Apache’s stock. According to the current stock price of Apache,
$103.29, this indicates that it is fairly valued. This was no surprise because of the close
proximity of Apache’s price to book ratio compared to the industry price to book ratio.
DIVIDEND YIELD PPS DPS D/P INDUSTRY AVERAGE
APA SHARE PRICE
Apache 99.18 0.15 0.0015 0.0021 72.92
Occidental 66.76 0.22 0.0033
Anadarko 57.24 0.09 0.0016
Devon 91.31 0.14 0.0015
XTO 65.68 0.12 0.0018
95
Dividend Yield
Using the dividend yield, informs investors and managers the amount of
dividends the company pays out based on its stock price per share. The dividends were
found using Yahoo Finance, and then the ratio Dividend to Price was found. Once this
was done, we were able to compute the industry average. The industry average
consisted adding the Dividend to Price ratio of all of Apache’s competitors, and then
dividing by four. Apache’s stock price was computed by dividing their dividend per
share, as of November 1, 2007, by the industry average. The price per share ended up
being $72.92, which makes the current stock price overvalued when comparing it with
its current stock price of $99.18.
Price Earnings Growth
Price Earnings Growth, or PEG, is a measure of a stocks overall value while
considering earnings growth. Using Yahoo Finance, we were able to find the PEG for all
of Apache’s competitors. By adding each company, with the exception of Apache, and
dividing by all four of the competitors we were able to determine the industry average.
From here, we were able to conclude Apache’s stock price per share by multiplying the
industry average by Apache’s total revenue growth rate of 7%, and then multiplying
that value by Apache’s EPS. The stock price per share of Apache based on this model is
$59.88. Clearly, this price is much lower than the November 1, 2007 stock price of
$99.18. We can conclude the current price of Apache’s stock is overvalued.
PRICE EARNINGS GROWTH PPS EPS PEG
INDUSTRY AVERAGE
APA SHARE PRICE
Apache 99.18 6.67 1.78 1.28 59.88
Occidental 66.76 5.77 1.18
Anadarko 57.24 12.124 1.95
Devon 91.31 6.356 1.27
XTO 65.68 4.382 0.73
96
PRICE TO EBITDA PPS
EBITDA (IN BILLIONS) P/EBITDA
INDUSTRY AVERAGE
APA SHARE PRICE
Apache 99.18 6.77 14.65 11.17 75.65
Occidental 66.76 9.38 7.12
Anadarko 57.24 6.74 8.49
Devon 91.31 7.51 12.16
XTO 65.68 3.88 16.93
Price to EBITDA
Price to EBITDA takes into consideration the price per share compared to
Earnings before interest, taxes, depreciation, and amortization. We found Apache’s
EBITDA on the December 31, 2006 10-K and recorded it on the graph above as a
decimal of a billion. From here we were able to compute the Price to EBITDA ratio by
dividing the price per share by their EBITDA. After this, we were able to find the
industry average by adding Apache’s competitors Price to EBITDA ratio, taking that sum
and dividing it by four. This gave us an industry average of 11.17 which we used in
calculating the price per share of Apache’s stock. Along with the Industry average, we
used Apache’s EBITDA and multiplied the two. The product of this gave us our price
per share of $75.65. This too makes Apache’s stock overvalued.
97
ENTERPRISE VALUE TO EBITDA EV
EBITDA (IN BILLIONS) EV/EBITDA
INDUSTRY AVERAGE
APA SHARE PRICE
Apache 43.78 6.77 6.47 6.37 97.24
Occidental 58.26 9.38 6.21
Anadarko 39.89 6.74 5.92
Devon 43.06 7.51 5.73
XTO 29.52 3.88 7.61
Enterprise Value to EBITDA
Enterprise value to EBITDA, earnings before interest, taxes, depreciation, and
amortization, takes into account companies Enterprise Value based on its EBITDA. We
found Apache’s competitors Enterprise Value as well as EBITDA on Yahoo Finance. For
Apache, we located their EBITDA on the December 31, 2006 10-K. The Enterprise
Value was computed by adding Apache’s price per share with the book value of
liabilities, and subtracting cash and cash equivalents. This resulted in Apache’s
Enterprise Value being 43.78. Next, we divided Enterprise Value by EBITDA in order to
find Enterprise Value to EBITDA. After this, we calculated the industry average by
adding Apache’s competitors Enterprise Value to EBITDA ratios and dividing it by four.
The stock price consisted of first multiplying the industry average by Apache’s EBITDA
which resulted in $43.1 billion. Then, we subtracted Apache’s book value of liabilities,
$11.0, and added cash and cash equivalents, $0.140 billion. We ended up with $34.16,
and then divided this number by the number of shares Apache has outstanding,
0.330737 billion. After these calculations were complete, the formula gave us a stock
98
price of $97.24. Obviously, this is extremely close to the actual November 1, 2007
stock price of Apache. According to this model, our stock price is fairly valued. This
was not surprising, because our Enterprise Value to EBITDA ratio is particularly close to
the industry average.
Price to Free Cash Flows
The Price to Free Cash Flows ratio compares a company’s market value, or price,
to its free cash flows. To compute this, we added Apache’s Operating Cash Flows,
$4.31 billon, with its Investing Cash Flows, $(5.78) billion. We ended up with a free
cash flow total of $(1.46) billion. Due to the negative cash flow, we decided to throw
this model out because of its lack of value. If we were to continue to compute the Price
to Free Cash Flow ratio, we would gather our competitors Operating Cash Flows and
Investing Cash Flows. After adding the two, we would divide the company’s November
1, 2007 stock price by the free cash flow. Then we would determine the price per
share of the stock. However, due to the negative free cash flow of Apache, this model
will not be a valid indicator of our stock price per share.
Conclusion
According to most of the method of comparable computations, Apache is an
overvalued company. Only two models, Forwarding Price to Equity and Enterprise
Value to EBITDA, gave us a result which reported that Apache was fairly valued. Using
the method of comparables to attempt to find the price per share of stock is not the
most reliable method. Also, the method of comparables does not take into account that
you may operate or be different from your competitors. This is evident when
computing the industry average based solely on your competitors figures. The Intrinsic
Valuation is a much more reliable and sensible
Cost of Equity
The cost of equity, ke, is determined by using the CAPM model. The cost of
equity is an estimation of the firm’s expected return on stock or securities for the
99
current year. In order to compute the cost of equity using the CAPM model, we had to
gather the risk-free rate, the expected market return, and also Apache’s beta. We
found Apache’s beta from a regression analysis. The beta with the highest r-squared
was used because it is correct the most amount of time. The risk-free rate was
obtained from the St. Louis Federal Reserve website, where Treasury bill rates are
listed. The market risk premium was calculated by subtracting the risk-free rate from
the S&P 500 rate of returns.
We used regression data analysis to compute the beta and r-squared for 72, 60,
48, 36, and 24 month periods. These time intervals are important because they assess
the overall stability of beta. Using a large range of intervals cuts out any outliers and
inconsistencies. We ran a regression for all of these periods using the 3 month, 6
month, 2 year, 5 year, 7 year, and 10 year Treasury bill rates. The beta in the 3
month, 6 month, 2 year, and 5 year ranges was extremely consistent, at an almost
constant 1.60. The beta in years 7 and 10 was also constituent holding at a .14. The
highest r-squared was in the 24 month period in every regression we computed. Using
the CAPM model, we were able to determine that the cost of equity, ke, to be 15.73%.
100
Regression Analysis
3 MO Rate 72 60 48 36 24 RF 3.99 3.99 3.99 3.99 3.99 R2 -0.01 -0.02 0.00 0.15 0.19 Beta -0.31 -0.33 1.31 1.42 1.60 ke 3.99 3.99 4.00 4.00 4.01 6 MO Rate 72 60 48 36 24 RF 4.20 4.20 4.20 4.20 4.20 R2 -0.01 -0.02 0.00 0.15 0.19 Beta -0.31 -0.33 1.31 1.42 1.60 ke 4.20 4.20 4.21 4.21 4.22 2 YR Rate 72 60 48 36 24 RF 4.01 4.01 4.01 4.01 4.01 R2 -0.01 -0.01 0.00 0.15 0.19 Beta -0.31 -0.34 1.29 1.41 1.60 ke 4.01 4.01 4.02 4.02 4.03 5 YR Rate 72 60 48 36 24 RF 4.20 4.20 4.20 4.20 4.20 R2 -0.01 -0.01 0.00 0.14 0.19 Beta -0.32 -0.35 1.25 1.41 1.59 ke 4.20 4.20 4.21 4.21 4.22 7 YR Rate 72 60 48 36 24 RF 4.33 4.33 4.33 4.33 4.33 R2 -0.01 -0.01 0.00 0.14 0.19 Beta -0.01 -0.01 0.02 0.12 0.14 Ke 4.33 4.33 4.33 4.33 4.33 10 YR Rate 72 60 48 36 24
101
RF 4.52 4.52 4.52 4.52 4.52 R2 -0.01 -0.01 0.00 0.14 0.19 Beta -0.01 -0.01 0.02 0.12 0.14 ke 4.52 4.52 4.52 4.52 4.52
Cost of Debt
To find the cost of debt for Apache Corp. we had to find an interest rate for all
current and long term debt. To find the rate for long term debt we were able to take a
weighted average of the rates for their outstanding bonds, debentures, lines of credit
and commercial paper. Apache did a good job of disclosing their long term debt in their
annual report and provided rates for each item along with their maturities. For long
term debt we came up with a weighted average rate of 5.83%. For Apaches current
liabilities, such as their accounts payable, we used the one month AA financial
commercial paper rate of 4.76%. We also needed to find a rate for Apaches deferred
income taxes since it is a main contributor to their overall debt. For this rate we chose
to use the one year government risk free rate of 4.10%. After applying each rate to the
designated debt we took a weighted average of the total debt and came up with a cost
of debt of 4.74%.
Weighted Average Cost of Capital
To find the weighted average cost of capital (WACC) we used the following
formula: E/V * Re + D/V * Rd * (1-Tc). Where Re is the cost of equity and Rd is the
cost of debt both of which were calculated earlier. E is the value of the firm’s equity
and D is the value of the firm’s debt. V is computed by adding E and D together. After
plugging Apache’s computed numbers into the WACC formula we found their before tax
weighted average cost of capital to be 4.34%. Using a 35% corporate income tax rate
we computed the after tax weighted cost of capital to be 3.59%.
102
Intrinsic Valuations
The intrinsic valuation methods used to value Apache Oil Corporation were the
discount dividend model, the free cash flows model, the residual income model, and the
long run residual income model. These models are superior to the method of
comparables models because they examine many different angles of the company.
Using these models, it is easier to get an overall view of Apache Oil.
Discount Dividends Model
Shareholders receive value of a firm through dividends. The discount dividends
model shows the value of the future dividends, which is also how shareholders
determine the amount of value they will receive from the firm. The model forecasts out
future dividends and discounts them back to the present. If the value given by the
discount dividends model is higher than the current stock price, then the company’s
stock is undervalued.
The discount dividends model is only as reliable as the assumptions used. The
model requires assumed discount prices, as well as growth rates. In reality, it is not
likely that a company’s dividends will grow at a constant growth rate indefinitely. For
this reason, this model cannot be extremely dependable.
Sensitivity Analysis
Growth 0 0.02 0.04 0.06 0.08 0.09 0.1 $11.06 $12.45 $14.76 $19.39 $33.27 $61.02 0.12 $8.99 $9.78 $10.95 $12.92 $16.84 $20.76
ke 0.14 $7.55 $ 8.02 $8.69 $9.69 $11.36 $12.69 0.157 $6.62 $6.95 $7.39 $8.00 $8.94 $9.61 0.18 $5.67 $5.88 $6.14 $6.48 $6.97 $7.29 0.2 $5.04 $5.18 $5.35 $5.57 $5.87 $6.06
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
103
To begin valuing Apache Oil Corporation using the discount dividends model, the
first step was to forecast out the dividend prices. There was a consistent growth rate
of 25% in the dividend prices through 2002 to 2006. Although the growth rate was
constant, we decided that a 25% growth rate over the next 10 years would be too
large. Instead, we grew the dividend price at $.08 per year. This growth seemed to be
more realistic and could provide us with the most reliable valuations. We then
discounted the dividends back to the present value and found the sum of these. We
then used the perpetuity equation to value the firm from beyond the forecasted out 10
years. To determine the final value of the company, we added the value of the firm for
the next 10 years with the value of the perpetuity.
The results from the discount dividends model show that Apache Oil is largely
undervalued. This means that there is a very small amount of dividends that are being
paid out to shareholders, which is not beneficial for them. The reliability of this model
could have been compromised by our assumptions, but there is no way of knowing this.
In order for Apache’s stock to be fairly valued, the cost of equity would need to be
Free Cash Flows Model
To create the free cash flows model, the first step was to calculate the annual
free cash flows. This was done by the cash flows from investing activates from cash
flows from operating activities. We then calculated the present value factor. This was
used in calculating the present value of the annual free cash flows by multiplying the
present value factor by the annual free cash flow. We added all of these together to
get the total present value of annual free cash flows. The continuing terminal value
perpetuity was then computed by dividing year 10’s cash flow from investing activities
by the initial before tax WACC minus the growth rate. This number was multiplied by
year 10’s present value factor to get the present value of terminal value perpetuity.
The value of the firm was then computed by adding together the total present value of
total free cash flows and the the present value of terminal value perpetuity. The
104
estimated market value of equity was then computed by the book value of liabilities
from the value of the firm. The estimated price per share was the calculated by
dividing the estimated market value of equity by the number of shares outstanding.
Finally, the time consistent implied price, which are the numbers that are included in
the sensitivity analysis, are computed by multiplying the estimated price per share by
one plus the initial before tax WACC and taking that forward 2 months.
Sensitivity Analysis
Growth 0 0.02 0.03 0.04 0.045 0.05 $ 7.64 $ (178.89) $ (412.05) $ (1,111.55) $ (2,510.53) 0.06 $ 62.23 $ (43.81) $ (149.85) $ (361.93) $ (574.00)
WACC 0.07 $ 96.56 $ 30.36 $ (27.56) $ (124.09) $ (201.32) 0.0852 $ 126.84 $ 90.62 $ 62.67 $ 22.35 $ (5.33) 0.09 $ 132.91 $ 102.35 $ 79.43 $ 47.34 $ 25.95 0.1 $ 141.96 $ 119.99 $ 104.30 $ 83.38 $ 70.17
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
Our sensitivity analysis shows that Apache’s stock is overvalued. This model has
the most fairly valued share prices out of all the sensitivity analyses computed. This
model also has the most undervalued share prices in comparison to the others. Despite
this, the sensitivity analysis shows that Apache’s stock price is largely overvalued.
Residual Income Model
The residual income model is the most reliable of the intrinsic valuation methods.
This is because the overall value of the firm includes a high percentage of the present
value of residual income. This number is based off of the forecasted out earnings of
the firm, which is why this model is the most accurate.
105
Sensitivity Analysis
Growth 0 -0.05 -0.1 -0.15 -0.2 -0.25 0.1 $ 26.15 $ 29.08 $ 30.55 $ 31.43 $ 32.02 $ 32.44 0.12 $ 31.68 $ 33.18 $ 34.00 $ 34.52 $ 34.87 $ 35.13
ke 0.14 $ 35.39 $ 36.19 $ 36.66 $ 36.97 $ 37.19 $ 37.35 0.157 $ 37.72 $ 38.21 $ 38.51 $ 38.71 $ 38.86 $ 38.97 0.18 $ 40.18 $ 40.44 $ 40.61 $ 40.72 $ 40.81 $ 40.87 0.2 $ 41.91 $ 42.06 $ 42.16 $ 42.23 $ 42.29 $ 42.33
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
To derive the numbers used in the residual income model, earnings had to be
forecasted out. The difference between the operating cash flows and investing cash
flows are the actual earnings. We then determined the benchmark earnings, which is
the previous year’s earnings multiplied by the cost of equity. The residual income is the
difference between the actual earnings and the benchmark earnings.
Our sensitivity analysis determined that, once again, Apache’s stock is highly
overvalued. In order to make our stock price fairly valued, Apache would need to
greatly decrease their cost of equity, or highly increase their growth rate. Both of these
options are unrealistic and would be impossible for the firm to follow through with.
Residual income, which is the added or destroyed value of the firm, is the main
component in the residual income model. After the residual income was computed for
each year, it was then brought back to the present by multiplying each year’s residual
income by the present value factor. This number demonstrates whether the company
is adding or taking away value from the firm.
0 1 2 3 4 5 6 7 8 9 10 11
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 PV of Annual Residual Income
$ 343,602
$ 155,413
$ 14,061
$ (90,291)
$ (165,539)
$ (218,010)
$ (252,765)
$ (285,474)
$ (282,951)
$ (286,095)
$ (267,970)
106
As a company continues to grow, their residual income will eventually decrease
until it declines to or past zero. Every company’s residual income will join with the
market. Apache’s residual income goes negative on the fourth forecasted year. It is
difficult to be sure that this number is correct because of the assumptions that had to
be made about forecasted earnings.
Abnormal Earnings Growth Model
The first step in creating the abnormal earnings growth model is to find the
company’s earnings and dividends. These are used in computing the Drip income,
which is dividends paid multiplied by the cost of equity. We then determined
cumulative earnings, which is calculated by adding the earnings of the company to the
drip earnings for each year. Normal earnings are then computed by multiplying each
year’s earnings by the cost of equity. Abnormal earnings growth is finally determined
by subtracting the normal earnings from the cumulative dividend earnings. These
values were then brought back to the present by multiplying them by the present value
factor. These were all added together to get the total present value of abnormal
earnings, which we calculated to be 1,308,635.15.
We then computed a continuing terminal value, which was the forecasted
abnormal earnings growth for year 11, divided by Apache’s cost of equity minus the
growth rate. The continuing terminal value was then multiplied by the forecasted year
10’s present value factor to determine the present value of the terminal value. The
core earnings per share, which equals year zero’s earnings, was added to the present
value of the AEG to determine the total average earnings per share perpetuity in time
1. We finally computed the intrinsic value per share, which is the total average
earnings per share perpetuity in time one divided by the cost of equity. Finally, the
numbers in our sensitivity analysis were computed by multiplying the intrinsic value per
share by one plus the cost of equity and then bringing this number forward 2 months.
107
The numbers included in the sensitivity analysis were determined by changing the cost
of equity and the growth rate.
Growth 0 -0.05 -0.1 -0.15 -0.2 -0.25 0.1 $ 22.24 $ 28.40 $ 31.48 $ 33.33 34.56 35.44 0.12 $ 21.42 $ 25.25 $ 27.34 $ 28.65 29.56 30.22
ke 0.14 $ 20.25 $ 22.81 $ 24.30 $ 25.27 25.96 26.48 0.157 $ 19.23 $ 21.12 $ 22.27 $ 23.05 23.61 24.03 0.18 $ 17.94 $ 19.25 $ 20.10 $ 20.68 21.12 21.45
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
After the numbers in the sensitivity analysis were computed, the results showed
that, again, Apache’s stock price is highly overvalued. The numbers were significantly
below the November 1st, 2006 stock price of $99.18.
The AEG model and residual income model are linked. The change in residual
income from year to year is equal to the abnormal earnings growth computed.
This chart shows the consistency between the annual AEG and the change in residual
income per year. Because of this link, the share prices determined in the residual
income model and the abnormal earnings growth model should be similar. The
greatest difference in the share prices determined in both models is at most $20, and at
the least, less than $1. The reason for the difference in these share prices is because
the present value of the perpetuities is different in each model. The differences in the
share prices will lessen as the perpetuity grows towards infinity, and because a portion
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Annual AEG
$ (446,501)
$ (188,528)
$ (199,497)
$ (211,525)
$ (224,686)
$ (239,060)
$ (254,728)
$ (321,791)
$ (232,478)
$ (311,459)
Change in RI
$ (188,528)
$ (199,497)
$ (211,525)
$ (224,686)
$ (239,060)
$ (254,728)
$ (321,786)
$ (232,478)
$ (311,459)
108
of the share prices are only off by less than $1, this shows that both models are closely
linked.
Long Run Residual Income Model
The long run residual income model is also a reliable model because it links the
cost of equity, long run return on equity, and the long run growth on equity.
The first sensitivity analysis is determined by holding the cost of equity constant,
and changing the return on equity and the growth rate on equity. The different stock
prices are computed by multiplying the book value of equity by one plus the return on
equity minus the cost of equity, divided by the cost of equity minus the growth.
Sensitivity Analysis
Ke= 15.7%
Growth
0.14 0.16 0.18 0.2 0.22
0.15 $ 23.46 $ 132.95 $ 52.02 $ 46.38 $ 44.32
ROE 0.17 $ 70.38 $(132.95) $ 17.34 $ 27.83 $ 31.65
0.19 $ 117.31 $(398.84) $ (17.34) $ 9.28 $ 18.99
0.21 $ 164.23 $(664.73) $ (52.02) $ (9.28) $ 6.33
0.23 $ 211.15 $(930.62) $ (86.70) $ (27.83) $ (6.33)
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
The next sensitivity analysis was determined holding the growth rate of equity
constant and changing the cost of equity and the return on equity.
109
Sensitivity Analysis
Growth= 17.77%
Ke
0.12 0.14 0.16 0.18 0.2 0.15 $ 19.13 $ 29.29 $ 62.48 $(469.27) $ (49.34)
ROE 0.17 $ 5.29 $ 8.10 $ 17.29 $(129.83) $ (13.65)
0.19 $ (8.54) $ (13.08) $ (27.91) $ 209.60 $ 22.04
0.21 $ (22.38) $ (34.27) $ (73.10) $ 549.04 $ 57.73
0.23 $ (36.22) $ (55.46) $ (118.30) $ 888.48 $ 93.42
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
The last sensitivity analysis was computed holding the return on equity constant,
while changing the growth of equity and the cost of capital.
Sensitivity Analysis
ROE= 18.6%
Growth 0.13 0.15 0.17 0.19 0.21 0.12 $(223.43) $ (47.89) $ (12.78) $ 2.27 $ 10.63
Ke 0.14 $ 223.43 $(143.66) $ (21.30) $ 3.17 $ 13.66 0.16 $ 74.48 $ 143.66 $ (63.89) $ 5.29 $ 19.13 0.18 $ 44.69 $ 47.89 $ 63.89 $ 15.87 $ 31.88 0.2 $ 31.92 $ 28.73 $ 21.30 $ (15.87) $ 95.64
Overvalued > 114.06 Undervalued < 84.30
Fairly Valued Within 15%
Actual Price per Share as of 11/1/06= $99.18
To calculate the return on equity, we averaged the return on equity from the
past 5 years. We then calculated the growth of equity, which we calculated by
110
averaging the growth of the book value of equity from the past 5 years also.
These three sensitivity analyses also show that Apache’s stock is overvalued.
Credit Analysis
We measured the financial health of Apache by using the Altman Z-Score model,
which predicts the probability of a company failing financially. The Altman Z-Score
model uses five financial ratios to compute the likelihood a company is to falling into
bankruptcy. According to the model a company with a z-score of 3 or more is financially
healthy and at low risk to fall into bankruptcy. A z-score between 1.8 and 3 lies in a
grey area and is at a higher risk for financial failure. While a score of less than 1.8 is an
indicator that a company is likely to experience financial failure. The Altman Z-Score is
computed by using the following equation:
1.2 (Working Capital/Total Assets)
+ 1.4 (Retained Earnings/Total Assets)
+ 3.3 (EBIT/Total Assets)
+ 0.6 (Market Value of Equity/Book Value of Equity)
+ 1.0 (Sales/Total Assets)
By inputting Apaches financial figures in the Altman Z-Score model we computed
a current score of 3.32. We also computed the Z-Score for the previous four years and
found that Apache has stayed consistently within the Z-Score range of being financially
healthy except for in 2004. In 2004 their score dropped to 2.72 and into the grey area.
We attribute this decline in the rating to the fact that their market value of equity
declined substantially and their book value of liabilities continued to grow. Even though
the score did decline in 2004 it was still in the upper range of the grey area and did
increase in 2005 back to a level above the 3.0 threshold.
111
Altman Z-Score
2002 2003 2004 2005 2006
Z-Score 3.51 3.97 2.72 3.13 3.32
Analyst Recommendation
After reviewing Apache’s financial statements, industry analysis, accounting
analysis, valuations, and forecasted future financial statements, we were able to
determine that Apache’s stock price is overvalued. Our recommendation for Apache’s
current stockholders would be to sell.
Apache’s financial statements were forecasted using industry averages, as well
as their past and current financial statements. This industry average was taken from
the 10-K’s and financial statements of their four main competitors, Anadarko, Devon
Energy, XTO Energy, and Occidental. Apache’s ratios were consistent with the industry
average which helps make our forecasting credible.
Apache uses high levels of disclosure and apart from using the aggressive full
cost method, uses relatively conservative accounting practices. This is also in line with
the industry norm as the oil and gas industry as a whole has a relatively high level of
disclosure. Apache’s accounting ratios did not reflect any unusual accounting practices
that would have led to an overstatement of net income, to make the company more
attractive to investors.
In order to properly value Apache, we used two different types of commonly
used valuation methods. The first one is the method of comparables and the second is
the intrinsic valuation methods. Overall the intrinsic valuation method is more reliable
than the method of comparables because it examines many more angles of the
112
company. The method of comparables valuation method stated that Apache was only
slightly overvalued whereas the more reliable intrinsic valuation method stated that
Apache was highly overvalued.
On September 6, 2007, when we began valuing Apache, its stock price closed at
$80.40. As we finish our analysis on December 5, 2007, the stock price has closed at
$98.38. We used Apache’s closing stock price from November 1, 2007, which was
$99.18 in all of our valuations. Though Apache’s stock prices rose consistently from
September 6 to November 1, these numbers are somewhat misleading as this can for
the most part be contributed to the rising oil prices. Each one of Apache’s four
competitors had similar growth in stock price which lends credibility to the reason why
despite rising stock prices, Apache is still highly overvalued. As oil prices steady and
taper off, their stock prices will as well, which is why we are recommending that any
investor holding Apache’s stock sell it as soon as possible.
113
Appendix
Liquidity Ratios
Current Ratio
2002 2003 2004 2005 2006
APA 1.44 1.09 1.05 .99 .65
APC .69 .77 1.26 1.21 .28
DVN 1.02 1.14 1.16 1.43 .69
OXY .84 .98 1.29 1.54 1.27
XTO .86 .81 .87 1.07 1.28
Quick Asset Ratio
2002 2003 2004 2005 2006
APA 1.15 .87 .86 .82 .47
APC .61 .68 1.16 .90 .23
DVN .94 1.07 1.11 1.31 .58
OXY .55 .73 1.07 1.29 1.03
XTO .70 .66 .71 .95 1.18
Accounts Receivable Turnover
2002 2003 2004 2005 2006
APA 4.85 6.56 5.67 5.25 5.02
APC 3.48 4.64 4.49 3.70 3.10
DVN 6.21 7.68 6.96 6.71 7.59
OXY 6.80 8.08 5.09 4.84 5.46
XTO 5.57 6.00 5.69 5.18 6.34
Days Sales Outstanding
2002 2003 2004 2005 2006
APA 75.26 55.64 64.37 69.52 72.71
APC 104.77 78.67 81.22 98.65 117.92
DVN 58.78 47.51 52.43 54.41 48.07
OXY 53.67 45.17 71.76 75.39 66.81
XTO 65.50 60.81 64.13 70.43 57.59
Inventory Turnover
2002 2003 2004 2005 2006
APA 5.5 8.3 7.05 7.61 6.4
APC N/A N/A N/A N/A N/A
DVN 90.19 36.25 N/A N/A N/A
OXY 6.89 7.82 8.27 7.53 7.61
XTO N/A N/A N/A N/A N/A
Days Supply of Inventory
2002 2003 2004 2005 2006
APA 66.36 43.97 51.77 47.96 57.03
APC N/A N/A N/A N/A N/A
DVN 4.05 10.07 N/A N/A N/A
OXY 52.98 46.68 44.14 47.96 57.03
XTO N/A N/A N/A N/A N/A
Working Capital Turnover
2002 2003 2004 2005 2006
APA 10.91 53.25 80.93 -309.73 -6.27
APC -6.64 -13.10 11.92 13.84 -0.84
DVN 196.18 25.09 19.02 8.44 -7.38
OXY -20.27 -179.35 11.28 6.63 14.17
XTO -19.71 -20.03 -30.43 59.64 13.26
114
Profitability Ratios
Gross Profit Margin
2002 2003 2004 2005 2006
APA .351 .459 .499 .555 .484
APC .741 .761 .846 .881 .777
DVN .457 .645 .828 .811 .687
OXY .539 .572 .603 .636 .654
XTO .841 .753 .874 .885 .893
Operating Profit Margin
2002 2003 2004 2005 2006
APA .358 .461 .530 .577 .508
APC .369 .431 .475 .565 .479
DVN .125 .359 .403 .455 .419
OXY .290 .340 .381 .423 .447
XTO .431 .422 .472 .558 .584
Net Profit Margin
2002 2003 2004 2005 2006
APA .216 .268 .313 .346 .308
APC .215 .243 .264 .347 .476
DVN .024 .238 .238 .273 .269
OXY .135 .164 .226 .347 .230
XTO .230 .242 .261 .327 .406
Asset Turnover
2002 2003 2004 2005 2006
APA .271 .337 .344 .394 .341
APC .212 .249 .300 .314 .173
DVN .266 .271 .309 .355 .302
OXY .443 .513 .531 .582 .561
XTO .306 .329 .319 .357 .355
Return on Assets
2002 2003 2004 2005 2006
APA .062 .119 .134 .169 .132
APC .049 .068 .078 .122 .215
DVN .008 .108 .080 .098 .094
OXY .005 .092 .141 .247 .160
XTO .164 .189 .255 N/A .189
Return on Equity
2002 2003 2004 2005 2006
APA .125 .228 .255 .320 .242
APC .130 .178 .186 .266 .439
DVN .022 .375 .198 .214 .191
OXY .176 .242 .324 .501 .278
XTO .425 .553 .627 N/A .442
115
Capital Structure Ratios
Debt to Equity Ratio
2002 2003 2004 2005 2006
APA .921 .901 .890 .828 .843
APC .609 .602 .565 .505 1.050
DVN 2.487 1.457 1.196 1.037 1.010
OXY 1.691 1.291 1.028 .737 .687
XTO 1.917 1.464 1.351 1.342 1.197
Times Interest Earned
2002 2003 2004 2005 2006
APA 10.57 13.36 15.88 19.26 19.68
APC 1.05 7.02 8.69 8.22 19.98
DVN -1.02 10.17 12.41 11.61 9.74
OXY .687 4.00 4.82 10.02 26.23
XTO 1.197 1.16 .90 1.00 N/A
Debt Service Margin
2002 2003 2004 2005 2006
APA 1.2 .90 1.2 1.35 .143
APC 1.3 1.14 .98 .89 .140
DVN 2.34 2.12 1.89 1.34 1.39
OXY 2.45 1.23 1.21 .87 .142
XTO 2.56 1.25 2.68 2.63 2.64
116
Method of Comparables
TRAILING PRICE TO EARNINGS PRICE EPS P/E AVERAGE P/E APA SHARE PRICE
Apache 99.18 7.51 10.68 10.95 82.20
Occidental 66.76 4.8 12.02
Anadarko 57.24 10.39 4.84
Devon 91.31 6.41 13.08
XTO 65.68 5.01 13.84
FORWARD PRICE TO EARNINGS PRICE EPS P/E AVERAGE P/E APA SHARE PRICE
Apache 99.18 6.67 14.15 14.01 93.41
Occidental 66.76 5.77 12.32
Anadarko 57.24 12.124 18.28
Devon 91.31 6.356 11.25
XTO 65.68 4.382 14.17
PRICE TO BOOK PPS BPS P/B INDUSTRY AVERAGE APA SHARE PRICE
Apache 99.18 43.81 2.26 2.36 103.29
Occidental 66.76 26.43 2.53
Anadarko 57.24 34.56 1.66
Devon 91.31 46.84 1.95
XTO 65.68 19.91 3.30
DIVIDEND YIELD PPS DPS D/P INDUSTRY AVERAGE APA SHARE PRICE
Apache 99.18 0.15 0.0015 0.0021 72.92
Occidental 66.76 0.22 0.0033
Anadarko 57.24 0.09 0.0016
Devon 91.31 0.14 0.0015
XTO 65.68 0.12 0.0018
117
PRICE EARNINGS GROWTH PPS EPS PEG INDUSTRY AVERAGE APA SHARE PRICE
Apache 99.18 6.67 1.78 1.28 59.88
Occidental 66.76 5.77 1.18
Anadarko 57.24 12.124 1.95
Devon 91.31 6.356 1.27
XTO 65.68 4.382 0.73
PRICE TO EBITDA PPS EBITDA (IN BILLIONS) P/EBITDA INDUSTRY AVERAGE APA SHARE PRICE
Apache 99.18 6.77 14.65 11.17 75.65
Occidental 66.76 9.38 7.12
Anadarko 57.24 6.74 8.49
Devon 91.31 7.51 12.16
XTO 65.68 3.88 16.93
ENTERPRISE VALUE TO EBITDA EV EBITDA (IN BILLIONS) EV/EBITDA INDUSTRY AVERAGE APA SHARE PRICE
Apache 43.78 6.77 6.47 6.37 97.24
Occidental 58.26 9.38 6.21
Anadarko 39.89 6.74 5.92
Devon 43.06 7.51 5.73
XTO 29.52 3.88 7.61
Price
Trailing Price to Equity 82.20
Forwarding Price to Equity 93.41
Price to Book 103.29
Dividend Yield 72.92
Price Earnings Growth 59.88
Price To EBITDA 75.65
Enterprise Value to EBITDA 97.24
Price to Free Cash Flows N/A
118
3 Month
SUMMARY OUTPUT 72
Regression Statistics Beta R2-adjMultiple R 0.062036002 72 -0.31 -0.010R Square 0.003848466 60 -0.33 -0.015Adjusted R Square -0.010382271 48 1.31 -0.00054Standard Error 0.175962341 36 1.42 0.1471Observations 72 24 1.60 0.1882
ANOVAdf SS MS F Significance F
Regression 1 0.008373359 0.008373359 0.270433341 0.604682012Residual 70 2.16739218 0.030962745Total 71 2.175765538
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.024669263 0.020851013 1.183120586 0.240764038 -0.016916771 0.066255298 -0.016916771 0.066255298X Variable 1 -0.312349764 0.600635594 -0.520032057 0.604682012 -1.510279669 0.885580141 -1.510279669 0.885580141SUMMARY OUTPUT 60
Regression StatisticsMultiple R 0.046194937R Square 0.002133972Adjusted R Square -0.015070614Standard Error 0.190440944Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.004498473 0.004498473 0.124035076 0.725975163Residual 58 2.103529678 0.036267753Total 59 2.108028151
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.028490886 0.025529127 1.116014882 0.269018171 -0.022611214 0.079592986 -0.022611214 0.079592986X Variable 1 -0.333295185 0.946360885 -0.352186138 0.725975163 -2.227642299 1.561051929 -2.227642299 1.561051929
SUMMARY OUTPUT 48
Regression StatisticsMultiple R 0.144049122R Square 0.02075015Adjusted R Square -0.000537891Standard Error 0.194068708Observations 48
ANOVAdf SS MS F Significance F
Regression 1 0.036711031 0.036711031 0.974732734 0.328667527Residual 46 1.732482525 0.037662664Total 47 1.769193556
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.028507299 0.028957966 0.984437195 0.330050394 -0.029782063 0.086796661 -0.029782063 0.086796661X Variable 1 1.307185203 1.324019397 0.987285538 0.328667527 -1.357927572 3.972297979 -1.357927572 3.972297979SUMMARY OUTPUT 36
Regression StatisticsMultiple R 0.414063R Square 0.171448Adjusted R Square 0.147079Standard Error 0.068563Observations 36
ANOVAdf SS MS F Significance F
Regression 1 0.033073 0.033073 7.035433817 0.012055422Residual 34 0.159832 0.004701Total 35 0.192905
Coefficientstandard Erro t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.011859 0.011815 1.003704 0.32261166 -0.012151971 0.035869024 -0.012151971 0.035869024X Variable 1 1.420602 0.535583 2.652439 0.012055422 0.332165838 2.509037622 0.332165838 2.509037622
SUMMARY OUTPUT 24
Regression StatisticsMultiple R 0.472759775R Square 0.223501805Adjusted R Square 0.188206432Standard Error 0.062528658Observations 24
ANOVAdf SS MS F Significance F
Regression 1 0.024758338 0.024758338 6.332325997 0.019649258Residual 22 0.086016328 0.003909833Total 23 0.110774666
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.00738025 0.013451706 0.54864789 0.588772369 -0.02051688 0.03527738 -0.02051688 0.03527738X Variable 1 1.603336149 0.637151855 2.516411333 0.019649258 0.281964083 2.924708215 0.281964083 2.924708215
119
6 month
SUMMARY OUTPUT 72 6 month
Regression Statistics Beta R2 adjMultiple R 0.062149583 72 -0.312799477 -0.010367964R Square 0.003862571 60 -0.333829883 -0.015060586Adjusted R Square -0.010367964 48 1.306478277 -0.000532982Standard Error 0.175961095 36 1.417708476 0.14658208Observations 72 24 1.60000198 0.187282275
ANOVAdf SS MS F Significance F
Regression 1 0.008404048 0.008404048 0.271428357 0.604019486Residual 70 2.16736149 0.030962307Total 71 2.175765538
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.024632189 0.020843166 1.181787337 0.241289309 -0.016938193 0.066202572 -0.016938193 0.066202572X Variable 1 -0.312799477 0.600396856 -0.520987866 0.604019486 -1.510253232 0.884654279 -1.510253232 0.884654279SUMMARY OUTPUT
Regression StatisticsMultiple R 0.04630152R Square 0.002143831Adjusted R Square -0.015060586Standard Error 0.190440003Observations 60
ANOVAdf SS MS F Significance F
Regression 1 0.004519 0.004519 0.124609323 0.725367825Residual 58 2.103509 0.036267Total 59 2.108028
Coefficients tandard Erro t Stat P-value Lower 95% Upper 95%Lower 95.0%Upper 95.0%Intercept 0.02845077 0.025494 1.11596 0.269041496 -0.022581889 0.079483 -0.02258 0.079483X Variable 1 -0.333829883 0.945692 -0.353 0.725367825 -2.226839072 1.559179 -2.22684 1.559179SUMMARY OUTPUT
Regression StatisticsMultiple R 0.144065798R Square 0.020754954Adjusted R Square -0.000532982Standard Error 0.194068232Observations 48
ANOVAdf SS MS F ignificance F
Regression 1 0.03672 0.03672 0.974963 0.328611Residual 46 1.732474 0.037662Total 47 1.769194
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.02871445 0.028905 0.993401 0.325712 -0.02947 0.086898 -0.02947 0.086898X Variable 1 1.306478277 1.323147 0.987402 0.328611 -1.35688 3.969835 -1.35688 3.969835SUMMARY OUTPUT
Regression StatisticsMultiple R 0.413479684R Square 0.170965449Adjusted R Square 0.14658208Standard Error 0.068583395Observations 36
ANOVAdf SS MS F ignificance F
Regression 1 0.03298 0.03298 7.01156 0.012189Residual 34 0.159925 0.004704Total 35 0.192905
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0%Intercept 0.012101178 0.011796 1.025845 0.312208 -0.01187 0.036074 -0.01187 0.036074X Variable 1 1.417708476 0.535402 2.647935 0.012189 0.329642 2.505775 0.329642 2.505775SUMMARY OUTPUT
Regression StatisticsMultiple R 0.471823938R Square 0.222617828Adjusted R Square 0.187282275Standard Error 0.06256424Observations 24
ANOVAdf SS MS F ignificance F
Regression 1 0.02466 0.02466 6.300109 0.019927Residual 22 0.086114 0.003914Total 23 0.110775
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0%Intercept 0.007609698 0.013433 0.566476 0.576804 -0.02025 0.035469 -0.02025 0.035469X Variable 1 1.60000198 0.637451 2.510002 0.019927 0.27801 2.921993 0.27801 2.921993
120
2 year
SUMMARY OUTPUT
Regression Statistics Beta R2 adjMultiple R 0.062607738 72 -0.314123352 -0.01030999R Square 0.003919729 60 -0.341492122 -0.01495454Adjusted R Square -0.010309989 48 1.285824505 -0.00113388Standard Error 0.175956047 36 1.411515487 0.145675435Observations 72 24 1.595824058 0.187308584
ANOVAdf SS MS F Significance F
Regression 1 0.008528411 0.008528411 0.275460755 0.601350276Residual 70 2.167237127 0.03096053Total 71 2.175765538
Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0%Upper 95.0%Intercept 0.024528183 0.020822149 1.177985177 0.242791802 -0.017000283 0.066057 -0.017 0.066057X Variable 1 -0.314123352 0.598508547 -0.524843553 0.601350276 -1.507810993 0.879564 -1.50781 0.879564SUMMARY OUTPUT
Regression StatisticsMultiple R 0.047413939R Square 0.002248082Adjusted R Square -0.014954538Standard Error 0.190430055Observations 60
ANOVAdf SS MS F ignificance F
Regression 1 0.004739 0.004739 0.130683 0.719039Residual 58 2.103289 0.036264Total 59 2.108028
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.028421194 0.025431 1.117597 0.268347 -0.02248 0.079326 -0.02248 0.079326X Variable 1 -0.341492122 0.944652 -0.3615 0.719039 -2.23242 1.549435 -2.23242 1.549435SUMMARY OUTPUT
Regression StatisticsMultiple R 0.142010005R Square 0.020166841Adjusted R Square -0.001133879Standard Error 0.1941265Observations 48
ANOVAdf SS MS F ignificance F
Regression 1 0.035679 0.035679 0.946768 0.335632Residual 46 1.733515 0.037685Total 47 1.769194
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0%Intercept 0.02909099 0.028845 1.008522 0.31848 -0.02897 0.087153 -0.02897 0.087153X Variable 1 1.285824505 1.321478 0.97302 0.335632 -1.37417 3.945822 -1.37417 3.945822SUMMARY OUTPUT
Regression StatisticsMultiple R 0.471850605R Square 0.222642994Adjusted R Square 0.187308584Standard Error 0.062563227Observations 24
ANOVAdf SS MS F ignificance F
Regression 1 0.024663 0.024663 6.301025 0.019919Residual 22 0.086111 0.003914Total 23 0.110775
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.00742423 0.013456 0.551733 0.586693 -0.02048 0.035331 -0.02048 0.035331X Variable 1 1.595824058 0.63574 2.510184 0.019919 0.27738 2.914268 0.27738 2.914268SUMMARY OUTPUT
Regression StatisticsMultiple R 0.412413273R Square 0.170084708Adjusted R Square 0.145675435Standard Error 0.068619816Observations 36
ANOVAdf SS MS F ignificance F
Regression 1 0.03281 0.03281 6.968037 0.012436Residual 34 0.160095 0.004709Total 35 0.192905
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.012185863 0.011797 1.033004 0.308894 -0.01179 0.036159 -0.01179 0.036159X Variable 1 1.411515487 0.534725 2.639704 0.012436 0.324824 2.498207 0.324824 2.498207
121
5 year
SUMMARY OUTPUT
Regression Statistics Beta R2 adjMultiple R 0.063298568 72 -0.31732611 -0.01022177R Square 0.004006709 60 -0.35171084 -0.0148228Adjusted R Square -0.010221767 48 1.2535968 -0.00214123Standard Error 0.175948364 36 1.406613623 0.144434248Observations 72 24 1.591537136 0.186122665
ANOVAdf SS MS F ignificance F
Regression 1 0.008717659 0.008717659 0.281597891 0.597335Residual 70 2.16704788 0.030957827Total 71 2.175765538
Coefficients Standard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.024366387 0.020794296 1.171782227 0.245257415 -0.01711 0.065839 -0.01711 0.065839X Variable 1 -0.31732611 0.597986126 -0.53065798 0.59733539 -1.50997 0.87532 -1.50997 0.87532SUMMARY OUTPUT
Regression StatisticsMultiple R 0.048760513R Square 0.002377588Adjusted R Square -0.014822799Standard Error 0.190417696Observations 60
ANOVAdf SS MS F ignificance F
Regression 1 0.005012 0.005012 0.138229 0.711403Residual 58 2.103016 0.036259Total 59 2.108028
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.028333885 0.025326 1.118761 0.267854 -0.02236 0.07903 -0.02236 0.07903X Variable 1 -0.351710841 0.94599 -0.37179 0.711403 -2.24532 1.541894 -2.24532 1.541894SUMMARY OUTPUT
Regression StatisticsMultiple R 0.138495216R Square 0.019180925Adjusted R Square -0.002141229Standard Error 0.194224141Observations 48
ANOVAdf SS MS F ignificance F
Regression 1 0.033935 0.033935 0.899577 0.347852Residual 46 1.735259 0.037723Total 47 1.769194
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.029639375 0.028766 1.030348 0.308234 -0.02826 0.087543 -0.02826 0.087543X Variable 1 1.2535968 1.321717 0.94846 0.347852 -1.40688 3.914076 -1.40688 3.914076SUMMARY OUTPUT
Regression StatisticsMultiple R 0.410948883R Square 0.168878984Adjusted R Square 0.144434248Standard Error 0.068669644Observations 36
ANOVAdf SS MS F ignificance F
Regression 1 0.032578 0.032578 6.908603 0.012783Residual 34 0.160328 0.004716Total 35 0.192905
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.012306145 0.011796 1.043207 0.304214 -0.01167 0.036279 -0.01167 0.036279X Variable 1 1.406613623 0.535155 2.628422 0.012783 0.319048 2.49418 0.319048 2.49418
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.470647039R Square 0.221508636Adjusted R Square 0.186122665Standard Error 0.062608858Observations 24
ANOVAdf SS MS F ignificance F
Regression 1 0.024538 0.024538 6.259787 0.02028Residual 22 0.086237 0.00392Total 23 0.110775
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.007386508 0.013474 0.548196 0.589077 -0.02056 0.03533 -0.02056 0.03533X Variable 1 1.591537136 0.636117 2.501957 0.02028 0.272311 2.910763 0.272311 2.910763
122
7 year
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.063221544R Square 0.003996964Adjusted R Square -0.010231651Standard Error 0.035058212Observations 72
ANOVAdf SS MS F ignificance F
Regression 1 0.000345261 0.000345 0.28091 0.597782Residual 70 0.086035474 0.001229Total 71 0.086380735
Coefficients Standard Error t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.002659091 0.004169355 0.63777 0.525704 -0.00566 0.010975 -0.00566 0.010975X Variable 1 -0.012597011 0.023767511 -0.53001 0.597782 -0.06 0.034806 -0.06 0.034806
SUMMARY OUTPUT
Regression StatisticsMultiple R 0.048511097R Square 0.002353327Adjusted R Square -0.014847478Standard Error 0.026384089Observations 60
ANOVAdf SS MS F ignificance F
Regression 1 9.52E-05 9.52E-05 0.136815 0.712815Residual 58 0.040375 0.000696Total 59 0.04047
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.006382052 0.003439 1.85581 0.068564 -0.0005 0.013266 -0.0005 0.013266X Variable 1 -0.006721568 0.018172 -0.36988 0.712815 -0.0431 0.029654 -0.0431 0.029654SUMMARY OUTPUT
Regression StatisticsMultiple R 0.137711215R Square 0.018964379Adjusted R Square -0.002362483Standard Error 0.021464445Observations 48
ANOVAdf SS MS F ignificance F
Regression 1 0.00041 0.00041 0.889225 0.350614Residual 46 0.021193 0.000461Total 47 0.021603
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.00417158 0.003151 1.323721 0.192137 -0.00217 0.010515 -0.00217 0.010515X Variable 1 0.015217308 0.016137 0.942987 0.350614 -0.01727 0.0477 -0.01727 0.0477
Regression StatisticsMultiple R 0.411136896R Square 0.169033547Adjusted R Square 0.144593357Standard Error 0.020071692Observations 36
ANOVAdf SS MS F ignificance F
Regression 1 0.002786 0.002786 6.916213 0.012738Residual 34 0.013698 0.000403Total 35 0.016484
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.002873003 0.003466 0.828977 0.4129 -0.00417 0.009916 -0.00417 0.009916X Variable 1 0.120183827 0.0457 2.629869 0.012738 0.027311 0.213056 0.027311 0.213056SUMMARY OUTPUT
Regression StatisticsMultiple R 0.469840251R Square 0.220749861Adjusted R Square 0.185329401Standard Error 0.018530049Observations 24
ANOVAdf SS MS F ignificance F
Regression 1 0.00214 0.00214 6.23227 0.020526Residual 22 0.007554 0.000343Total 23 0.009694
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.004183488 0.003914 1.068878 0.296713 -0.00393 0.0123 -0.00393 0.0123X Variable 1 0.138988693 0.055675 2.496451 0.020526 0.023527 0.254451 0.023527 0.254451
123
10 year
SUMMARY OUTPUT
Regression Statistics Beta R2 adjMultiple R 0.000369763 72 0.186153039 -0.01428558R Square 1.36725E-07 60 -0.63719401 -0.01724019Adjusted R Square -0.014285576 48 -97.0027287 -0.00334164Standard Error 0.176301902 36 -46.8776409 -0.00057854Observations 72 24 -84.4515431 0.008036467
ANOVAdf SS MS F Significance F
Regression 1 2.97481E-07 2.97481E-07 9.57074E-06 0.997540419Residual 70 2.175765241 0.031082361Total 71 2.175765538
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%Intercept 0.02284719 0.224478994 0.101778745 0.919223281 -0.42486204 0.470556421 -0.42486204 0.470556421X Variable 1 0.186153039 60.17239273 0.003093662 0.997540419 -119.8238986 120.1962046 -119.8238986 120.1962046SUMMARY OUTPUT
Regression StatisticsMultiple R 0.001079227R Square 1.16473E-06Adjusted R Square -0.017240194Standard Error 0.190644356Observations 60
ANOVAdf SS MS F ignificance F
Regression 1 2.46E-06 2.46E-06 6.76E-05 0.99347Residual 58 2.108026 0.036345Total 59 2.108028
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0%Intercept 0.028399616 0.284577 0.099796 0.920851 -0.54124 0.598043 -0.54124 0.598043X Variable 1 -0.637194009 77.52551 -0.00822 0.99347 -155.821 154.547 -155.821 154.547SUMMARY OUTPUT
Regression StatisticsMultiple R 0.134186643R Square 0.018006055Adjusted R Square -0.003341639Standard Error 0.194340432Observations 48
ANOVAdf SS MS F ignificance F
Regression 1 0.031856 0.031856 0.843466 0.363198Residual 46 1.737337 0.037768Total 47 1.769194
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0%Intercept 0.399396275 0.396939 1.006191 0.319588 -0.3996 1.198393 -0.3996 1.198393X Variable 1 -97.00272867 105.621 -0.9184 0.363198 -309.607 115.6013 -309.607 115.6013SUMMARY OUTPUT
Regression StatisticsMultiple R 0.16736R Square 0.028009Adjusted R Square -0.00058Standard Error 0.074261Observations 36
ANOVAdf SS MS F ignificance F
Regression 1 0.005403 0.005403 0.979763 0.32925Residual 34 0.187502 0.005515Total 35 0.192905
Coefficientstandard Erro t Stat P-value Lower 95%Upper 95%Lower 95.0%Upper 95.0%Intercept 0.198097 0.180535 1.09728 0.28023 -0.16879 0.564988 -0.16879 0.564988X Variable 1 -46.8776 47.3593 -0.98983 0.32925 -143.123 49.36804 -143.123 49.36804SUMMARY OUTPUT
Regression StatisticsMultiple R 0.226197517R Square 0.051165317Adjusted R Square 0.008036467Standard Error 0.069120068Observations 24
ANOVAdf SS MS F ignificance F
Regression 1 0.005668 0.005668 1.186336 0.287858Residual 22 0.105107 0.004778Total 23 0.110775
Coefficients tandard Erro t Stat P-value Lower 95%Upper 95%ower 95.0%Upper 95.0%Intercept 0.351616348 0.30656 1.146974 0.263714 -0.28415 0.987383 -0.28415 0.987383X Variable 1 -84.45154306 77.53605 -1.08919 0.287858 -245.251 76.34839 -245.251 76.34839
124
Discounted Dividends ApproachWACC(BT) 0.0852 Kd 0.0474 Ke 0.157
Perp0 1 2 3 4 5 6 7 8 9 10 11
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017EPS (Earnings P 7.72 7.51 8.03 8.60 9.20 9.84 10.53 11.27 11.91 12.90 13.80DPS (Dividends 0.45 0.53 0.61 0.69 0.77 0.85 0.93 1.01 1.09 1.17 1.25 1.33BPS (Book Value 39.88 46.86 54.29 62.19 70.62 79.61 89.21 99.47 110.29 122.02 134.57Cash From Oper 4312906.00 4724604.03 5055326.31 5409199.15 5787843.09 6192992.11 6626501.56 7090356.67 7586681.64 8117749.35 8685991.80Cash Investmen -5775582.00 -5891093.64 -6008915.51 -6129093.82 -6251675.70 -6376709.21 -6504243.40 -6634328.27 -6767014.83 -6902355.13 -7040402.23
PV Factor 0.6061 0.3673 0.2226 0.1349 0.0818 0.0496 0.0300 0.0182 0.0110 0.0067PV Dividends Year by Year 0.32 0.22 0.15 0.10 0.07 0.05 0.03 0.02 0.01 0.01Total PV of Annu 0.99Continuing (Terminal) Value Perpetuity 2.046153846PV of Terminal V 0.0137Estimated Price 1.0035 Growth Time consistent $1.52 0 0.02 0.04 0.06 0.08 0.09Observed Share $99.18 0.1 $11.06 $12.45 $14.76 $19.39 $33.27 $61.02Initial Cost of Eq 0.65 0.12 $8.99 $9.78 $10.95 $12.92 $16.84 $20.76Perpetuity Grow 0 ke 0.14 $7.55 8.02$ $8.69 $9.69 $11.36 $12.69
0.157 $6.62 $6.95 $7.39 $8.00 $8.94 $9.610.18 $5.67 $5.88 $6.14 $6.48 $6.97 $7.29
0.2 $5.04 $5.18 $5.35 $5.57 $5.87 $6.06
Overvalued > 114.06Undervalued < 84.30Fairly Valued Within 15%
125
Free Cash Flows ApproachWACC(BT) 0.0852 Kd 0.0474 Ke 0.157
0 1 2 3 4 5 6 7 8 9 10 112006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
EPS 2552451 2483318 2657150 2843151 3042172 3255124 3482982 3726791 3987666 4266803 4565479DPS 148831.65 175290.61 201749.57 228208.53 254667.49 281126.45 307585.41 334044.37 360503.33 386962.29 413421.25 439880.21BPS 13191053.00 15849662.00 18708562.00 21779921.00 25076760.00 28613010.00 32403578.00 36464413.00 40812583.00 45466348.00 50445249.00Cash From Operations 4312906 4724604.03 5055326.312 5409199.154 5787843.095 6192992.111 6626501.559 7090356.668 7586681.635 8117749.35 8685991.804 9294011.2Cash Investments -5775582.00 -5891093.64 -6008915.513 -6129093.823 -6251675.7 -6376709.214 -6504243.398 -6634328.266 -6767014.831 -6902355.128 -7040402.23Book Value of Debt and Preferred Stock $11,216
Annual Free Cash Flow 10615697.67 11064241.82 11538292.98 12039518.79 12569701.32 13130744.96 13724684.93 14353696.47 15020104.48 15726394.03 9294011.2PV Factor 0.91 0.83 0.75 0.68 0.62 0.56 0.51 0.47 0.42 0.39PV of Free Cash Flows 9650634.25 9144001.51 8668890.29 8223153.33 7804795.58 7411963.21 7042933.49 6696105.33 6369990.54 322.00Total PV of Annual Free Cash Flows 71012789.53Continuing (Terminal) Value Perpetuity -128007313PV of Terminal Value Perpetuity -49352360.63Value of Firm 21660428.90Book Value of Liabilities $11,216 Growth Estimated Market Value of Equity $21,649,213.39 0 0.02 0.03 0.04 0.045Number of Shares 330737 0.05 7.64$ (178.89)$ (412.05)$ (1,111.55)$ (2,510.53)$ Estimated Price per Share (end of 2006) $65.46 0.06 62.23$ (43.81)$ (149.85)$ (361.93)$ (574.00)$ Time Consistent implied price $70.07 WACC 0.07 96.56$ 30.36$ (27.56)$ (124.09)$ (201.32)$ Observed Share Price $99.18 0.0852 126.84$ 90.62$ 62.67$ 22.35$ (5.33)$ Initial WACC 0.1 0.09 132.91$ 102.35$ 79.43$ 47.34$ 25.95$ Perpetuity Growth Rate (g) 0.045 0.1 141.96$ 119.99$ 104.30$ 83.38$ 70.17$
Overvalued > 114.06Undervalued < 84.30Fairly Valued Within 15%
126
Residual Income ApproachWACC(BT) 0.0852 Kd 0.0474 Ke 0.157
Change in RI -188528.30 -199496.87 -211524.97 -224686.21 -239059.62 -254728.26 -321786.22 -232477.54 -311458.99 -219612.440 1 2 3 4 5 6 7 8 9 10 11
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017EPS 2552451 2483318 2657150 2843151 3042172 3255124 3482982 3726791 3937666 4266803 4564479DPS 148831.65 175290.61 201749.57 228208.53 254667.49 281126.45 307585.41 334044.37 360503.33 386962.29 413421.25 439880.21BPS 13191053 15499080 17954481 20569423 23356928 26330925 29506322 32899069 36476231 40356072 44507130
Put in your total forecast Net Income 2483318.00 2657150.00 2843151.00 3042172.00 3255124.00 3482982.00 3726791.00 3937666.00 4266803.00 4564479.00"Normal" (Benchmark) Earnings 2070995.32 2433355.62 2818853.49 3229399.46 3667037.66 4133955.28 4632492.54 5165153.77 5726768.30 6335903.30Residual Income (Annual) 412322.68 223794.38 24297.51 -187227.46 -411913.66 -650973.28 -905701.54 -1227487.77 -1459965.30 -1771424.30 -1991036.74PV Factor, Discount Factor 0.83 0.69 0.58 0.48 0.40 0.33 0.28 0.23 0.19 0.16 0.13PV of Annual Residual Income 343602.23 155412.76 14061.06 -90291.02 -165538.86 -218009.63 -252764.68 -285474.42 -282951.06 -286094.91 -267969.62Total PV of Annual Residual Income -1068049Continuing (Terminal) Value Perpetuity -595488.05PV of Terminal Value Perpetuity -96174.65 Growth Initial Book Value of Equity 13191053 0 -0.05 -0.1 -0.15 -0.2 -0.25Market value of Total Equity 0.1 26.15$ 29.08$ 30.55$ 31.43$ 32.02$ 32.44$ Estimated Price per Share (end of 200 12026829.82 0.12 31.68$ 33.18$ 34.00$ 34.52$ 34.87$ 35.13$ Time consistent implied by model 42.33$ ke 0.14 35.39$ 36.19$ 36.66$ 36.97$ 37.19$ 37.35$ Observed Share Price $99.18 0.157 37.72$ 38.21$ 38.51$ 38.71$ 38.86$ 38.97$ Initial Cost of Equity (You Derive) 0.2 0.18 40.18$ 40.44$ 40.61$ 40.72$ 40.81$ 40.87$ Perpetuity Growth Rate (g) -0.25 0.2 41.91$ 42.06$ 42.16$ 42.23$ 42.29$ 42.33$
Overvalued > 114.06Undervalued < 84.30Fairly Valued Within 15%
127
Long Run Residual Income Perpertuity
Book Value of Equity 13191053 Overvalued > 114.06Cost of Equity 0.2 0.157 Undervalued < 84.30Return on Equity (AVG) 0.23 0.18602 Fairly Valued Within 15%Growth 0.17765 0.17765
Price 30897164Price Per Share 93.42Observed Share Price (11/1/06) $99.18
Growth0.14 0.16 0.18 0.2 0.22
0.15 23.46$ 132.95$ 52.02$ 46.38$ 44.32$ ROE 0.17 70.38$ (132.95)$ 17.34$ 27.83$ 31.65$
0.19 117.31$ (398.84)$ (17.34)$ 9.28$ 18.99$ 0.21 164.23$ (664.73)$ (52.02)$ (9.28)$ 6.33$ 0.23 211.15$ (930.62)$ (86.70)$ (27.83)$ (6.33)$
Ke0.12 0.14 0.16 0.18 0.2
0.15 19.13$ 29.29$ 62.48$ (469.27)$ (49.34)$ ROE 0.17 5.29$ 8.10$ 17.29$ (129.83)$ (13.65)$
0.19 (8.54)$ (13.08)$ (27.91)$ 209.60$ 22.04$ 0.21 (22.38)$ (34.27)$ (73.10)$ 549.04$ 57.73$ 0.23 (36.22)$ (55.46)$ (118.30)$ 888.48$ 93.42$
Growth0.13 0.15 0.17 0.19 0.21
0.12 (223.43)$ (47.89)$ (12.78)$ 2.27$ 10.63$ Ke 0.14 223.43$ (143.66)$ (21.30)$ 3.17$ 13.66$
0.16 74.48$ 143.66$ (63.89)$ 5.29$ 19.13$ 0.18 44.69$ 47.89$ 63.89$ 15.87$ 31.88$
0.2 31.92$ 28.73$ 21.30$ (15.87)$ 95.64$
128
AEG Approach WACC(BT) 0.0852 Kd 0.0474 Ke 0.157
0 1 2 3 4 5 6 7 8 9 10 112006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
EPS 2552451 2483318 2657150 2843151 3042172 3255124 3482982 3726791 3937666 4266803 4564479DPS 148831.65 175290.61 201749.57 228208.53 254667.49 281126.45 307585.41 334014.07 360503.33 386962.29 413421.25 439880.21DPS invested at 15.7% (Drip) 23366.57 27520.63 31674.68 35828.74 39982.80 44136.85 48290.91 52440.21 56599.02 60753.08Cum-Dividend Earnings 2506684.57 2684670.63 2874825.68 3078000.74 3295106.80 3527118.85 3775081.91 3990106.21 4323402.02 4625232.08Normal Earnings 2953185.81 2873198.93 3074322.55 3289525.71 3519793.00 3766178.47 4029810.17 4311897.19 4555879.56 4936691.07Abnormal Earning Growth (AEG) -446501.24 -188528.30 -199496.87 -211524.97 -224686.21 -239059.62 -254728.26 -321790.98 -232477.54 -311458.99 -242639.08
PV Factor 0.86 0.75 0.65 0.56 0.48 0.42 0.36 0.31 0.27 0.23PV of AEG -385912.91 -140834.75 -128805.97 -118039.73 -108370.14 -99656.60 -91779.06 -100209.06 -62572.11 -72454.82Residual Income Check Figure
Annual Residual Income 412322.68 223794.38 24297.51 -187227.46 -411913.66 -650973.28 -905701.54 -1227487.77 -1459965.30 -1771424.30 -1991036.74Change in Residual Income -188528.30 -199496.87 -211524.97 -224686.21 -239059.62 -254728.26 -321786.22 -232477.54 -311458.99 -219612.44
Core EPS 2552451.00Total PV of AEG (1,308,635.15) Growth Continuing (Terminal) Value 0 -0.05 -0.1 -0.15 -0.2 -0.25 (564,276.93) PV of Terminal Value (131,267.95) 0.1 22.24$ 28.40$ 31.48$ 33.33$ 34.56 35.44Total PV of AEG (1,439,903.10) 0.12 21.42$ 25.25$ 27.34$ 28.65$ 29.56 30.22Total Average EPS Perp (t+1) 1,112,547.90 ke 0.14 20.25$ 22.81$ 24.30$ 25.27$ 25.96 26.48Capitalization Rate (perpetuity) 0.180 0.157 19.23$ 21.12$ 22.27$ 23.05$ 23.61 24.03
0.18 17.94$ 19.25$ 20.10$ 20.68$ 21.12 21.45Intrinsic Value Per Share (end 1987) 6180821.65time consistent implied price 21.45Observed price 99.18$ Ke 0.180 g -0.25
Actual Price per share 99.18$
Overvalued > 114.06Undervalued < 84.30Fairly Valued Within 15%
129
Z-Score Analysis Z-Score = 2002 2003 2004 2005 2006 1.2 (Working Capital/Total Assets) 234546 78694 65891 -24487 303707 9459851 12416126 15502480 19271796 24308175 + 1.4 (Retained Earnings/Total Assets) 1427607 2445698 4017339 6516863 8898577 9459851 12416126 15502480 19271796 24308175 + 3.3 (EBIT/Total Assets) 898970 1922257 2663083 4206254 4009595 9459851 12416126 15502480 19271796 24308175 + 0.6 (Market Value of Equity/Book Value of Equity) 17837870 26357500 16936499 22713600 32875257 4535521 5883328 7298059 8730581 11117112 + 1.0 (Sales/Total Assets) 2559873 4190299 5332577 7584244 8288779 9459851 12416126 15502480 19271796 24308175 WEIGHTED 2002 2003 2004 2005 2006 0.0298 0.0076 0.0051 -0.0015 0.015 0.2113 0.276 0.3628 0.4734 0.5125 0.6359 0.6629 0.6125 0.7203 0.6751 2.3597 2.688 1.3924 1.5869 1.7743 0.2706 0.3375 0.344 0.3935 0.341
2002 2003 2004 2005 2006 2006 Z-Score 3.51 3.97 2.72 3.13 3.32 3.32
130
References
1. Apache Oil Corporation website: www.apachecorp.com
2006 Annual Report
2006 10-K
2. Independent Petroleum Association of America website: www.ipaa.org
3. Consumer Reports website: www.consumerreports.org
4. Wikipedia website: www.wikipedia.com
5. Encyclopedia website: www.encylopedia.com
6. Securities information website: www.secinfo.com
7. Investing Business Week website: www.investing.businessweek.com
8. CNN website: www.cnn.com
131