Friday, August 29, 2008

Screen Result No. 4: Anadarko Petroleum

Today is the last installment in my value screen series. If you're just tuning in, check back over this week's posts or ask to borrow a classmate's notes. We've covered three opportunities so far.

Today is the fourth. The last company that met my screen is Anadarko Petroleum.

Its shares are currently selling for about 29 times earnings, the highest multiple in our screen and indeed higher than the S&P 500 overall. They've declined 5.3% % in price since the beginning of the year, though when I ran the screen they'd fallen about 10%. and are trading at about 1.75 times their book value, at a market cap of $29 billion.

Anadarko drills and produces oil and natural gas. It has made a huge bet on natural-gas production with a $23.3 billion acquisitions of Kerr-McGee and Western Gas in 2006. It also has significant deep-water operations in the Gulf of Mexico, where its rigs are scheduled through 2013. The company has 2.4 billion barrels of proven reserves and nearly nine trillion cubic feet of gas.

The company is expected to sell about 210 million barrels of oil this year, though it will add about 225 million barrels to its hoard, partly from some successful finds in Utah's Uinta Basin. This will mean a net gain in reserves. Though about 85% of its wells are right in the U.S. of A, Anadarko has an international footprint, mostly in Algeria. It does, however, also own 28% of the very promising "Jubilee" field in Ghana, which is likely to contain 1.45 billion barrels. Exploration is expanding to nearby Sierra Leone.

Anadarko is the oil business' juggling act. It engineered a massive one-two punch acquisition, and it since has been offloading assets for cash and repositioning its financial footing. Some of those assets are being transferred to a master limited partnership, a separate entity that will generate cash for its owners until the wells literally run dry. With so many balls in the air, this is sort of a rebuilding year for the company, and another is likely in the offing. But Anadarko is certainly benefiting from high oil prices, and though its per barrel finding costs are a little higher than the industry average, it still operates at a higher operating margin than many of its peers. Anadarko is something forgotten amid the ExxonMobils and the Diamond Offshores, but it's a good company that makes a lot of money -- $3.78 billion last year.

The best news of all is that Anadarko just announced a buyback totaling $5 billion. That's a major deal that can seriously alter the company's earnings calculations. I've mentioned buybacks in passing before, so I thought I'd explicitly review what this one means:

Anadarko has 465 million shares outstanding. It's going to buy back 18% of them and basically cancel them. This will reduce the number of shares out to about 380 million.

Now, earnings per share are computed by dividing net profit by the number of shares outstanding. So, say we assume 2008 earnings will be $1.535 billion. If we divide that by 465 million shares, we get earnings of $3.30 per share.

But if we divide that same profit by the reduced 380 million shares, we get $4.04. Same exact profit, but fewer shares to spread it over. Given a constant earnings multiple, reducing the number of shares by 18% actually raises EPS by 22.4%. That should, in turn, raise the price a commensurate amount.

This is a great use of the company's cash. In fact, I'm awarding chairman and CEO Jim Hackett with a pair of Brass Umlauts. He joins Merrill Lynch's John Thain and Harvard Management Company in the hallowed halls of the Order of the Umlaut, my hunble honor for executives who show serious spheres in the management of their companies.

. OK, so let's look at our questions:

How have earnings per share fared over time?
They've certainly been on the upswing: EPS was 45 cents in 1997. Ten years later it was an astonishing $8.08.

Is that likely to continue?
No. And in fact 2008 results are likely going to come in at less than half of that; 2009 earnings will be a little better, at about $5.80. However, if we assume the buyback is completed by then, then EPS will be $7.03.

What is the current earnings multiple?
The current PE is 29.

Where will the multiple be in two years?
Believe it or not, 8 to 10 is typical based on historical average annual PE data. I'm not willing to forecast anything higher than 12.

Given the earnings estimates and PE predictions, what will the fair market value of the stock be for 2009?
12 times $7.03 is within shouting distance of $90. (You'll note I reworded that question for a one-year window; we've projected two years for previous companies.)

Am I willing to accept the risk/reward this potential return represents?
Yes. Shares are at $62. The one-year return could reach 45%, and that's significantly more than I think one can reasonably expect from the broader market. Anadarko is in a volatile industry, yes, but it's a still a stable, $30 billion enterprise with smart management and strong financials.

In conclusion:

I'm buying American Eagle, Anadarko and Best Buy at today's close and will track them with the rest of the "Deep Discount" picks. I'm passing on Valero.

Have a good holiday, and, as always, many happy returns.

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