Callon Acquisition Boosts Synergies, Yet Analysts Forecast Shrinking Margins And Earnings Uncertainty

Key Takeaways

• Enhanced capital efficiency and operational improvements from the Callon acquisition are expected to significantly reduce costs and increase net margins.
  
• Strong performance in Egypt and higher natural gas and NGL production in the U.S. are set to bolster revenue and profit margins.
  
• The company's financial performance is heavily dependent on the successful integration of Callon and operational efficiencies, amid challenges in production, capital expenditure, and market volatility.

Catalysts

An independent energy company, explores for, develops, and produces natural gas, crude oil, and natural gas liquids.

• The Callon acquisition has led to an increase in estimated annual Callon cost synergies from $225 million to $250 million, driven by economies of scale, which is expected to enhance capital efficiency and reduce overall operational costs, positively impacting net margins.
  
• Improved well performance and capital efficiency in the Callon acreage, due to operational changes such as drilling unit design, are anticipated, with preliminary estimates suggesting drilling a standardized 2-mile lateral for roughly $1 million less than previously, enhancing earnings through reduced capital expenditure.
  
• Enhanced cash flow sensitivity in the U.S., with a $5 per barrel change in oil price now resulting in approximately $300 million annually, potentially increasing revenue and providing leverage for growth in a favorable oil price environment.
  
• Strong performance in Egypt with new wells and improved base production, along with the implementation of new water injection projects, is likely to sustain volumes and support continued production efficiency, contributing to steady international revenue streams.
  
• The expectation of higher natural gas and NGL production in the U.S. driven by fewer discretionary curtailments, coupled with income growth from third-party oil and gas purchased and sold by $120 million to around $350 million, is poised to bolster overall revenue and profit margins.

Assumptions

• Analysts are assuming APA's revenue will grow by 2.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 32.6% today to 0.2% in 3 years time.
• Analysts expect earnings to reach $1.5 billion (and earnings per share of $4.35) by about August 2027, down from $2.9 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $2.4 billion in earnings, and the most bearish expecting $1.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.0x on those 2027 earnings, up from 3.6x today. This future PE is greater than the current PE for the US Oil and Gas industry at 10.2x.
• Analysts expect the number of shares outstanding to grow by 20.39% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 8.46%, as per the Simply Wall St company report.

Risks

• High reliance on the success of the Callon acquisition integration and operational efficiency improvements could lead to financial underperformance if these synergies and cost savings do not materialize as expected, potentially impacting net income and earnings.
  
• Reduction in the Egyptian drilling rig count might not adequately sustain production levels, which could lead to a decline in international oil revenues despite current operational improvements and cost efficiencies.
  
• Potential for increased discretionary curtailments in natural gas and NGL production in the U.S., particularly related to Permian Basin operations, which could negatively impact revenue and margins due to volatile Waha gas price differentials.
  
• Elevated capital expenditure ($2.7 billion guidance with a potential decrease) amidst efforts to generate higher free cash flow in the second half of the year. If not managed effectively, it could negatively impact the company's financial leverage and ability to reduce debt.
  
• The future trajectory of APA’s share price could be adversely affected by the increased sensitivity to oil price fluctuations, given the company’s expanded exposure to oil production post the Callon transaction, potentially impacting cash flow and profitability in a volatile oil market.

Valuation

• The analysts have a consensus price target of $38.28 for APA based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $57.0, and the most bearish reporting a price target of just $28.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $9.7 billion, earnings will come to $1.5 billion, and it would be trading on a PE ratio of 21.0x, assuming you use a discount rate of 8.5%.
  
• Given the current share price of $27.92, the analyst's price target of $38.28 is 27.1% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.