Why APA is Underperforming the Sector and Why That May Change

There are times when I look at the price and performance of a stock as compared to the performance of the underlying company and just scratch my head. That could be because momentum has pushed a price way too high, as happened a lot a couple of years ago with some of the so-called meme stocks, or it could be that a stubbornly low price seems to be completely detached from reality, as is the case right now with APA Corporation (APA).

Figure 1: APA 1-Year 1-Day Chart

One of the things I have learned over the last forty years of making a living from markets, though, is that, when that happens, it is far more likely that I have missed something than it is that the majority of smart, highly paid, and very well-informed institutional traders and investors have. I have therefore dug quite deep into why APA is trading at a 52-week low. There seem to be reasons, but none of them put me off buying the stock at these levels.

Following a great 2021 and 2022 when energy stocks played catch up after years of lagging the overall market the last year has been a bit disappointing for the sector. However, even in that context, APA has been a stinker…

Figure 2: XLE (blue body) versus APA (green line) 1-Year Chart

The question is why APA has underperformed and has kept heading lower, even as oil has bounced back a bit and most stocks in the sector have at least stabilized, if not actually recovered somewhat. One cannot know for sure, of course, but there seem to be two main reasons…

1: A Heavy Debt Load

APA, with a market cap of around $9 billion, carries $5.7 billion of debt on its balance sheet with a debt/equity ratio of 270.15%. Contrast that with the two largest US multinational oil companies, Exxon Mobil (XOM) and Chevron (CVX), whose debt to equity ratios are 19.6% and 12.4% respectively, and you get an idea why that might be seen as a problem.

One could, I suppose, argue that APA is different. It is less of a giant integrated oil firm and more of an E&P company, a part of the business that is typically more capital-intensive than others where borrowing to invest in reserves is quite normal. Even when compared to other E&P companies, though, APA’s debt load is substantial. Diamondback Energy (FANG), for example, has a debt-to-equity ratio of 38.4%, while Occidental (OXY)’s is 68.9%.

A company’s debt-to-equity ratio always matters to some extent, but when interest rates are rising, as they were for most of the last year, it is a real problem for traders and investors.

2: Multinational Exposure:

APA has plenty of exposure and business interests outside of the US. Most of the time, in a conventional analysis of APA, geographic diversification would be a positive, but right now the global economy is in a strange place. The US has remained strong while Japan has just confirmed its second straight quarter of negative GDP growth, which is still the definition of a recession for most people. Germany and other big economies look on track to follow Japan soon and the world’s biggest oil importer, China, is in the midst of a problem as a real estate bubble deflates. The feeling among investors seems to be that E&P companies more focused on the US market are better placed at the moment and they have outperformed APA as a result.

Both of the above are causes for concern to some extent, but I still believe that APA is undervalued at current levels.

First off, debt only really becomes a problem for any company when they struggle to service it, even if some long-term obligations come due and need to be refinanced at a higher rate. For APA, trailing twelve-month free cash flow runs at around $1.55 billion, or around 27% of their total debt. That puts them in a better position in some ways than, say FANG, who have $6.46 billion of debt and negative free cash flow.

Then there is the assumed trajectory of interest rates in America. “Higher for longer” has become a thing, but most economists, analysts, and traders believe that rates will come down again at some point, probably this year. That means that companies like APA that carry substantial debt have only a fairly short window of refinancing at significantly higher rates before the situation should improve.

As for multinational exposure, that too is a temporary issue. There is a reason that it is usually seen as a plus…because it smooths out volatility in the economic performance of individual countries. Even though not being as US-focused as some rivals is hurting APA now, it will be a benefit at some point in the future. That is how diversification as risk mitigation works.

So, what we are left with is a stock that is trading close to a 52-week low with trailing and forward P/Es below 10 and prospects that are more likely to improve than worsen. I don’t know about you, but that looks like a buy to me.