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Sell Anadarko - Debt Load Is Much Worse Than Other Oil And Gas E&Ps

All oil & energy companies have high debts and low earnings and cash flow in the industry downturn, but some are worse than others.

Among the large E&P companies, Anadarko Petroleum (NYSE:APC) stands out as having a debt load that appears particularly onerous. It appears to be much worse than that of its competitors, such as Occidental Petroleum (NYSE:OXY), EOG Resources (NYSE:EOG), Pioneer Natural Resources (NYSE:PXD), Hess Corp. (NYSE:HES), and Cimarex Energy (NYSE:XEC).

Anadarko's Q2 2015 quarterly report revealed a total debt of $16.058 billion vs. stockholders' equity of $16.389 billion. This ratio of 0.98 is quite elevated and should be very concerning to investors.

Anadarko's Earnings Reports Disguise Debt Level

The debt/equity ratio is somewhat disguised in Anadarko's report, because the company chooses to provide its capitalization ratios in terms of total debt and total equity rather than stockholders' equity. This makes its debt/equity ratio appear as a less alarming 0.83 (the report presents it as 45% total debt and 55% total equity) to the reader who does not carefully examine every line of the balance sheet.

In fact, Anadarko only switched to this method of presenting its capitalization ratios in its Q4 2014 quarterly report. Prior to that, in its Q3 2014 quarterly report, Anadarko presented its capitalization ratios in terms of total debt and stockholders' equity. You can see the switch in these two condensed balance sheets:

Note that the "Total equity" balance sheet line did not even exist in Anadarko's Q3 2014 report. It was added to the Q4 2014 report, and it serves to make the Capitalization Ratio percentage on the Total debt line look smaller than it actually is under the standard calculation of debt and equity ratios.

The standard financial calculation of a company's debt/equity ratio is total debt to stockholders' equity, not total debt to total equity. This is why Anadarko's debt/equity ratio properly appears as 0.98 in sources of financial data.

It should be noted that Anadarko made this change during the period when the collapse of the oil price became most severe.

Anadarko's Debt/Equity Much Worse Than Other Oil & Gas E&P's

By comparison, here are the debt/equity ratios of some of Anadarko's major competitors among large-cap oil & gas E&P companies:

-Occidental Petroleum -- 0.25 -EOG Resources -- 0.37 -Pioneer Natural Resources -- 0.32 -Hess Corp. -- 0.28 -Cimarex Energy -- 0.36 To be fair, other competitors are in between these relatively low debt/equity levels and Anadarko's extremely high debt/equity level: ConocoPhillips (NYSE:COP) 0.50, Apache (NYSE:APA) 0.62, Noble (NYSE:NBL) 0.55, EQT (NYSE:EQT) 0.64, Marathon Oil (NYSE:MRO) 0.41. Devon Energy (NYSE:DVN) is pretty bad at 0.79, and Cabot Oil & Gas (NYSE:COG) is almost as bad as Anadarko's at 0.93. Continental Resources (NYSE:CLR) is even worse at 1.44, but Anadarko is over two and a half times larger than Continental and is a much bigger player in the industry. Among the biggest names most respected by investors in the E&P space, Anadarko's debt load clearly stands out as by far the worst of them all.

For the record, Anadarko's debt/equity ratio at the end of Q1 2015 was even worse, over the critical 100% level at 1.03. A bullish optimist would say that shows Anadarko at least improved its situation slightly from Q1 to Q2; the bearish view is that it's still extremely bad, and the fact that its debt/equity ratio ever exceeded 100% is cause for great concern. I take the bearish view; judge for yourself.

Out of all the large-cap companies on the stock market today, only two have a debt/equity ratio greater than 0.80 but negative earnings for the last twelve months and negative earnings forecast for the next twelve months: Anadarko and Sprint (NYSE:S). But Sprint stock is priced at a low valuation of 0.83 Price/Book, as it should be. Anadarko stock is still trading at a high valuation of 2.24 Price/Book. Such a valuation is entirely unjustified by Anadarko's financial data and its extreme debt levels.

Anadarko's 4.65 Debt/EBITDA Ratio Is Also Extremely High

Another financial metric of debt load by which Anadarko fares very poorly is its debt/EBITDA ratio. I examined Anadarko's last four quarterly reports to calculate its trailing twelve months EBITDA by removing the costs and expenses for interest expense, income tax expense, other taxes, and depreciation, depletion, and amortization from net income. By this method I calculate Anadarko's ttm EBITDA to be $3.449 billion. With the company's total debt of $16.058 billion, Anadarko has a debt/EBITDA ratio of 4.65.

Many analysts consider such a debt/EBITDA ratio in the 4-5 range to be very concerning; a ratio of 2 would indicate much better financial health. (See, for example, the article by Anthony Lerner on a site about troubled oil and gas companies.)

Anadarko Produces More Natural Gas Than Oil

In investigating the possible reasons behind Anadarko's extremely high debt levels, I found a strong correlation between high debt levels and the top producers of natural gas. As a group natural gas producing companies are carrying much heavier debt loads than oil producers. And it turns out that Anadarko produces more natural gas than oil.

Anadarko's latest quarterly operations report (Q2 2015) showed that it sold 2,354 MMcf/d (million cubic feet per day) of natural gas, which amounted to a total of 37 million BOE (barrel of oil equivalents) of natural gas in the quarter. At the same time the company sold 318 MBOPD (million barrels of oil per day), which amounted to a total of 29 million BOE of oil in the quarter. Within the continental U.S. (Lower 48), Anadarko's production was even more heavily tilted toward natural gas: 386,000 BOE of gas/day vs. 174,000 BOE of oil/day.

The natural gas price peaked a decade ago, at $15.50/MMBtu in December 2005. It never recovered after the Great Recession, only getting as high as $6.40 in February 2014. And the energy price collapse of the past year has brought the price all the way down to around $2.50.

This is one reason why the top U.S. natural gas producers have much worse debt problems than oil producers. Exxon Mobil (NYSE:XOM), the #1 U.S. gas producer, is relatively immune since natural gas makes up only a modest portion of its entire operation. But the next five names on the list all have a problem with very high debt/equity ratios: •Chesapeake Energy (NYSE:CHK) -- 1.96 •Anadarko -- 0.98 •Southwestern Energy (NYSE:SWN) -- 0.73 •Devon Energy -- 0.79 •Cabot Oil & Gas -- 0.93

The issue is, investors have rightfully sold off Chesapeake and Southwestern stock, lowering their prices over 65% since the end of August 2014, but investors have not recognized the extent of the problems at Anadarko, Cabot and Devon, with their stock prices down only 30%-40% over that time frame.

Watch The Upcoming Earnings Report

Anadarko's Q3 2015 quarterly report is due out in late October. Investors must examine it very carefully, in particular the total debt and stockholders' equity (not total equity) figures, to see what kind of financial shape Anadarko is in.

Actions to take: Bearish investors (such as myself), who see that energy stock prices have not yet fallen as much as they should have since the oil price collapse, may wish to focus on Anadarko as a target for short selling. More bullish energy investors betting on a quicker recovery may want to choose other stocks in the sector with lower debt levels. Investors may also hedge their bets on the direction of the oil price and the energy sector by going short Anadarko and long EOG, for example.

As I write, the oil price is temporarily back over $50/barrel and Anadarko's stock price is temporarily back over $70/share. If you own Anadarko stock, take advantage of this golden opportunity to sell at an inflated price, before the Q3 earnings report is released. It may be the last good chance you get to sell high.

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