Anadarko Petroleum  recently announced the sale of a 10% stake in Mozambique Area1 to India's biggest energy explorer, ONGC Videsh. Let's find out why this sale is a strategic move by the company that could result in value creation for shareholders.

Cutting open the deal
Valued at $9.6 billion, the stake sold includes Prosperidade and Golfinho/Atum natural gas complexes, which are estimated to hold 35 to 65 trillion cubic feet of recoverable gas. Anadarko intends to use the sale proceeds to speed up the development of its assets in the Eagle Ford, Wattenberg and Permian and Powder River Basins. The objective of the capital allocation is to increase cash flow growth with relatively attractive well head margins in the blocks mentioned above. High cash flow will translate into shareholder value creation through increased dividends.

Let's have a look at some of the factors that make Anadarko an attractive investment opportunity.


Valuation
A useful tool to analyze the valuation of an oil drilling company is enterprise value to free cash flow (EV/FCF). The lower the ratio, the faster a company can pay back the cost of its acquisition or generate cash to reinvest in its business. Even after a 32% rise in its stock price in 2013, Anadarko's EV/FCF is lower than its major competitors, Occidental and EOG Resources. This suggests that Anadarko is trading at an attractive valuation compared to its peers.

Even in terms of price to cash flow, Anadarko looks most attractive compared to peers. A high cash flow is not completely discounted in the stock price and this strengthens the case for further upside in the stock. More importantly, robust cash flows add to valuation premiums in a capital-intensive business. The upside potential for Anadarko might therefore be significant.

 

APC

OXY

EOG

EV/FCF 54.4 75.9

NA*

P/S

3.4

3.1

3.5

P/B

2.1

1.8

3.2

P/CF

5.0

6.4

7.7

Source: Msn Money, Author's Calculations -- *FCF is negative for EOG Resources

I must mention here that Occidental has outperformed the industry average in terms of revenue growth year over year primarily because of a high output from the Permian Basin. The biggest disadvantage for Occidental is its exposure to the Middle East. The company has 35% of its business in the region. A high geopolitical risk coupled with conflicts has resulted in a continuous decline in oil prices in the region. This has affected the company's revenue and key margins. It will be interesting to see how the company deals with the rising risks. Amid these uncertainties for Occidental, Anadarko certainly seems to be a better investment option.

Proved and probable reserves are another strong indicator of future growth for an oil drilling company. As of December 2012, proved reserves for Anadarko were 2,506 million barrels of oil equivalent as compared to 2,422 MMBOE in 2010. For EOG Resources, proved reserves were relatively low at 1,811 MMBOE as of 2012. Anadarko therefore has a higher reserve life compared to EOG, and this makes it a better bet in terms of long-term revenue visibility.

Bottom line
In spite of a 32% rise in Anadarko's stock price in 2013, the company is still undervalued compared to its peers. Also, with the company's objective of strategically investing its capital in higher-margin assets, as discussed above, Anadarko can be considered as a good long-term investment opportunity.

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The article Should You Make a Bet on This Energy Giant? originally appeared on Fool.com.

Anjum Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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