I'm Making a Contrarian Bet on Energy With This Undervalued Name
Here's how I've strategically taken a position in a mid-cap E&P concern.
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The energy sector has been an market underperformer over the past six months as oil prices have moved down to below $70 a barrel. Being an innate contrarian, energy has been one of the few parts of the market I have been increasing exposure to within my portfolio. It is also one of the few areas I am finding relative bargains within an overbought market.
As I mentioned in my column on Wednesday, I have just initiated a starter position in APA Corp. APA, a mid-cap oil & gas exploration and production concern previously known as Apache Corp. Today, I'll discuss how to play this name using a covered call strategy.
APA has oil and gas producing operations in the United States, Egypt, and North Sea as well as other assets in Suriname and Uruguay. The company’s daily production is approximately 400,000 barrels of oil equivalent (BOE).
Other than being a contrarian bet, there are several things to like about the renamed Apache. First of all, APA has a well-covered dividend payout that yields nearly 4.5% on an annual basis. The stock is down nearly 40% year to date on the pullback in oil and natural gas prices. In my view, a lot of bad news appears to be priced into the shares at this level when the equity seems to be trying to find a floor.
APA recently raised its expected annual synergies from its acquisition of Callon Petroleum to $250 million from $150 million. In September, the company announced a deal to sell off some non-core producing properties in the Permian Basin for about $950 million. This will reduce production by approximately 21,000 BOE per day but the proceeds will be utilized to pay down the debt incurred during the Callon acquisition, which closed earlier this year.
In addition, APA's joint venture in Suriname is estimated to have 700M to 800M BOE in reserves and the first production should come online sometime in 2028.
The stock is quite cheap trading at five times trailing earnings per share and with a forward P/E multiple of 6x. The stock trades just under $22.50 a share, but it feels like it should at least trade in the high $20s.
The company has a market cap of approximately $8.4 billion and an enterprise value of just under $15 billion. APA threw off around $220 million in free cash flow in the recently completed quarter.
Option Strategy
Here is how one can initiate a position in APA utilizing a covered call strategy. Covered call orders involve buying an equity and simultaneously selling just out of the money call strikes against the new position.
Selecting the June $22.50 call strikes, fashion a covered call order with a net debit in the $19.45 to $19.55 a share range (net stock price - option premium). Liquidity is quite solid with the options against this equity.
This strategy provides downside protection of around 15% over the trade’s duration, which includes two quarterly dividend payouts of $0.25 cents a share.
This strategy also provides return potential of approximately 18%, including dividends, even if the stock trades roughly flat over the next seven months.
At the time of publication, Jensen was long APA.
