The Short Case for Apache Corp.

As I continue to believe that the downtrend is in for crude prices, I am still looking for opportunities on the short side in the oil patch. On September 28th, I put on my first short in the portfolio in National Oilwell Varco (NOV). Since then the market has taken this stock down (though it is bouncing higher over the last few days).

My newest oil addition to the short side is Apache Corp (APA). I believe that the market is incorrect in its pricing assumptions for both natural gas and crude oil. I am holding $57 and $52 for the first two quarters of next year for crude respectively and $7 and $6 for natural gas for those same two quarters. This would shave nearly $1.50 per share from APA’s earnings giving the company a negative growth rate year over year into 2007.

Fundamentals Story
As I mentioned, the story here is the expectation as to where crude prices will be in the next 6 to 9 months. I believe they will be lower while the analyst community believes that they will be higher. According to Yahoo, Apache is expected to earn 7.95 in 2006 and 8.66 in 2007. I believe that these numbers are way off.

I think APA will post earnings of $7.55 in 2006 (implying downside to the fourth quarter earnings and $7.18 in 2007 – also another level much lower than the market thanks to the fall off in energy prices.) I think there could be more risk to earnings if the market starts to see a lack of profitability in certain projects as participants cut back on funding thanks to falling levels in crude and Natural gas. Overall, the fundamental model argues for a short position.

Economic Impact
The economic model that I use for the NRG side of the market does not seem to impact APA much. If there is a downturn in rates, APA corrects but does not outright break down like NOV and others do in the patch. In short, what the crude and natural gas markets do, dictates the direction of APA. In past downturns over the last 15 years, APA has corrected with the downturn but normally about one third the previous move. So if that is the case with the current trade, the stock could trade back towards $45-$50 before support. Overall, the economic model argues for a short position.

Technicals
The DM sell trend started to move up a few months ago and while not aggressively moving up, it is still in play and supports as short position. There weren't bearish candle formations for this stock when it was trading in the 70’s earlier this year so the overall trend in this case is dictated by the direction of the DM trends.

Looking short term, the stock is trading up to its 65 week moving average today which is one reason I am a seller (thinking it will not get above this level). There is a double bottom in play, though, which could argue for the bull’s side of the equation and send the stock to the top of the range near $72. Since I think the trend for both NRG products is lower, I do not believe this will occur. Also the DM sell trend on this shorter term chart is still in control, with the buy trend far from turning bullish. Overall, the technicals argue for a short position.

Sentiment
Apache has seen mostly upgrades lately from assorted brokers. Lehman was the latest in early October upgrading the stock from the 63 area. They actually had downgraded last February from 68 so they locked in a modest gain. They also upgraded it in August of 2005 from 71 so the trading around their calls has not been very helpful.

As for other opinions, there were four initiations from the summer with 3 of them being neutral (seems like nobody wants to take a stand). From a short interest perspective, currently 2% of the float is short (according to shortsqueeze.com). 77% of the stock is held by institutions so support is to the buy side here. Overall, I would classify the crowd as bullish on APA which is supportive to my short story.

Summary
The 4 tier model supports my action to short Apache for my MIR 2 portfolio. Given the strong sentiment underneath this stock, an earnings miss could lead to a swift break in the price. Since the selling pressure has not been dramatic though and the analyst community is not exactly falling over itself to make a call either way, I expect this to take a while to make some gains.

One risk to this call obviously is that oil prices break the downtrend and have a big fall. Also natural gas prices appear to have found some sort of support. If this support continues, $8 per contract may be seen in the months ahead though as I argued earlier in the day, the trend is not a strong one.

APA vs. NOV 1-yr chart:

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