In my last article, I made the case that energy stocks are cheap.  They are all selling at single-digit P/E's despite their massive sales and earnings growth.  With that in mind, I truly believe if you buy any low P/E energy stock today you will be rewarded.  (Or for safety, buy a basket of energy stocks or an energy index.)

I was talking with a fellow StokBlogs member the other day and he asked why I chose Apache Corporation (APA) over others like ConocoPhillips (COP) or even doubling up on Chesapeake Energy Corporation (CHK)?  Let me answer that here.

The first reason was because of an excellent article in the July 2006 edition of SmartMoney.  There was a section talking about Apache:

When energy giants such as BP or Exxon Mobil want to pull oil and gas out of the ground, they spend billions to develop giant fields, which they then tap for decades. Over time, however, the fields start producing less, and the giants don't want to keep spending their dough to suck out every last drop. Enter Houston-based Apache, the nation's No. 2 independent driller, which has made a killing by buying aging fields from bigger oil firms. Since 1992, the firm has averaged a 36% annual return on investment on wells it has acquired in the Gulf of Mexico. Part of Apache's success can be attributed to good management: The conservatively run company has one of the lowest debt loads in the industry and a return on equity of 28%. But the stock trades at a discount to its peers, punished by investors because Apache hasn't increased earnings per share as quickly as its more debt-laden rivals.

We think that's a mistake. Even though the company had to halt some Gulf production in the wake of last year's hurricanes, it still increased profit to $2.5 billion, or $7.84 a share, up from $1.7 billion, or $5.02 a share, in 2004. In April the firm bought 18 more Gulf fields from BP for $1.3 billion. Apache is paying $22 for every barrel of proven reserves in the fields, estimates Tom Covington, an oil analyst at A.G. Edwards. That's not a bad price considering oil is $70 a barrel. And unlike many oil companies, Apache doesn't have to worry about political instability, since most of its production comes from Australia, Canada and the U.S. What's more, Apache recently announced a stock buyback of up to 4.5% of its shares, or $1.1 billion worth. Yet the stock still trades at less than nine times expected 2006 earnings of $8.18 a share, compared with a P/E of 12 for the average oil-exploration firm. And even if oil prices fall, Apache has some protection - the company uses hedging strategies such as futures contracts to lock in today's high prices.

Basically APA grew their earnings last year despite a major setback in their Gulf of Mexico production.  In other words, in a normal year their earnings would be even higher.  Combine that with a share buyback program and you have an extra margin of safety than some of the other oil stocks.

But most important, I also did some number crunching and discovered APA is significantly more undervalued than its peers according to reserves numbers.  That shall be the subject of my next article...

Finally, I still like CHK a lot.  The reason I didn't double up on CHK is simply because I wanted to diversify my energy holdings a bit.