Time to Buy Anadarko

NEW YORK (TheStreet) -- In December, Anadarko Petroleum's (APC) Kerr-McGee unit was held liable for billions of dollars of environmental claims and liabilities related to the 2005 spinoff of Tronox (TROX). According to the ruling, the energy firm could end up paying between $5.15 billion and $14.17 billion in environmental cleanup costs. The amount, even at its low end, is considerably higher than market's or Anadarko's expectations.

Following this revelation, Anadarko's shares plummeted and have still not fully recovered. Anadarko shares were at $79.32 at market close on New Year's Eve, and will likely remain under pressure in the coming months. This could translate into a buying opportunity for long-term investors because the company's outlook over the next several years is still positive. Moreover, in these challenging times, the business will likely increase its dividend and buyback expenditure to encourage shareholder confidence.

Tronox is a small-cap company that makes paint materials. Spun off from Kerr-McGee in 2005, Tronox became associated with Anadarko when the oil firm acquired Kerr-McGee in 2006. Tronox filed for bankruptcy in 2009 and emerged from it in early 2011.

As part of the bankruptcy proceedings, Tronox and the government sued Kerr-McGee for fraudulently transferring massive pre-existing environmental liabilities to Tronox and its shareholders.

The markets were expecting an estimated $2.5 billion fine to Anadarko. The energy firm itself was expecting even less; the business had set aside around $525 million as reserves. Therefore, the enormous sum mentioned in the ruling came as a shock to shareholders. Anadarko's shares dropped by more than 6% on Dec. 13. Shares of Tronox gained 6.5% on the same day.

As expected, Anadarko has said that it strongly disagrees with the verdict and will likely file an appeal against the decision. It will take several months before the verdict and environmental costs are finalized; the case could drag on through 2016. Citigroup thinks that the companies should reach a settlement of between $5 billion and $8 billion.

Judging from the ruling and Citigroup's recommendation, it appears that a $5 billion payout is something close to a best-case scenario right now. Even that, however, is significant for Anadarko, which had annual net income of $2.4 billion in 2012. The massive potential payout dwarfs that amount. The company's current cash reserves of nearly $4 billion are significantly less than the estimated environmental cleanup costs.

Moreover, the recent downward trend in oil prices may have an adverse impact on Anadarko's cash flow. That would seriously hurt investor confidence.

In the worst case scenario, Anadarko would be slapped with a fine of more than $10 billion. Then the business might have to tap its $5 billion line of credit, as well as sell some its less lucrative emerging-market assets in Mozambique and Brazil that are worth nearly $18 billion.

At this point, two things are fairly certain. First, although Anadarko's reserves and profits are under no immediate threat from the litigation, in the next several years the business will take a serious hit.

Second, we have learned from BP's (BP) enormous environmental disaster and lengthy litigation that the oil company's shares will likely remain under pressure until the liabilities and claims are finalized.

This is the primary reason why Anadarko's shares have not fully recovered. Before the ruling, the company's shares were hovering around $84. Since then, the stock has remained below the $80 barrier.

Anadarko shares will likely remain under pressure. They could fall even lower on any negative news.

On the other hand, this could turn into a buying opportunity for a long-term position in Anadarko Petroleum.

Although these massive environmental costs will be a big setback for Anadarko, the lawsuit is a short-term, one-off event which will be over within three years. The business has ample resources that can cover the potential payout. The long term outlook of the company beyond the next three years is still positive. The business is the biggest player at Eagle Ford and has impressive international properties that could continue to fuel growth.

Anadarko has not been known as a high-yield stock. Currently, the business gives a below-average yield of just 0.9%. Given that Anadarko is not short of resources, the company could work on rewarding shareholders by pumping up its dividend and buyback expenditure. This could go a long way toward restoring shareholder confidence. A similar move was also taken by BP, which continues to reward shareholders by offering a yield of more than 4.5%.

At the time of publication the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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